Over the last ten years, most of the funding into the Nigerian tech ecosystem has come from abroad. Domestic investors including private equity (PE) funds and high net worth individuals have steered clear from investing in startups.
This behaviour could change soon. According to industry insiders, a number of domestic private equity companies are planning to lower their minimum funding amount so they can invest in startups. At an event in December, a partner at a major PE company confirmed this development to me but did not go into specifics.
“It’s not like they [the firms] are going around telling everyone about it. But we’ve seen them do smaller deals,” said a partner at another PE firm.
Why do Nigerian PE firms shy away from investing in startups?
According to one investor pleading anonymity, after watching Jumia and Konga burn so much cash to accomplish so little, Nigerian PE firms have been sceptical about the growth story of many tech startups. Although no Nigerian firm invested in the two companies, PE firms are still too cautious.
But he explained that the foreign exchange situation of Nigeria has made it cheaper for firms to make dollar investments in startups. In 2014, a dollar was equivalent to ₦160. “Somebody who was running around looking for $1 million suddenly needs a lot less,” he said.
“Our minimum investment is $20 million, that’s over ₦7 billion,” the investor quipped during a chance meeting, “what does a startup want to do with ₦7 billion?”
Other insiders say the nature of private equity operations globally is different from venture capital. This has made it challenging for PE firms to jump at the tech scene in Nigeria and other parts of the world.
“At their core, private equity and venture capital are similar in their fundamentals,” said Dr Ponmile Osibo, Chief Investor Relations Officer at Platform Capital. But their investment focus is on the stage of a company, he explained.
While VC firms target high growth startups, PE firms pursue deals with mature, later stage companies. They take a controlling interest in companies by offering investment in the form of debt and or equity.
Meanwhile most Nigerian tech companies over the last ten years are early stage companies pursuing high growth in uncertain markets. They’re not the ideal types for PEs looking for more stable companies with a proven model that are in need of cash.
Funding and investment strategies of PE firms had also put them off startup investing for so long.
These firms usually raise funding from external investors called Limited Partners (LPs). Osibo explains that one important condition for funding is that these firms have to develop an investment strategy that is acceptable by the LPs.
This sets a minimum and maximum amount they can invest in any company. The strategy also specifies what sectors they want to focus on.
For instance, if a PE raises funding to invest in the logistics or agriculture business, all investment activity must focus on this sector. This is not the case for venture capital firms. A single VC could raise a fund and invest more flexibly in tech companies from different sectors like health, finance among others.
This also means that VC firms have larger portfolios. The investment strategy of a PE firm with a billion dollar fund may require them to invest a minimum of $100 million in a single company. That gives them a portfolio of less than ten.
PE funds also have a 10-year life cycle that dictates their funding and exit plans, Osibo explains. During this period, firms are expected to take over a company, restructure it and make a profitable exit. This would be challenging for startups due to their risky and unproven business models.
Consonance Investment Managers is one PE firm that has made a serious commitment to investing in startups. With offices in Lagos and Mauritius, Consonance led the $1.1 million seed round of Nigerian startup MDaas in 2019. It invested over $500,000 in Kenyan fintech Pezesha and led the Series A round of Nigerian startup, VerifyMe in January. The firm recently led the $1 million seed round
More funds are targeting African Startups
The interest of Nigerian PE firms in startups is coming at a time when a number of new funds have launched to target African startups.
Last year, Partech Partners doubled the size of its Africa fund from $70 million to $143 million. It has invested in nine startups on the continent. Partech has deployed between $3 million and $7 million in around four deals. But it’s ticket size has gone lower. It joined two other firms to invest $2 million in Ethiopian startup Gebeya in February.
In late 2018, Kenya’s Novastar Ventures created a $72.5 million fund to invest in startups in Anglophone Africa.
Last year, the German government also announced a €1 billion fund for Africa, with €400 million dedicated to venture capital firms.
Startup competition, Seedstars announced a $100 million fund for African startups in April 2019.
Osibo shares that Nigerian PE firms may have to raise new dedicated funds to join the startup investing train. This is already happening.
In March 2019, Verod Capital Management, a PE firm focused on Nigeria and Ghana, co-invested $10 million in clean energy company Daystar Power. The investment came from Verod’s $115 million Growth Fund II LP which was launched in 2014. Growth Fund II targets “middle market high growth companies”; a standard focus for most PE funds. But by July 2019, Verod announced a new $150 million Verod Fund III. The new fund targets ” consumer-facing small and medium scale enterprises in anglophone West Africa”; by extension startups. Verod Fund III has grown to $200 million.
Another PE firm, Aruwa Capital Management launched a $20 million fund in 2019. The fund will invest between $1 and $5 million up to five small scale businesses. Fous areas are non-banking services, healthcare, B2B and consumer goods.
A similar development is happening at the continental level.
Last year, Africinvest, a Tunisian-based private equity fund, partnered with Cathay Innovation to launch a $168 million fund to target African startups. It plans to invest between $3.23 million and $16 million in startups across the continent.
In October 2019, Francophone-focused PE firm, Adiwale Partners closed a €50 fund aimed at SMEs in the region. It plans to invest between €3 million and €8 million in 12 companies developing education, health and tech solutions.
With these trends, we should see more PE activities in Africa’s startup ecosystem.