The aftermath of the 2021 funding boom isn’t pretty. While the local and global appetite for African Venture Capital (VC) continues to grow, capital availability has been affected by the market corrections that followed quantitative easing during the pandemic. To survive in a tough fundraising market, startups must return to first principles and work harder and smarter to raise new investment rounds.
Taking a step back, in Q4 of 2021, global VC funding peaked at just over US$180 billion. 12 months later, the figure stood at US$74 billion. In Africa, the numbers - albeit slightly lagging - tell a similar story. VC funding on the continent was pulling in a monthly average of US$600 million until April 2022, when the markets started to show a steady decline of 17%.
Source: AVCA Venture Capital in Africa Report, April 2023
While the isolated figures paint a less-than-ideal scenario, panning back to 2019 and looking at the bigger picture clearly depicts the now-infamous funding boom effective from July 2021. At the time, the peak was underpinned by an oversupply of capital in global markets that also made its way to frontier markets like Africa. In practical terms, this means cheap capital fuelled by a low-interest-rate environment.
Unfortunately, the overly frothy and easy money flowing into the startup ecosystem led to externally overinflated company valuations, which soared to unsustainable levels. Out of the seven African unicorns to date, four were first valued at US$1 billion in 2021. It’s not to say those startups were overvalued, but it's a good indicator of the market sentiment at the time.
Over the past 18 months, the oversupply has been tempered by rising inflation and interest rates and strict economic policies. And the resulting market correction - compounded by ongoing interest rate hikes - has left a tough fundraising market in its wake.
Despite a healthy demand for the new ‘in things’ like AI or ChatGPT, VC volumes in developed markets have decreased by 50% over the last 12 months. And with startups now competing for a smaller pool of capital, the current fundraising environment is highly competitive. The knock-on effect has been startups failing to raise further rounds and either closing shop, scaling back, or reorganising to break even.
However, despite tougher capital conditions, African startups continue to raise significant capital compared to pre-2021. This includes funding from the continent, the US, and European markets. Of course, the valuations previously achieved have certainly been corrected in favour of investors. In the US alone, we have seen a marked correction, with good companies often raising on down rounds where valuations are lower than a previously priced investment round.
Despite difficult conditions, investors will continue funding if a startup’s growth story, containment of costs, and future earnings stack up. The sentiment is evident in SAVCA’s 2023 VC Survey, indicating that while investment value dropped 14.5% to R1.12 billion in 2022, the deal volume - particularly co-invested deals - increased 4.8% to 195. This continues the five-year trend of an annual increase in investment rounds.
For VCs, we’ve seen a return to the basics of good investment principles - looking beyond the hype to back business principles of quality revenue and solid commercial prospects. Until recently, this has not always been the case, with investors’ judgment clouded by ideas, experienced teams, and hyped market opportunities.
While the market is challenging, there is no lack of opportunities in Africa. Startups looking for savvy investors should play by the following guiding principles -
Solid growth story
A well-conceived business plan backed by a realistic growth story helps investors understand prospective investments. It proves that the startup has taken the time to carefully assess its challenges and the wider market forces at play. It gives potential investors a concrete roadmap and details to comprehensively evaluate the business and opportunity.
Strong financials
It is vital to have a track record of strong quality revenue growth and prospects, ideally in a mix of local and hard currencies. What’s more, the bulk of a startup's value rests on future potential or earnings and demonstrating an ability to actualise pipeline and prospects is key. Startups must also be proven to practice stringent cash containment measures by effectively managing and reducing expenses to optimise profitability. In capital-poor markets, it’s important to prioritise building leaner businesses that preserve cash and can reach breakeven in the medium term when playing on various growth levers.
Supported management
Founders need a right to play in their chosen market and remain open to working with a local investment partner to help them scale and prepare for further rounds of capital. This ranges from governance items, board composition, revenue diversification, and redomiciling where relevant. Expert strategic guidance ensures a startup has the right framework to entice investors and scale their business globally.
Cash runway
While many startups operate in cash-flow negative positions, it's essential to have a decent cash runway of around 18 months. This gives startups time and space to get up the growth curve and prepare for the next capital raise, which, in the life of an early-stage business, can make or break it.
With the right combination of strong management, compelling product, and client growth, as well as a path to break even in the near future, investors will continue to back the right companies in a tough market, even if valuations are muted from previous highs. And with interest in African VC still on the rise - spearheaded by new funds and growing interest from institutional investors - the industry is set to continue growing and driving local economies.
This article was first published in the December/ January 2023/4 issue of BusinessBrief.
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