African startups raised a record $1.34 billion in venture capital in 2019, up from just under $200 million in 2015, according to WeeTracker, a media firm focused on the African entrepreneurship space. That’s about a 46.3% increase on a compound annual growth rate (CAGR) basis. WeeTracker estimates show that the total African venture funding had reached $725.6 million in 2018.
Despite the impressive growth rate, there are still huge funding gaps that the continent needs to fill and here’s why.
The larger portion of funds being raised by African startups comes from venture capital firms outside the continent. Given how the technology ecosystem in Africa is still in its nascent stage, coupled with how venture capital funds are typically directed toward growth, many early-stage startups on the continent still struggle to raise early-stage funding. And that’s because there aren’t sufficient local angel investors to fill this gap.
For instance, in Nigeria, only about $1.5 million of the $133.5 million that the country attracted in 2018 came from the Lagos Angel Network, Africa’s largest angel network, according to online business news publication Quartz. Nigeria attracts the majority of African venture capital — nearly 50% in 2019.
The consensus within the African angel investing community during the 2018 Africa Early Stage Investor Summit is that the lack of clear exit opportunities is a major contributory factor.
“It is easy to invest money in Africa right now, but it is hard to make money in investing here. The key is to be exit centric — we only invest in entrepreneurs who are focusing on building sustainable businesses that can exit,” Ben White, the CEO of Venture Capital for Africa (VC4A) said. “This conversation succinctly captures the challenges venture capital faces in Africa and why we need to keep working to strengthen and support the entire African venture ecosystem.”Today In: Money
How blockchain can solve the early-stage liquidity problem
Traditionally, investors in startups are able to exit and make money from their investments through three major avenues including IPOs, acquisitions and mergers. Each of these typically requires that a company achieves a reasonable level of growth. For a technology ecosystem that’s still at its nascent stage like Africa, reaching this level of growth can take a longer time frame than in matured markets.
The implication of the longer time frame here is that convincing investors and high net worth individuals (HNIs) to inject funds into the African startup landscape can be tough. They already have access to more stable investment opportunities elsewhere. For instance, the Central Bank of Nigeria’s Open Markets Operations Bills returns about 15% per annum.
One of the ways to encourage investors to inject money into startups in the early stages is to develop a liquid market.
“One of my key thesis is that if we have more secondary markets in Africa and that allows early-stage investors to get some kind of liquidity, we will be able to recycle funds within the ecosystem,” said Yele Bademosi, a Binance Labs director and founder of Nigeria-based angel investment firm Microtraction. “However, the current infrastructure for capital markets across Africa doesn’t necessarily support this.”
Here’s where blockchain comes into play.
The distributed and trustless technology has powered a new method of fundraising that can be borderless. This is evident in the initial coin offering boom and subsequently the emergence of the security token market.
While ICO fundraising, for the most part, has sought to circumvent regulatory spotlight, the development of security tokens has been about redesigning the regulated capital markets to increase access and remove the inefficiencies that presently exists.
In Africa, blockchain can help increase market access for early-stage companies for a start.
“There is an opportunity to create our own funding infrastructure using blockchain to issue security tokens or hybrid tokens,” Bademosi added. “We will need to define our own guidelines and regulations around that, but what gets me excited about blockchain is that it can allow us to rethink capital formation and capital markets from the ground up in a way that could be trustless.”
The potentially improved liquidity comes from the possibility of these tokens to be traded on blockchain-powered secondary markets.
Over the past few years, a few blockchain companies including as Overstock-backed tZero, Polymath, Securitize and Harbor have been building the infrastructure to support the issuance, management and trading of security tokens.
We’re now seeing the efforts gradually make it to the actual investment scene with a few equity crowdfunding services emerging to allow companies to raise tradable security tokens.
Malta-based equity crowdfunding company Bloomio is one of the companies building on the new infrastructure to help startups raise early-stage capital in exchange for security tokens, which investors can trade on blockchain-powered secondary markets.
“Blockchain-powered equity crowdfunding can open up access to emerging tech startup hubs like Nigeria, South Africa and Kenya to a new set of investors, including anyone interested in investing in promising projects, regardless of their financial capability,” said Bloomio’s CEO Maxim Lyadvinsky. “Investors who are looking to diversify their expected profit/risk levels can now access vetted startup opportunities.”
African startups are able to use Bloomio to raise early-stage funds and a few have started using it.
The last decade saw the rise of equity crowdfunding, with the market reaching an estimated value of $10.2 billion in 2018 and a $28.8 billion projection for 2025. Thanks to a favorable regulatory framework in the developed markets, anyone can now provide early-stage capital for startups. Equity crowdfunding services such as SeedInvest and StartEngine are taking things a notch higher by securing FINRA approval to operate alternative trading systems (ATS).
However, these platforms are mostly available to companies formed in the U.S., Canada and perhaps a few other developed markets.
The African technology ecosystem can examine what works in the existing equity crowdfunding systems and build more blockchain-powered markets that encourage the participation of more local early-stage investors.