Evaluating African Startups from a Mainstream Perspective

Data from VC4Africa’s new Venture Finance in Africa 2016 report shows that venture capital funding and angel investments secured by the 462 African ventures tracked has more than doubled from $27 million last year to $73 million.  – Yomi Kazeem, Quartz Africa

It’s common knowledge to many that Africa is witnessing a revolution of sorts in entrepreneurial and startup activity. The continent has garnered the attention of businesspeople and techies alike for its vast – yet largely untapped – resources for innovation.

A rudimentary evaluation of African startup investment trends shows a rather drastic upward trend in funds invested. Initially, this seems to be a promising development for prospective entrepreneurs, even if certain unknowns remain.

This article evaluates African startups from an investor perspective by applying a sort of “litmus test” that many who hold the funds often insist upon, evaluating current investment activity while identifying and attempting to explain investment patterns.

An Investor’s Perspective

office workerOutside of charitable giving – which often has noble and selfless intentions – most investors are concerned with return on investment (ROI). Many financiers are businessmen and businesswomen who remain “neutral” in their approach and are ultimately concerned about profitability, both for themselves and the operations that seek their resources.

In order to make rational and profitable decisions, investors often apply a type of litmus test – an analysis evaluating both internal and external factors that every for-profit venture must contend with. Investment factors one may consider are numerous, but most frameworks of this type have four common denominators:

  1. State of marketplace: Is there enough demand to support operations?
  1. Entrepreneurial resources: Are entrepreneurs supported, and how?
  1. Economic stability: What is the state of the economy in the country or region?
  1. Risk/reward: Given the perceived amount of risk, what can we potentially gain?

By no means is this an exhaustive list, but one could reasonably make most investment decisions by carefully addressing such questions.

Africa’s Litmus Test

Africa is among the most diverse places on the globe in terms of economics, demographics, infrastructure, and so forth. Some countries in Africa (e.g. Nigeria, South Africa, Egypt) are quite advanced, while other African countries remain chronically underdeveloped.

It should come as no surprise, then, that the more-developed parts of Africa collect disproportionate amounts of startup funding. This analysis focuses exclusively on these areas. For reasons of simplicity, the aforementioned litmus test will be applied.

State of Marketplace

Africa is home to one of the fastest-growing middle classes in the world. Economics  suggests that when income rises, so does consumption – a vitally-important factor for potential investors.

Disposable income – funds available after meeting obligations – is necessary for purchasing non-essential goods and services. In the past, prior to the current economic shift, most Africans in underdeveloped areas had little to no disposable income. This trend is currently shifting as well, which makes investment in countries in Africa more realistic.

Entrepreneurial Resources

Many organizations seek to promote the startup culture in Africa, and they have been relatively successful in doing so in recent years. The more important question is whether or not these supportive factors will persist amidst the uncertainty surrounding the state of startups on the continent.

In this case, it is necessary to evaluate the source of startup capital – an important indicator in determining the level of available resources. Most startup capital in 2016 (57 percent) is being invested by the founder(s), while only 12 percent is invested by private sources. While these numbers may be construed as a negative, it is worth mentioning that startup capital investment is on a downward trend globally.

Economic Stability

moneyAs mentioned, a growing middle class means more disposable income for citizens of many African nations. When considering whether or not to invest, it is important to consider whether the middle class is expanding or contracting. Answering this question allows investors to project business growth or stagnation.

Evaluating the expansion or contraction of Africa’s middle class is complicated, and experts are divided on the subject. The consensus, if one could define it as such, is one of both optimism and caution. Historically, and almost without exception, all nations experience economic turbulence over time. Many countries in Africa, having experienced a positive economic stretch, are considered “due” by some to enter a period of stagnation.

Risk/Reward

African startup investment is no different from that in other areas of the world, in that it is a risk-laden endeavor. Investors that have traditionally seen sizeable returns in Africa have had a long-term approach that takes into account the uncertainty of the African marketplace.

The consensus is that many investments in African startups are deemed riskier than those in other areas of the world, but may yield significantly higher rewards. One predominant example is iROKOtv, a company that has been called the “Netflix of Africa,” where early investors made a 3000 percent profit on their initial capital investment.

The Future of Startups in Africa

African startups have yet to mature to levels seen in many areas of the developed world. Yet, the collective entrepreneurial spirit on the continent is filled with promise. No developed part of the world has thrived without subjecting itself to the unknown, and Africa is no different in this regard.

If savvy startups are willing and able to weather the storm of uncertainty surrounding the state of the region’s capabilities, they and others who take sizeable financial risks may be the beneficiaries of such vision.

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