Authors: Blaise Bayuo, Roxanne Bamford, Belinda Baah, Judith Mwaya, Chizi Gakuo, Sophie Tholstrup
Affiliated organization: Tony Blair Institute for Global Change
Type of publication: Report
Date of publication: February 15th, 2022
Introduction
Africa has the potential to become a startup superpower in the tech sector. Home to the world’s largest free-trade area and a vibrant entrepreneurial culture, the continent saw 22 per cent of Africa’s working-age population start new businesses before the pandemic. People in Africa have shown a willingness to embrace the use of technology, for example bypassing landlines to adopt mobile phones or embracing e-banking and mobile money in place of traditional banking. Funding for tech startups on the continent is growing at an impressive rate – six times faster than the global average – and a record $4.9 billion was raised in 2021, the amount more than tripling in one year. But this is still a fraction of the total: African startups account for just 0.2 per cent of the $3.8 trillion value globally. Cumbersome regulations, the digital-skills gaps, limited funding and highly fragmented markets continue to hold Africa’s startups back.
Why African Countries Need Thriving Tech Ecosystems
The case for action is clear: the digital economy is a critical lever of economic and social development for African nations, enabling governments to improve public services and achieve the United Nations’ Sustainable Development Goals quicker.
Tech ecosystems drive economic growth. The digital economy will contribute an estimated $300 billion to African GDP by 2025, providing much-needed employment on a continent where three to four times more people enter the job market than actual roles are created. In Nigeria, the technology sector contributed more to the country’s GDP than the oil and gas sector between 2010 and 2019. Meanwhile, Kenya’s information and communications technology (ICT) sector was on course to contribute up to 8 per cent of the country’s GDP through IT-enabled services, also generating up to 250,000 jobs by the end of 2021.
To fully benefit from the tech revolution, African nations must be creators, not just users of tech. Vibrant tech ecosystems will put the continent on the path to digital sovereignty: this means creating the technology and setting the rules that will shape the continent’s future, while proactively driving the fourth industrial revolution. Expanding Africa’s capacity to innovate as well as its ability to retain world-class tech talent will ensure the continent is the master of its own digital destiny.
A thriving tech sector can boost post-pandemic recovery. Africa has experienced an unprecedented economic shock as a result of the Covid-19 pandemic. While African governments and regional bodies face a daunting task in facilitating recovery, new growth sectors will be crucial to swift economic development and job creation. African governments need to rapidly identify and deploy a digital economic policy to open up and connect markets, and to generate opportunities for their burgeoning youth populations.
Seizing This Moment
This is an extremely hopeful moment for the African tech ecosystem. While investment in African tech startups is far behind other regions, it is accelerating at pace, with the sector having attracted $4.9 billion in funding in 2021, a 243 percentage change on 2020. Recognising the importance of these ecosystems for jobs and growth, governments are putting in place bold measures to support tech entrepreneurs. With the creation of the AfCFTA, the possibility of a continent-wide single digital market (SDM) is now real. If current positive trends are sustained, and the transformative potential of technology is unlocked, Africa could secure tech-startup funding of more than $90 billion by 2030.
Swift Action on Funding, the Business Environment and Networks
Far-reaching policies at the national and regional levels are needed so that African startups can reach their potential. For this to happen, they need access to funding at every stage of their growth, markets that generate demand for their solutions, institutions that help to bring down costs and strong support networks. Falling broadly under three main challenges that require action and are described below, we also set out ten policy recommendations in the chapters to come.
To fully benefit from the tech revolution, African nations must be creators, not just users of tech
First, tech startups face funding and liquidity challenges throughout their lifecycles. The average amount for African startup seed rounds is $1.5 million, versus $4.6 million and $5.7 million in India and Latin America respectively. Investors are deterred by the lack of information, perceived risks and a shortage of suitable financing vehicles. To close this funding gap, policy measures that unlock local financing, diversify investor profiles and facilitate global funding inflows will be required.
Second, next-generation tech startups need an agile and responsive business environment so that the costs of starting and scaling tech solutions across the continent can be reduced. Africa’s Ease of Doing Business ranking, according to the World Bank, is well below the global average (a score of 51.8 for sub-Saharan Africa versus 78.4 for high-income countries), with the continent facing major infrastructure gaps and a digital-skills deficit that results in high operational costs.
The third challenge arises from the poor networks between startups, and between the private and public sectors. Weak connections within the ecosystem affect the knowledge-sharing and support mechanisms that are so essential to tech startups in overcoming operational and business challenges. Africa’s tech startups would benefit from greater cooperation between founders, tech hubs, universities and the state in order to open up opportunities, overcome the skills shortages, and attract and retain talent.
Close the Funding Gap to Secure Investment of $90 Billion for Tech Startups by 2030
There has been rapid growth in funding for Africa’s tech startups since 2015, as shown in Figure 2, but the gap between the continent and other regions is increasing. For example, Africa attracted just over $1.4 billion in 2020, which more than tripled to $4.9 billion in 2021. Latin America meanwhile secured $4.2 billion in 2020, which more than quadrupled to $19.6 billion in the same period. At the other end of the spectrum, North America attracted $150 billion in 2020, a figure that rose to $330 billion in 2021.
The third challenge arises from the poor networks between startups, and between the private and public sectors. Weak connections within the ecosystem affect the knowledge-sharing and support mechanisms that are so essential to tech startups in overcoming operational and business challenges
Growth in Africa is skewed towards the “big four” markets of Nigeria, South Africa, Kenya and Egypt, with these countries accounting for 87 per cent of tech-startup funding between 2010 and 2020. The four sectors of fintech, agritech, health tech and energy tech secured approximately 60 per cent of funding deals in 2020. Last year fintech continued to be the leading sector, receiving up to five times more funding than the second-placed sector of health. Lessons on how to attract more investment and innovation to the continent can be learned from the fintech sector so that leaders can make tech an enabler across all economic sectors. Also notable are gender inequalities, with all-male tech-startup founders raising 78 per cent of funding versus just 0.6 per cent for all-female.
By 2030 Africa could attract more than $90 billion in funding for tech startups, up from the current $4.9 billion. To achieve this, governments will need to decisively address the factors affecting funding of tech startups. The existing investment landscape presents challenges and deters investors: our analysis takes a deep dive into the risks, the economic and regulatory disincentives, and the lack of diversity in funding solutions. We then follow up with policy recommendations to address these challenges.
The High-Risk Climate
Both real and perceived risks deter investors based outside the continent, including:
Information Asymmetries: There is a positive correlation between the quality of data that investors have access to and the likelihood of investment. Asymmetries (i.e., an imbalance of knowledge between parties) diminish the ability of investors to take decisions, thus weakening how markets are able to function. Information flows across Africa remain a problem for stakeholders seeking to complete due diligence on tech-startup opportunities. Both investors and startups need trusted information on the people, financials, product (technology and services offered, and market coverage) and regulations involved. The absence of official databases in Africa on tech-startup investments adversely affects the regularity and rhythm of investment on the continent.
Growth in Africa is skewed towards the “big four” markets of Nigeria, South Africa, Kenya and Egypt, with these countries accounting for 87 per cent of tech-startup funding between 2010 and 2020. The four sectors of fintech, agritech, health tech and energy tech secured approximately 60 per cent of funding deals in 2020
Compared to the Single Digital Gateway in the EU, the US Small Business Administration and the Startup India Portal, Africa does not have reliable and comparable public information on tech startups. In 2020 close to 48 per cent of VC deals on the continent were either partially or entirely undisclosed. There is also a shortage of information on tech-startup revenues and governance, which can result in misreporting and misrepresentation. The near absence of credible public databases increases the costs of transactions and due diligence while reducing investor confidence and diminishing financing inflows to tech innovators.
Volatile exchange rates: In Africa, exchange rates fluctuate significantly, increasing the risks to investors. For tech startups, the price of many components (for example, servers located abroad) are in a foreign currency, partly due to underdeveloped technical and physical infrastructure in the countries of operation. Yet subscription fees and other revenue channels remain in local and national currencies. Risk-mitigation tools to address fluctuation are often cost-prohibitive and inaccessible, so unpredictable exchange-rate movements affect the bottom line of startups and their potential to grow and scale, which in turn puts off investors. In Nigeria, back in 2015, iROKOTV introduced an annual NGN3,000 ($18) subscription plan for audiences but two years later, this fee had more than halved in dollar value due to currency depreciation, resulting in the company scaling back its Africa operations in 2020.
Underdeveloped investment vehicles: Africa suffers from an absence of financing vehicles. While there is potential for more capital to be channelled to startups especially at the early stages, the existing mechanisms are limited. Innovative investment vehicles for smaller ticket sizes (relatively small investments by VCs) at the funding phases of early stage, pre-seed and seed would help to address gaps in funding that other sources may not.
Few exit options: In the African tech ecosystem, exits are seen as the exception, rather than the norm, because of insufficient liquidity events, i.e., an event that allows early investors in a company to cash out some/all of their equity. There are four stock exchanges (South Africa, Morocco, Egypt and Nigeria) in Africa with a market value of more than $30 billion. There are only two African startups that have exited through an initial public offering (IPO): e-commerce platform Jumia was the first, but was listed on the New York Stock Exchange, while Egyptian fintech Fawry went public on African soil.
Recommendations to Close the Funding Gap
In the short to medium term, governments should focus on the necessary policy levers to attract funding from foreign and domestic investors. The measures should focus on addressing information asymmetries through public databases and developing the necessary financing vehicles.
Establish a Public Data-Sharing Platform on Tech Startups
Governments should provide a platform on which investors can access reliable information about tech startups to reduce information asymmetries. While individual countries should prioritise building national databases in the short term, these should be harmonised into a regional database as soon as is practical, with clear guidance on national tech-investment laws and regulations to reduce the transaction costs for cross-border activities. Efforts to make information on tech startups publicly available have been launched by VC4A, Partech, The Big Deal, Briter Bridges, Disrupt Africa and others but most – for now – are partial in coverage or available only to paying subscribers. A framework for a national platform is outlined below.
While governments should lead the process of maintaining public data, they should also actively engage the private sector in the design and implementation process. Tech-startup information, such as company tax and ownership data, can be provided by statutory agencies. Certified incubators and hubs should also play a role in feeding information about startups under their umbrella into the national database. Of course, any platform is only as useful as the data it contains, and the active and direct participation of tech startups and investors is essential.
Develop Innovative Financing Vehicles
Closing the funding gap requires the development of innovative financing mechanisms that meet the needs of the African tech ecosystem.
Innovation Funds
Governments should establish an innovation fund as a critical investment vehicle to de-risk, catalyse, and crowd-in investment and commitment from the private sector and donor community into the tech-startup ecosystem. Leading examples include the Rwanda Innovation Fund, formulated to support local innovation.
The donor community, including the World Bank, the International Finance Corporation (IFC) and the African Development Bank (AfDB), should support the development of innovation funds by providing the catalytic, flexible, patient and risk-tolerant capital needed to attract investment into nascent tech ecosystems. More financing initiatives, such as the $30 million concessional loans the AfDB provided to Rwanda to support the establishment of the Rwanda Innovation Fund, need to happen across the continent.
Fund of Funds
In partnership with donors and investors, governments should establish a “fund of funds” to develop risk capital (funds allocated to speculative activity) for startups at the early stages of their growth. Like the innovation fund, the fund of funds should be managed independently by a fund manager with experience of the Africa tech ecosystem. This fund would provide the necessary risk capital to VC funds in the ecosystem to then invest in early-stage startups. Such a move would be particularly crucial in nascent ecosystems with underdeveloped VC networks. A recent example of a national fund of funds is ANAVA, the Tunisian vehicle established to scale up funding for startups and innovative enterprises. The fund launched with a target size of €200 million to invest in 13 VC funds dedicated to startups in the seed, early and late stages.
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