Global markets have slowed down since the turn of the year, and many thoughts have been shared on how founders and investors around the world should approach the current market downturn. A few of our favourite takes on the subject are linked here:
In this article, we want to focus thoughts on what this downturn will mean for our African startup ecosystem.
How does the downturn affect venture capital in Africa?
Venture capitalists take their cues from the public market as these are what represent exits. A fall in the value of public companies leads to a fall in the valuations of late-stage companies, leading to a fall in early-stage valuations.
For private companies in their growth stage, valuations are often based on the multiples that can be attained in the public market. So when the stock prices of counterparts and similar big tech companies go down, this reduces the multiple that can be applied.
Even though this is predominantly the case with later stage startups, the after effects of these happenings trickle down to the earlier stage firms with more and more investors becoming sceptical and questioning the numbers.
Events in the big financial markets eventually trickle down to emerging markets, and there’s no denying the influence of Silicon Valley on startups across the continent. Investors adopt Silicon Valley frameworks and multiples for assessing African companies even though they are largely different, and US investors have the propensity to pay more than they ought for African companies, basing prices on parallels in the Western market.
Disclosed growth-stage deals in Africa have largely been funded by foreign investors such as Tiger Global, Avenir, Greycroft, and the effects of the downturn are likely to affect their propensity to invest. Historically, foreign investment into the continent declines during global shocks as evidenced with the 2008 global recession, the crude oil price crash of 2015-2016 and most recently, during the pandemic.
International VCs are typically backed by big corporates, pension funds and endowments that have the tendency to cross over to safer investments. This means that we might see a reduction in the amount of capital channelled to Africa from these VCs during a downturn, and immediate future capital will be affected at later stage rounds (Series B+). We have not yet begun to see the effect on African deals (as funding grew 105% year on year in Q1 of 2022) but we are bracing ourselves for the changes.
On the flip side, most of the funding to African focused venture capital firms come from Developmental Financial Institutions (DFIs) and Sovereign Wealth Funds, whose premises for investments are not only based on the global market trends but impact and development. These players have committed money to funds, and funds have deployment cycles that span from 2 to 4 years on average. We have also seen a number of startups that have been backed directly by DFIs like Moove and Twiga.
What this means is that there is capital sitting on the sidelines to be deployed but startups will be in a tough competition for it and only the best companies will get funded. This will result in an increased turnaround time to founders as due diligence will be carried out with more intensity, with VCs slowing down on investments. This deal slow down will then ultimately affect valuations on the continent.
The valuation boom of 2020/2021 may have given founders the impression that fundraising was a walk-in-the-park endeavour. High valuations were seen as the norm and not the exception – less traction was demanded by investors and it was possible to raise capital based on an idea and a team. Now with an increased competition between who and what should get funding, pricing will prove a major deal breaker for investors playing in the market, as there is no easy money left to spare. There will be a more measured approach to valuations and more investors will be looking at revenue, product market fit and viable paths to growth even at earlier stages.
What should founders do?
The African market has never really been free from macroeconomic challenges. In fact, the continent’s poor macroeconomic indicators (compared to those of other markets) have been the reasons behind the majority of solutions in the market today. This means that for companies building real solutions poised to meet the needs of the African population, this is a great time to build. There will be less competition from impracticable businesses that were previously propped up by abundant capital, and the best businesses based on fundamentals will stand.
For founders in the process of raising or looking to start, be flexible and open to valuation negotiations. Try to close swiftly to get enough runway for the next 18-24 months. Valuations for true contenders will bounce back once you are able to prove durability. In times like this, founders should be flexible and open to negotiations with their valuations.
As much as investors are assessing you for investment, you are assessing them as potential partners as well. Work with investors not just based on the prices they are willing to pay but on the basis of their track record of supporting founders and helping their companies raise follow on rounds. Ask about their fund deployment cycles, how they plan to construct their portfolio and the value you stand to gain from working with them.
Run your business like you will not be able to raise money in the next 12 – 18 months. Focus on revenue drivers and cost efficiency. Be creative with your market positioning (positioning yourself as a business that helps your customers navigate the environment – helping them make more money or save significant costs).
Above all else, founders should act with integrity at all times and should not succumb to pressure to embellish or create value out of thin air. It is always best to underpromise and overdeliver so you can continue to build confidence with your market first, and investors second.
For investors, our business is turning these challenges to opportunities
‘There is a long list of valuable companies on the continent and globally that have been built through recessions like this one so it’s not a death sentence. Future Africa is moving from pipeline to active sourcing to find these companies. We have our problem frameworks that we believe are in the most dire need of solving and have a synopsis of how we think the solutions should look like, then we go ahead and find it.’ – Iyinoluwa Aboyeji, General Partner at Future Africa.
The challenges and opportunities in Africa’s market remain massive and unchanged and real solutions still need to be built for our very real problems. As a fund, we have always focused on funding and supporting strong founders solving hard problems in large markets investing at valuations we deem fit based on value and market demand – as evidenced by our portfolio. These companies will be in a strong position to succeed as the companies propped up with cheap capital will no longer be able to compete.
Economic downturns like this help filter noise from value across ecosystems and this will be the case for Africa. We believe that this is the best time to invest as diamonds in the rough will be discovered, and deals that were once inaccessible due to pricing will be available. We will double down on founder support, balancing friendliness with due diligence whilst building great companies. We intend to prove that we are indeed hands-on investors committed to venture building alongside our portfolio.
We see an opportunity for growth firms to expand through acquihires, mergers or outright acquisitions. Startups in new markets with a solid product market fit will be open to deals at friendlier terms and now is the time for companies with comfortable positions looking to grow and diversify to take advantage.
Lower valuations also present the perfect opportunity for corporates to get more involved with venture building. Given they understand these markets and can provide support, networks and context where needed, they can ensure these companies are on a more sustainable and profitable path much earlier in their lives. Banks can buy fintechs at a bargain price, inheriting products and teams thus spinning off new innovation segments within their operations.
Even as we anticipate a slowdown of international investments, local investors will have to step up and lead rounds especially at pre-seed and seed stages where possible in partnership with corporate partners who are more value driven in their investment strategy. We also expect increased collaboration on due diligence and deal syndication among investors – which further stresses the need for founder integrity and transparency.
Whilst we hope that circumstances improve and stabilise soon, no one can accurately predict what an economic downturn will bring. But as a firm dedicated to building the future of Africa, we are optimistic that the African ecosystem will be better for it. Startups need to hope for the best but expect the worst, and investors should gear up to support their founders like never before.
Global markets regardless, Future Africa is putting critical infrastructure in place to accelerate our work of building the future. Our commitment to the ecosystem remains unwavering as inside or outside of downturns we continue to collaborate with our Future Africa Collective community to provide financial, social and intellectual capital to mission-driven founders solving hard problems in large markets!