First published 19 November 2023

Africa investors need to learn to make VC math work instead of debating whether the continent needs unicorns or camels. VCs who focus on the math will be fine regardless.

Within days of each other last week, Financial Times and Business Insider published interesting articles about investors who are buying up startups that were counted as dead in venture capital portfolios. Startups that fall into this category include the ones struggling to raise additional capital (and are facing certain extinction) because of too-high valuations from their last round. But the list also overwhelmingly includes companies that are simply not growing fast enough for VC tastes.

The thesis is simple. Imagine that a solid business is at risk of shutting down because it had the misfortune to fall on the wrong side of the power law—the theory that only two out of 10 investments generate most of the profits VCs make—and is running out of capital. Almost no one will want to put in capital at the elevated valuations of 2021. But what if these companies, many of which have been silently written down by their investors, have the option to continue life as slow-growing but stable companies? According to Business Insider and the FT, some investors are offering a path to this.

UK-based Resurge Growth Partners and Tikto Capital, San Francisco-based Arising Ventures and even the American private equity giant KKR are some of the firms choosing this strategy. Given the steep decline in venture capital funding made into African startups and the rise of a “VC may become PE” narrative, which I wrote about earlier this year, I want to know if this is a viable strategy for some savvy investors out there, and why not, if not.

Here’s a thought experiment. If venture capital investors (and non-investor-observers) in Africa are calling for profitability from startups (some of them barely out of their seed-stage), would it not make sense to add dividend payouts to the requests? If the desire to correct the last two years of investment excesses is turning venture capitalists in Africa into equity analysts who want dividends on cash flow, why not abandon the VC game entirely?

Much of the recent stories about African startup-land have been dour, as you well know. The unfortunate result is that former growth-at-all-costs investors are now more conservative than KKR. To my mind, there are only two forks at this junction. It is either the venture capital story is not working, or the venture capital story is working just as designed and investors misread the book all along.

If the venture capital story is not working then maybe investors in Africa need to create something new. If however the philosophies that underpin venture capital are intrinsically undamaged, then we ought to look elsewhere to find the mismatch in expectations.

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I took the liberty of looking for the mismatch and it seems to me that (at least) part of the mismatch stems from seeing venture capital from at least three distorted perspectives.

The first is as a social and economic restructuring vehicle, where VC funds are expected to turn the economies startups are building in around. Unfortunately, while venture-funded startups can take advantage of adverse or tail economic winds, they rarely create economic breakthroughs or pitfalls by themselves. In other words, good VC-backed startups can be created in times of economic plenty or during economic adversity, but VC-backing rarely creates prosperity or adversity.

The second distorted perspective is seeing startups as a channel to build SMEs. And the third (and most egregious) perspective is treating venture capital as a means of personal enrichment without recourse to the owners of the invested capital.

As a result of the distorted perspectives around VC money and the 2021 deluge of capital, VC (globally not just in Africa) has been rightly criticised. Some of that criticism has called for the entire VC model to be reorganised (especially in Africa) to create gazelles, camels or some other NatGeo-type wild animal. For the uninitiated, “camels” are startups that supposedly prioritise survivability and profitability and are valued at less than a billion (i.e are not unicorns).

But the caveat to preaching and creating a new (and convenient model) of venture capital is that the more than $10 billion of VC money that has so far been invested into African companies (2020 to 2023) was attracted to the continent by a narrative of VC-style returns. Thus if anyone proposes something different (in the guise of advocating for more “reasonable” expectations. Then they have to justify why investors should prefer SME-style returns from backing African companies where there are VC-style returns to generate in other markets. Good luck to anyone having this conversation with LPs.

Meanwhile, the investors who still retain belief in the VC-philosophy seem to have been stunned into inaction. Or they try to role-play the hardball tactics better associated with private equity investments.

Both approaches are a mistake because they mix up consequences and results. Africa’s venture ecosystem does not necessarily need “camels”. It just needs an acknowledgment that most African companies in existence today public and private alike, are simply not billion-dollar companies. Some of the best investors have understood this and invested accordingly. Instead of obsessing over billion-dollar valuations, they obsess over making the VC math work.

When people call for venture capital in Africa to adopt an African model, it might just be an admission of a lack of the underlying principle of venture capital. Venture capital math does not work out automatically because one creates billion-dollar companies. It works because a portfolio is structured to invest in fund-returners. That is where the math starts from. So while unicorns are important, a hypothetical $10 million fund which invests $100k pre-money to acquire a 9% stake (post-investment) does not necessarily need a $1 billion exit to return its fund.

This is an oversimplified example. But the point is that the unicorn/camel/zebra/zoo argument is a distraction, maybe even a cop-out for backing SMEs. VCs that focus on the math will be fine.

Let us, however, indulge the argument because it is not altogether without merit.

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In this case, instead of swinging between venture capital and private equity when interest rates in the US permit, or creating a mocktail of both, I have another suggestion. What if the spectators (and investors) who complain about the VC-asset class (and argue over unicorns and camels) band together to create a third force with an investment mandate that strictly find and back Africa’s camels.

Like the examples in the Financial Times story I mentioned earlier, investors could specialise in backing and turning around VC-castoffs that have great camel potential. The way I see it, there are more than a few overlooked small tech ventures. And any savvy investment outfit that bites the bullet with a solid fixed turnaround team can take VC castoffs, put solid structures underneath them, and prime them for sustained SME-style growth.

There is so much value here no doubt mixed with chaff! So if you’re an investor who believes in creating camels, zebras and other realistic creatures of the NatGeo Wild variety, what’s stopping you from going after them?

Abraham Augustine,

Senior Reporter, TechCabal.

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