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Predicting promise: What Africa’s startup scene has to offer

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A new age of venture capital is unfolding in Africa. Venture capital investments are expected to hit record-high levels in 2021. A few big names in the global VC market, like SoftBank Vision Fund 2 and Tiger Global, have entered the market for the first time and placed some large bets. Valuations are up too; now, the region has more than twice as many unicorns compared to 2020. 
Africa’s startup market is largely untapped. Its size is only around 2% of the global venture capital market, implying a huge opportunity for companies and investors; as the tides are beginning to turn. Now seems to be the perfect time to explore Africa’s startup landscape. In this article, we will take a closer look at funding trends, leading countries in the continent, top segments, opportunities and challenges, and more.

Africa’s startup funding to hit an all-time high in 2021

The region’s venture capital investments are being tracked by a few sources, and the numbers differ because of the differences in methodology. But, everyone agrees that VC funding will reach an all-time high in 2021. 
The latest estimate (November 2021) by Briter Bridges indicates that startups operating in Africa will raise USD 5 billion by the end of the year, higher than all of the previous five years combined. That is not too ambitious; African Private Equity and Venture Capital Association (AVCA)’s estimate for VC funds in 1H2021 alone was at USD 2.1 billion, surpassing all historical full-year values. 
Clearly, the African startup landscape is bouncing back stronger than ever after being hit by the pandemic. This does not mean that investor interest in the region has declined during the pandemic; they were just betting with low-value investments. In fact, 2020 had the highest ever number of venture capital deals, but the ticket size was small, leading to lower funding value.

Large global investors scoop up stakes for the first time

Global investments have been the dominant source of venture capital funding for Africa, accounting for 78% of the total number of investors over 2014–2020. These used to be strategic investments from companies like Visa and Mastercard as well as funding from not-so-well-known VC firms or small-scale accelerator programs, but 2021 brought in some big-name VC investors to the market. These firms funded some of the mega-rounds during the year, and the most notable of them was SoftBank Vision Fund 2, which led the region’s largest-ever funding round in August.  
Here’s a summary of the large global VC investors' involvement in the African startup market in 2021: 

Much of VC money concentrated among the big four

The African venture capital market is highly concentrated, dominated by the big four: Nigeria, Kenya, Egypt, and South Africa. You may have realized that most, if not all, investments from leading global VC firms (highlighted previously) went into Nigeria. 
Given that we don’t have the final numbers for 2021 yet, we could refer to the 2020 funding by country data to understand how concentrated this market is. The big four together accounted for 80% of total funding, and the only other African country to exceed USD 100 million was Ghana; all other nations received investments of less than USD 15 million. Nigeria had only a slim lead over Kenya in 2020, but with some of the large global VC funding going into the West-African country, it is highly likely to have a significant margin in 2021.

What is fueling investor interest in Africa, specifically the big four?

Untapped market: Africa is still a largely untapped market across various industries, giving huge opportunities for startups. 
Relatively lower valuations: As valuations in the US and European markets have shot up, global investors who are on the lookout for bargains find African companies attractive. Such investments also help diversify their investment portfolio. We compared the top five startups (based on valuation) in the US, and the funding to valuation ratio was 17x, while the same for Africa’s leading five companies was 5x. 
Population growth: Africa’s population is expected to double to 2.5 billion by 2050, and more than 80% of this growth will take place in cities. This makes Africa the fastest-urbanizing region in the world. 
Nigeria currently has the highest population in Africa, capturing a 17% share, and it is estimated to become the third populous country in the world by 2050 (only behind India and China). The big four African regions collectively account for around 35% of the region’s population.
Demographic advantage: Africa is, in a sense,  the world’s youngest continent with almost 60% of its population being under the age of 25. Niger had the lowest median age of 15.1 years. Among the big four, Nigeria was the first but ranked the 18th youngest country in the region with a median age of 18.4 years (still much lower than the US— 38.1 years). 
Tech hubs and ecosystem: Africa has 643 tech hubs (2019), which includes co-working spaces, incubators, accelerators, etc. These hubs provide business support (sometimes only coworking spaces) as well as in-kind or cash support. The dominance of the big four was very clear in this area as they took the top four spots in terms of countries with the highest number of tech hubs with 43% of the combined share.  
Other factors: We compared metrics such as GDP growth/per capita, doing business index to see if they indicate any correlation with top venture capital receiving countries, and a relationship could not be found. As it turns out, Nigeria was ranked one of the lowest in terms of the ease of doing business index. The country has unfavorable business and tax regulations, so startups tend to incorporate their business in the US or other business-friendly African countries like Mauritius and conduct operations in Nigeria. The US or other Western country incorporation has actually helped some Nigerian startups garner investments from global VC firms (for e.g. Flutterwave, Andela were incorporated in the US). However, this trend was not very common among the other big four countries.

FinTech at the forefront of Africa’s VC rise

Africa added four unicorn startups in 2021, more than doubling the total from 2020. Now the region has seven unicorns, of which five are FinTech companies. 
FinTech has been a prominent sector in the African startup landscape for the past few years. Based on 2020 data, FinTech accounted for 25% of total venture capital funds, nearly twice the size of the second-largest segment, AgriTech. 
There are a couple of reasons why FinTech is such a dominant sector in Africa: 
  1. FinTech companies have mostly been successful throughout the world, including other less-developed regions like Latin America. Investors believe the same model can be an easily replicable formula for success in Africa. 
  2. The African market provides huge opportunities to challenger banks and mobile banking startups, especially those entering first, because of the lack of banking infrastructure. Take Nigeria for example, nearly half of its adult population does not have access to any sort of formal financial service even as of 2020. 
  3. Previously the lack of infrastructure is what deterred investors from betting in the African market. The FinTech model pretty much removes the need for physical infrastructure. Then, there is the need for communication infrastructure to support such services, which is rapidly expanding in the region. Google and Facebook are developing undersea cables around Africa. Fiber optic cable (e.g. Liquid Intelligent Technologies) and satellite internet technologies (e.g Starlink’s low-orbiting satellites) are also helping to bridge communication infrastructure gaps. Nigeria’s internet penetration has more than doubled to 34% in 2019 from 16% in 2012. 

Challenges persist……..

There are structural limitations to investing in Africa. Several countries in the region still lack some basic infrastructure necessities like electricity (Nigeria is ranked 171 out of 190 countries in terms of access to electricity) and commonly face power outages. Tech companies often say that they are concerned about political instability, corruption, and access to finance when setting up businesses in Africa. Companies agree that administrative and business regulations such as taxes, labor regulations, judiciary system, etc., are not very restrictive, but in some instances, they could also raise concerns. 
Africa is made up of 54 countries, so gaining a wide customer base across the region can be an expensive proposition. The majority of the consumers have low purchasing power. Africa’s mean income is four times lower than the global average. Adding to this, the typical African consumer is believed to be hesitant to adopt fully digital solutions. So, it's a risky arena for tech startups. 
A 2021 BCG report found that several startups do not go past the Series B round. Because of this, returns on African VC investments are significantly lower than in almost all other markets. This was calculated based on data from 2014–19, so how much of this will change if startups continue to get high levels of funds is yet to be seen, but one can see why investors are hesitant to invest in the region. Exit opportunities such as secondary buyouts are also limited. 

…….But a new VC age is unfolding

Money isn’t going to help solve all of the challenges for companies, but it will certainly help. Pouring in venture capital investments could help innovation in the region and also drive entrepreneurship among the significantly large young population.  
An increasing number of FinTech companies are opening up access to credit and improving financial inclusion. A research study found that M-Pesa (mobile banking system by Vodafone) has helped increase per capita consumption levels and moved 2% of Kenyan households out of poverty. It's a 2016 study, but it still explains the leapfrog that FinTech is delivering in the African financial system.
Large global VC firms’ entrance into the market is a reflection of investor confidence and could help attract more international investments. They could also create exit opportunities because of their capital advantage (e.g.large investors buying stakes in a startup from another investor). 
It is still early days for the African startup landscape. How long it could take to reach a certain level of maturity is difficult to tell; it is worth exploring the growth trajectory of other developing regions. India started seeing accelerated growth in 2011, and it took four years for the country to reach moderation. This growth was supported by the entrance of several VC firms. Whether Africa will follow suit remains to be seen, but with recent developments, we can safely say that Africa is entering a new venture capital era.

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