Here’s how early-stage investment mostly happens: An Investor and an ambitious entrepreneur get talking.  After a few background checks and business plan conversations, the investor decides whether to invest. But not before checking their gut feeling. Along the way the investor is constantly asking, “Does this feel right?”

In 2018, Franziska Reh and her Co-Founder felt this investment process wasn’t right. If this was the conventional way people made investment decisions, what would an unconventional approach look like? They started working on a way to revolutionize access to funding for entrepreneurs using technology. 

In the summer of 2019, Unconventional Capital (Uncap) was launched. Back then, it was simply a website with two pictures and one sentence: If you’re an entrepreneur in Africa and you need funding less than $50,000, please apply

They sent out the link to the site to a few friends in Uganda to help spread the word and the response was overwhelming.  They received applications from 20 countries and ended up investing in entrepreneurs from Uganda, Kenya, Nigeria, Zambia and other Sub-Saharan Africa countries. 

For Reh, the decision to invest in Africa was a very rational one. It started with the question of where they think entrepreneurship is the greatest at the moment. The answer to them was Africa. 

“Africa is this huge continent of young, bright people that are starting companies. We are convinced that this will change the narrative of Africa completely over the next few years. We decided we need to invest in this potential because it makes financial sense and also to level the playing field,” Reh said. 

Franziska Reh at a Conference

At the end of our interview Reh told me that a new platform and investment cycle is opening in August with plans to make 200 additional investments. But first let’s get to hear all about Uncap. 

Daniel Adeyemi: So what’s so unconventional about your capital? 

Franziska Reh: We’re not your typical investor. We’re a fintech company that invests in early-stage companies in Sub-Saharan Africa. We’ve done 27 investments so far. The goal is to get to 50,000 investments within the next five years and that is because we want seed funding to be accessible to every good entrepreneur. 

Basically, we believe that every entrepreneur – irrespective of their background or gender – as long as they have the potential to be good entrepreneurs, should get access to funding. 

To say that we’re really able to offer funding to every good entrepreneur, we had to reinvent the whole investment process. 

So to be able to do investments with ticket sizes below $50,000, we had to lower the cost of an investment to an absolute minimum. 

In order to give access to everyone, we also have to take out the bias of the investment process. 

At Uncap, in our investment process, no one in our team makes investment decisions. The selection process is based on an algorithm that focuses very much on the potential of the entrepreneur. It’s a model that measures entrepreneurial potential as a predictor of future success. Afterwards, we invest through a standardized model. We can’t have individual negotiations with thousands of entrepreneurs. 

We had to figure out a way that enables us to almost automatically invest in thousands of entrepreneurs at the same time with a model that is economically feasible for us and for the entrepreneurs. So we have one standard offer. It’s an equity-based revenue share, where the entrepreneurs buy back the equity at a pre-agreed price through their revenues. 

DA: Tell me more about this equity-based revenue share model.

FR: We do ticket sizes below $50,000 because we think that this is really the lower end of the pipeline. Most entrepreneurs are not your typical high tech high growth company, they don’t even need $500,000 in the first one or two years of their business. Currently, even our average ticket size is $19,000. 

These companies we invest in buy back their equity through 5% of their quarterly revenues. They transfer 5% of their quarterly revenues to us. By this act, over time, they buy back the whole investment, plus the price that we’ve paid before. It’s a fixed multiple on the investment, it’s basically the same for everyone. 

We’re flexible on the revenue threshold for companies we invest in but won’t invest in companies that have zero revenues.

DA: What’s the expected return on the investment?

FR: Currently between 2.5 to 3 times on the investment, accounting for the fact that most entrepreneurs will take eight to 12 years to buy back the investment.

Again, with every new investment that we do and with every new data point, we’re also able to adjust our terms. We’ll start offering terms such as If you buy back the equity within eight years, your multiples are lower and if you buy back the equity over 12 years, it multiples higher. We will never go to the point where we start to put pressure and high demands on those early-stage companies, because for a company that’s one or two years old, what’s the point? They’re buying back the equity completely.

DA: That’s so generous. It sounds so kind 

FR: I think it’s fair for both sides. Of course, we factored in a way where we’re also making money. We’re not getting rich with that, but we’re making money. It is cost-efficient because our due diligence is automated.

DA: How does this algorithm work?

FR: The algorithm measures the potential of the entrepreneur, through tests and questions, simulated interviews and other measures. Afterwards, we invest based on what the algorithm puts out. What we do is that there is an automated KYC process. We also conduct an automated KYC process, working with external KYC providers. If a KYC provider says there is a red flag with this investment or this shareholder in this company, then we would of course not invest. Other than that, we don’t do an additional assessment of the business model or the market.

DA: What does this algorithm look out for?

FR:  Of course I can’t tell you all the details, but basically, the algorithm looks for certain personality traits, skills and behaviors that are correlated with entrepreneurial success. Things around financial literacy, goal setting, ambition, how well do you understand what you’re doing, is your business scalable and what is your target group? We’re basically looking out for whether you’re a good entrepreneur. 

investees and members of the entrepreneur community at Uncap meeting up in Nairobi in early 2020.

DA: Do you involve gut feeling or intuition at any point in the process?

FR: I know that seed funding or startup funding is a very human-driven process. Currently, VC investors conduct interviews with startup founders and then they trust their gut feeling. This means that we’re always investing in the same entrepreneurs. We see that in Africa. A few years ago, there was this study by Village Capital that in East Africa, 90% of VC funding over a certain time span went to expat founder-led companies. I think that’s just highly unacceptable. It’s not because expat founders are better entrepreneurs, many of them don’t even know the market very well, but it’s because the investors that currently invest in Africa, are mostly white VCs. 

Of course, they invest in the people that look like them. I think it’s just human. That’s why we decided to really take out the bias completely.  

If we’re completely honest, it’s not that VCs and others are so great in doing that. Many of them are still hugely underperforming and even there nine out of 10 startups fail. You could even argue that this gut feeling does not even work that well. It depends.

DA: Tell me about your portfolio management. How do you interact with your investees?

FR: Our KYC process and portfolio management are completely online.  For us, it was a question of ‘how do you manage the portfolio of potentially thousands of early stage investments, in a way that’s scalable and profitable?’ 

Obviously there is no hand-holding. We’re using data. Based on the data they report we offer some sort of virtual coaching where we say, ‘looking at your accounting data, your cash flow is really low or your profit margin is lower compared to the average in your industry.’ 

There is also a resource center with access to curated information, webinars and training programs provided by partners. We also enable the entrepreneur to build up a track record over time that they can export if needed to apply for a loan or other types of funding at some point. For us it’s important that the entrepreneur is completely in the driver seat.

DA: Based on the investments you’ve made so far, how have they performed? 

FR: We have already done a first investment round at the beginning of 2020. We’ve invested in 27 entrepreneurs, to see if this investment process could work. So far we’ve had very good experiences with them. Many of them are still in business despite COVID. Some of them performed really well, some had troubles but none has been taken out of business so far. Although we never met the entrepreneurs, they are buying back their equity and they are reporting. Also, the performance overall looks quite promising.

There’s a second point I want to highlight. Our target group is not your typical high tech high growth entrepreneur. We’re investing in local entrepreneurs that have the potential to scale over time. That means entrepreneurs that are growing, but they don’t need to grow at rocket speed, they don’t need to become a unicorn, but they also need to be more than a mom and pop shop. 

So far we’ve invested in countries like Uganda, Rwanda, Kenya, Nigeria, Zambia, Malawi and Mali. With our investment process, it doesn’t matter where we invest and we are specifically able to invest in entrepreneurs that are not in Nairobi or Kampala. They’re far off the usual grid.

Although going forward we’ll focus a little more on East Africa and Nigeria due to the regulatory and Legal constraints of investing in many African countries.

DA: Do you focus on a particular sector or everyone is invited?

FR:  We don’t focus on particular industries or countries. We do have around 60% of our investments in agriculture-related sectors, but agriculture itself could also be byproducts, it could be for example e-commerce around agriculture products. We also have tech, health, education and finance. This is also part of our business model – we are aiming at a highly diversified portfolio across different industries but also countries.

DA: What are the expectations of the backers of Uncap?

FR:  So far, all our investors are invested directly in Uncap. That means that the money they’ve put into Uncap is used for investments, for capital and operational expenses. They are basically investing in us as a fintech company, then going forward, we will pay out the investments through a fund, like a special purpose vehicle (SPV). After this, we’ll be looking out for more debt investors. Investors that fit into a longer time horizon that works for our entrepreneurs.

Basically what we’re building at the moment is a vehicle where we have debt investors, probably foundations, pension funds over time, that want like a 4 or 5% interest rate every year, over 10 years. 

Over the next few years, we need to be creative in structuring that with parties that are interested in trying out this new model. 

DA:  It’s good to hear that you’ve thought about the investors too. Does it matter whether the companies you’ve invested in are acquired?

FR: No, not at all. That’s why we structure the investment deal the way it is. If we’re looking at early-stage companies in Africa, they’re probably divided into three categories: You have the mom and pop shops, they don’t want to grow too big. Then there are the high-tech high growth ventures. Then there’s this huge part in the middle that could become middle or large size companies over time. We’re targeting those. They don’t want to exit their companies and they most likely will never exit their companies because they are not the type of businesses that are usually bought up by other bigger companies. That’s why we also structured our investments in a way that’s independent of exits. I think even in the typical venture segment, we see that exits are still rare.

DA: What trends are you seeing?

FR: On the investment side, we’re seeing that there are investors that are willing to think beyond equity and debt investments. They’re thinking about how they can open up new target groups without being limited or dependent on an exit. 

On the entrepreneur side, we’ve noticed that most entrepreneurs that we invest in have an impact focus. It’s not because we need them to, but it’s because they are trying to solve problems that they grew up with, and they want to solve them. I think the combination of impact and offering products and services for the growing middle-class is pretty much interrelated. 

Also, I think generally now outside of Africa, talking to VC investors in Europe, there seems to be more openness towards actually using technology as part of the due diligence process. It’s not in the way that we’re doing it, but at least I’ve talked to some VCs that are starting to use personality tests as one part of their due diligence; to start taking out the bias. 

In the last year, the combination of the pandemic and the Black lives matter movement has helped investors to rethink investing remotely and opening up focus to marginalised groups.

Daniel Adeyemi | Author