Institutional Actors

 “There is a mismatch between sources and uses of capital. In other parts of the world, for businesses to scale that are selling products that people want, not need, a more traditional funding cycle is appropriate. Whereas we are building businesses that people need, more than want. And this takes much longer. This inherent disconnect causes so many issues.” - interviewee

 Scaling, without the usual capital scalers

Emerging market innovations require highly risk-tolerant, patient capital. Entrepreneurs are often attempting to build entirely new business models to serve consumers coming into the formal economy for the first time, and do so under variable and sometimes volatile macro conditions. Patient capital helps the most promising companies not lose momentum or sell short just when they are hitting their stride.

Blended finance seeks to de-risk potential investments in such a way that private sector investors will feel comfortable investing alongside or on top. 

Impact investors Omidyar Network call investments in ventures serving lower-income populations “frontier capital”, which they divide into three segments: 

• ‘Replicate and adapt’ - Proven business models, where the bulk of existing VC money is already flowing. What unites businesses in this segment is that the de-risking and proof of concept were achieved elsewhere with someone else’s money. Since these companies have much more predictable returns - and involve far less trial and error than their ‘frontier’ counterparts - there is typically much more financing available to them.

• ‘Frontier’ - Unproven business models that are asset light and serve both low- and middle-income populations. This segment represents under-tapped opportunity that can be unlocked using conventional VC structures. 

• ‘Frontier plus’ - Unproven business models that may be asset intensive, serve only lower- income groups, and/or operate in countries with less developed capital markets. This segment requires investors to be more creative with the tools they use, but offers tremendous impact potential. 

Improved strategic coordination amongst investors on the continent would enable investors to leverage a blended finance approach to increase the adoption of the latter two models. 

Private, impact and philanthropic funding all have a role to play to support commercial scaling, but how to make the most of each - individually and collectively - remains unclear. Development finance and philanthropic funding should be structured and coordinated to mobilise private capital flows to emerging and frontier markets, especially for earlier stage ventures. This would free up ‘replicate and adapt’ capital that can be reinvested in scale-ups.

Frank Aswani, Chief Executive of the African Venture Philanthropy Alliance (AVPA), suggests Africans need to reassess what he calls an “old-fashioned approach to problem-solving” which he says is still rooted in the idea that social financing challenges can only be solved by grant funding rather than sustainable investment.

Because of the unique African operating context (in which most ventures create products and services people need, rather than want), many startup business opportunities in Africa have a social impact, often a direct one. Given that there’s plenty of early-stage development and philanthropic funding available on the continent, some ventures pursue an impact investment funding route, rather than a commercial one, and end up with unsustainable business models that are reliant on donor funding. It’s possible that such ventures would have commercially scaled had the business model been commercial to begin with, and that the model is throttling scale up potential rather than increasing it.

“I think impact investors also play a controversial role. I think sometimes in optimising for impact first, you end up with businesses that are not commercially viable and are reliant on development funding and grant capital to stay alive, and it allows for business models that don't work to proliferate.” - interviewee

We heard feedback in our interviews suggesting that impact investors should focus more on verticals where really innovative solutions are needed and where their investments will add significant social value (such as water and sanitation), rather than competing with traditional VCs in areas such as agritech, edtech and healthtech. We note though that this feedback came from VCs rather than impact investors, and fails to acknowledge the big difference between the two sources of funding: unlike venture capital, impact investment capital is generally patient capital, and synced into the (more mature) social entrepreneurship ecosystem, which is one that provides significant support to scale-ups beyond supply of capital, and is better coordinated than the commercial scaling one. 

Whilst impact investors by definition have a commitment toward ecosystem development, more generally how this manifests itself could be far clearer, with greater coherence and coordination related to some of the potential activities we have proposed in our intended roadmapped planning. 

The role of blended finance to help plug the SDG financing gap involves leveraging low-cost funding via multilateral development banks and overseas development assistance (i.e. grant funding).  It has been suggested that far more effort is needed to capacitate African national and regional development banks to mobilise public and private investment for structural transformation. Governments are being encouraged to establish innovation funds as a critical investment vehicle to de-risk, catalyse, and crowd-in investment and commitment from the private sector and donor community into the tech startup ecosystem. By way of example, the Rwanda Innovation Fund was formulated to support local innovation, supported by a concessional loan from the AfDB. 

Africa has a lot of development banks: there are 95 of them (many small and undercapitalised), representing 21% of national and regional banks worldwide. However, only a handful dominate assets and financing, with African development banks collectively accounting for only 1% of development bank assets worldwide. African countries should rapidly raise the capitalisation of their development banks to enable higher levels of lending. But this is difficult to do when public debt in sub-Saharan Africa is at a two-decade high and viewed as unsustainable by ratings agencies and multilateral finance institutions. 

Ecosystem “fund of funds” models are also increasing in Africa, another encouraging development. 

• AfricaGrow, which is domiciled in Germany and is a $200m joint venture between AllianzGI and the German finance institution subsidiary, aims to finance 150 innovative SMEs and startups. Promoting sustainable economic and social development, the fund aims to create more than 25,000 new jobs by 2030. The basic notion of Government crowding-in to provide the necessary risk capital to VC funds in the ecosystem, which then invest in startups and scale-ups, will be increasingly important, especially in countries that have underdeveloped VC investment.

• UNDP’s Regional Bureau for Africa’s timbuktoo initiative - currently in development - is designed as a private sector-facing initiative that supports the tech startup economy through mobilising $1bn over 10 years (through partnerships between the public and private sector) in order to achieve 1,000 scale-ups, 100 million livelihoods impacted, and a 10X return, or the generation of $10bn of economic value. One of the initiative’s three priority areas is to close the gap between early-stage risk capital at pre-seed and seed stage, up to Series B, and encourage domestic VC industries.

The UNDP initiative envisages a parent fund (made up of catalytic capital partners such as governments, foundations and donor partners) which will invest first loss/ guarantee capital to incentivise follow-on commercial capital investment. Importantly, its vision considers how finance works alongside networked innovation hubs. Any scope to bridge partnerships with corporates and universities, develop vertical/ sector expertise, whilst trying to address the strengthening of  innovation infrastructure, is certainly welcomed. 

It has been suggested by the Center for Strategic and International Studies (CSIS) that, to maximise the reach of blended finance to support venture growth, donors should: 

• Incorporate flexibility;

• Map the investment ecosystem;

• Develop a methodology to identify areas of investment;

• Work with local markets; and 

• Engage in investment facilitation. 

CSIS proposes that efforts in this regard should be open, participatory, accessible, collaborative, consistent, and consultative: “Going forward, DFIs and other development actors should establish a common framework that reflects their foremost role as development institutions—prioritising early, higher-risk lending opportunities that can shape emerging markets and expand future access to private capital. They should establish a framework for understanding de-risking opportunities, weighing the financial and administrative capacities of a given SME with the potential for sustainable returns and greater market development.” We agree entirely.

Due to their market dominance, corporates like banks and mobile network operators are the gatekeepers to key industries and markets in Africa. Over recent decades, they have invested in building infrastructure, capital, and expertise that can be crucially leveraged by most startups and investors that are looking to start out or enter a new market. Partnerships between startups and corporates often hold the key to the market access that startups struggle with. 

In a 2017 BCG report, results from a survey of more than 400 US-based deep-technology startups - which, it must be noted, do not have the same socio-economic macro constraints that African startups face - indicated that the main reasons for partnering with corporates were to gain: 

• Market access (43 percent);

• Technical knowledge and expertise (26 percent); and

• Business knowledge and expertise (19 percent). 

But, equally, scale-ups are home to the innovation into which corporates need to tap. According to another BCG report, to be most effective, corporate venturing needs to be part of an overall corporate innovation approach that clarifies how innovation tools complement the traditional R&D function, as described in Figure 53. Each tool is geared toward one or more of the various types of innovation (process, product, service, and business model) and for different effects (either disruptive or incremental) and can accelerate innovation faster than traditional corporate R&D.

Corporate innovators have the opportunity to redesign and restructure their approaches between startups and corporates more generally: HYBR’s African Innovation Paradigm report for Thomson Reuters (available on request) covered this very subject area some years ago.  Our review of international academic literature on the subject reveals that, in the US market, the corporate venture capital (CVC) model encourages the growth of innovative firms and innovation generally, and is certainly to be encouraged.

In 2020, global CVC funding soared to an all-time high of $73bn, increasing 24 percent from 2019. GV (formerly Google Ventures), Salesforce Ventures, and Intel Capital topped the list of most active CVCs. Some of these CVCs have already made investments into African startups or those operating across Africa. For example, GV has previously backed Zipline and Tala, while Salesforce Ventures counts Andela and Samasource as portfolio companies.

Within Africa, South African corporate giants have led the way, with Standard Bank, Naspers and Nedbank setting up CVC arms in the last 5 years. Nigeria’s major corporates, on the other hand, are yet to show interest in CVC, and Nigeria’s leading scale-ups have found more success raising from US and Chinese corporations, including Visa, Mastercard, and Tencent. Given its nascency, there is still some distrust within the ecosystem on the effectiveness of CVC. Increased success cases will help to change minds. 

“There are other toxic influencers - for example, a lot of banks run accelerators and then say to the venture that they have to do business with the bank. Which means the entrepreneur goes through an 18 month procurement process, and that’s going to cost you a lot of time, it's going to cost you a lot of money, plus you're not focused on your business. They're probably not going to pay you any money anyway.” - interviewee

The lack of trust applies to both sides of the relationship spectrum. Historically, many African corporates have been cagey and defensive in their relationship with startups, particularly because of the fear that allowing startups free rein might hurt their businesses. As a result, they have often stacked odds against new entrants or tried to compete by launching copycat solutions. A case in point is the ongoing dispute in Senegal between Wave and Orange. 

A recent report by the Tony Blair Institute for Global Change suggested that Governments can help encourage corporates to invest by enacting regulations that increase the capacity of corporations to allocate assets to private-equity and VC firms. 

• In Nigeria, legislation has enabled banks to collaborate with other VCs to set up their own corporate VC arm. Furthermore, embedding tech startup financing as a core component of corporate social responsibility for companies, and reviewing the codes and standards that govern these investments would be beneficial. 

• In South Africa, incentives for doing so are already baked into the regulatory framework for broad-based black economic empowerment (B-BBEE). Unfortunately, the B-BBEE structure is compliance- rather than impact-driven, and encourages corporates to treat B-BBEE as a corporate tax, rather than as a corporate incentive in respect of which value is based on impact rather than amount spent, as should be the case. It’s no surprise that inequality and unemployment rates in South Africa have increased since enactment of the B-BBEE laws, contrary to the purpose and spirit of the legislation.

Peter Kisadha, Principal at Future Africa, believes that a fundamental rethink is needed. He suggests that, to date, most of Africa’s large corporates still have a vague appreciation of the value that can come from investing in younger, more innovative companies. He says that “they are wedded to their traditional performance metrics and lines of business and therefore find it hard to appreciate the strategic value of investing in startups”. He suggests that developing CVC requires a significant change in the company’s structure to build talent, expertise, and relationships in order to generate deal flow.

Smarter collaborative partnerships are needed. Peter continues that corporates should be able to leverage the expertise of experienced VCs without internally altering their operational structure or setting up a new unit. They would maintain direct access to the companies that their investment partners invest in, which they can exploit for strategic purposes. For example, when Imperial Venture Fund made an investment in Kenyan logistics startup Lori Systems, Mohammed Akoojee, the Group CEO of Imperial, noted that the investment would “enable the creation of further business opportunities in Africa and provide efficiency for Imperial’s clients and transport operators with whom we collaborate.” 

Aligning culture is key, and programmatic approaches can consider appropriate design models to draw in new partnership, especially syndicated models of innovation, which bring in non-competitive interests for mutual reciprocal gains.

Robust systematic processes are needed to identify, and accordingly support, high potential ventures. From a scaling perspective, efforts should be underpinned by gaining a clear understanding of what corporate clients and programme sponsors actually need. Through a corporate lens, methodological approaches should consider:  

• Fully understanding the business problem, market landscape, and reviewing existing networks, likely with a long potential partner list and considered engagement framework;

• Screening and selection criteria for ventures and prospective partners;

• Inclusive weighted partnership assessment framework(s) and a solid value proposition to target venture segments; 

• Jointly prioritising partners to progress with a 360 degrees blended approach to quickly evaluate ventures;

• Strong venture onboarding programmes; 

• Clearly defined “end of programme” benefits, expectations and success criteria are critical factors - including what the venture will actually take away from participating in a programme (specifically funding, partnerships, commercial contracts); and

• Defined guidelines for business stakeholders (internal and external) alongside systematic processes to support the ventures and properly bridge the venture/ corporate divide.

Public financing support schemes (such as government export programmes, loans and guarantees) to support innovation scaling activities are rare in Africa. Whilst donor funding is available, capital injections to social enterprises are small. Commercial scaling ventures need a very different treatment.

Institutional investors (including pension funds, sovereign wealth funds and insurance companies) should be the critical support actors during the scaling phase. African sovereign wealth funds are tilapia in comparison to the giant funds of the Middle East, as proven by the fact they only contributed 1 percent of their funding to tech startups between 2014-2020. 

The International Forum of Sovereign Wealth Funds and Franklin Templeton recently grouped the key challenges for Africa’s sovereign wealth funds into three areas, namely governance, social impact, and environment:

• Governance. For Africa’s sovereign wealth funds, robust, independent governance is key to attracting private capital. Most of the funds on the continent are established as independent, professional institutions that have boards consisting largely of non-government directors. For sovereign wealth funds seeking private sector co-investment, it is essential that international private investors see them as peers, with aligned interests. Similarly, independence and transparency are essential to building public trust, particularly in countries where the perception of government institutions is largely unfavourable.

• Social impact. African sovereign wealth funds must ensure that they have a material, and measurable, impact on the lives of their people. This builds legitimacy at home, an imperative that has become more important as a result of the COVID-19 pandemic. Much of this work is in the largely unseen world of market-making – creating financing providers such as insurers, mortgage lenders and import export financing. 

• Environment. Some African sovereign wealth funds are seeking to crowd in foreign capital by putting in place environmental, social and governance (ESG) frameworks, or by aligning their investment strategy with the United Nations’ SDGs. Such approaches are not very popular on the continent. A common perception of climate change, for example, was that it was “a way for the West to keep Africa subjugated”. Yet the problems caused by climate change, such as food and energy security (which in turn can drive conflict, migration and poverty), have a direct impact on the everyday lives of citizens. 

Their report points to the need for sovereign wealth funds to improve collaboration, which they recognise is insufficient. Whilst there are currently moves to enhance pan-African sovereign wealth fund cooperation, greater leadership is clearly necessary. Exploring an innovation programme design to unlock avenues would be advantageous.