Historically, entrepreneurs and small business owners have always made an important contribution to the economic welfare and development of nation states. Today, most countries that prosper economically do so based on a strong foundation of innovative and competitive businesses established by individual entrepreneurs. These risk takers contribute immeasurably to the expansion of any nation’s GDP by running their businesses on strictly commercial lines which focus on driving business growth.
Taken together, the wealth created by these businesses increases the wealth of the nation. So it follows that to encourage entrepreneurship is to encourage long term economic growth throughout the economy. It is not surprising then that as early as 1989 the World Bank declared that entrepreneurs will play a central role in transforming African economies – and so they have, and so they will continue to do if government policy embraces and encourages African entrepreneurs.
Nurturing entrepreneurial behaviour requires the coming together of many complex variables. Such a set of interconnected entrepreneurial support elements implies the existence of a strong national, entrepreneurial culture and access to capital at various stages of a start-up company’s development. These elements, when in place together, within a free market that has a well-developed skilled workforce, create a platform for smooth enhancement of entrepreneurship that ultimately promotes economic growth and social welfare.
In terms of entrepreneurial culture, Africa has some of the highest rates of entrepreneurial start-ups in the world with the African Development Bank estimating that 22% of the continent’s working population are starting businesses. The rate of female entrepreneurship is also astoundingly high with estimates showing that 27% of the female adult population in Africa is engaged in early-stage entrepreneurial activity. Some evaluations indicate that about 70% of jobs created across the continent are in entrepreneur led organisations. In Ghana, as many of 85% of manufacturing jobs in the country are in entrepreneurial ventures. These are of course very positive and encouraging numbers.
However, at the same time, Sub-Saharan Africa also has exceedingly high rates of business discontinuance with almost one in ten entrepreneurs giving up on their dream before fulfilling their aims. This has consequences for the job creation potential of the sector – a particular problem given that population growth will require the creation of very many more new jobs in the future. A further discouraging piece of news is that innovation levels in African start-ups are relatively low and only 20% of entrepreneurs actually introduce new products and services to market through their businesses. Innovation is the most fundamental justification for entrepreneurial activity and its absence diminishes the entrepreneurial spirit. It is clear then that many start-ups in Africa aim simply at survival and that entrepreneurs are driven into business as an alternative to unemployment. This cannot be the entrepreneurial eco-system that we want or need.
Yes we have the makings of a strong entrepreneurial culture, but I suggest that another factor holding back entrepreneurs in Africa from seeing their dream through and taking on more risky innovation, is the difficult access to finance and support. Around the world one frequently finds entrepreneur-oriented infrastructure that includes business angel finance, incubators, accelerators, science and technology parks, university-affiliated seed funds, corporate seed funds and venture capital. These exist in Africa – but then there is nothing in the world that cannot be improved.
Take for example the venture capital element of the entrepreneurial eco system. Venture capital is a type of financing used by start-ups and young companies at different stages of their growth. Particularly during the early stages of a start-up, raising debt capital can be extremely difficult for companies – primarily because of the significant uncertainty that backing them involves. Early stage companies, especially those with business models that aren’t fully proven in the marketplace, or firms that haven’t yet reached break even, often find it difficult to access funding because of their lack of a track record. This is where venture capital investors play a role. They make risky investments in start-ups and early stage companies in return for equity ownership in the expectation that the risk taken today will result in reward tomorrow.
However, the role that venture capital investors play is not limited to capital contribution. They also provide mentorship, industry connections and entire networks of support systems to the start-ups that they invest in. All of this helps enables faster and more solid growth for the start-ups that attract venture capital investment. The value of this approach to financing has been well documented and is well understood – in 2018, seven out of ten of the most valuable companies in the world were entrepreneurial start-ups that had grown from humble beginnings into household names. They had all developed through venture capital funding. They were: Apple, Amazon, Alphabet (Google), Microsoft, Facebook, Alibaba and Tencent. Interestingly, five out of these seven companies have their roots in the United States.
The flourishing entrepreneurial successes of Silicon Valley owe much to the strong venture capital industry that exists there. The widespread access to such strong institutional structures which provide capital to start-ups is something that is being reproduced in other countries. For example in Israel, which ranks second in entrepreneurship after the United States and is considered to be a leading start-up nation, there is also a widespread network of established venture capital firms. In addition, countries like Hong Kong and Singapore, two thriving economies of the South-East Asia, have well-established venture capital industries.
The venture capital scene in Africa is also thriving. In common with other geographies, venture capital companies in Africa are usually organised as limited partnerships, with the venture capitalists serving as general partners and the investors as limited partners. This is the structure that foreign limited partners, who constitute the main source of investment funds in the region, are familiar and comfortable with. Most such companies would manage several funds of capital with each one representing a legally separate limited partnership and directed at a different specialisation or geography. The capital of the fund is invested into start-up firms whose management and business model have been analysed in detail by the venture capital firm’s management. The firm would expect a management fee for this work (perhaps in the order of 2.5% of the deal value) and would also receive a percentage (perhaps 15-30%) of the profit of each fund. The overall objective of the investment would be to sell out the venture capital firm’s equity share for a substantial profit within a limited time frame of perhaps three to five years.
While the general idea of a partnership-based fund may still hold in much of Africa, the specific characteristics of the partnership – the management fee percentage, carried interest, fund life, team composition and investment instruments do not necessarily apply in the same way right across the continent. However, whilst significantly altering the industry’s structure might be desirable in order to accommodate various regional practices, it is not really feasible in the immediate future.
Whether looking at the predominantly western model of venture capital structure or its local African adaptations, it can be seen from this generalised outline of activity that venture capital works to a sophisticated business model – the success of which depends on two relationships. These are firstly, the relationship between the venture capital company and the start-up into which it invests and the and secondly, the relationship between the general partner in the venture capital company and its limited partners or investors.
This latter relationship is important because it influences the ability of the venture capital firm to attract investment. However, the industry in Sub Saharan Africa is at a different stage of development to its counterparts in the USA or Europe. For example, there is a dearth of local investors into venture capital undertakings in Africa and both the industry itself and its client entrepreneurs would certainly be better off with more local funding.
Perhaps one of the reasons for this is that there are some gaps that need to be filled in the continent’s entrepreneurial ecosystem in order to make it even more successful at attracting investors. These gaps, so things that investors wants to see fixed before committing their money, include a capability of entrepreneurs to move beyond a focus on their product and to be able to apply business skills such as making strategy and applying that to the implementation of practical plans for growth. Investors recognise that only 20% of African entrepreneurship is innovation based and they look forward to seeing greater levels of originality from African start-ups, particularly in the technology sector. Only a thriving opportunity driven entrepreneurship culture will produce the kind of deal flow investors are looking for and currently much of our entrepreneurship is employment driven. Training and education are the way to create a more attractive entrepreneurial climate for venture capitalist firms by ensuring that entrepreneurs have the skills necessary to make their ventures work.
Recent research that I have carried out, indicates that there is already a willingness in the venture capital industry to engage with government in these resolving matters. Nothing stands in the way of the industry taking the initiative in opening discussions on how it might cooperate with government to deliver a more efficient entrepreneurial start-up process. This would be achieved by firstly supporting widely available business education for entrepreneurs and secondly in supporting the venture capital industry as a tool of wider economic growth.
If such cooperation between the venture capital industry and government can be brought about and if it indeed succeeds in professionalising the entrepreneurial process then, as African start-ups develop, there is no reason to think that the involvement of traditional players such as Goldman Sachs would not increase. Goldman are already investing as venture capitalists through a $20 million Series A funding round for Nigeria-based freight logistics company Kobo360 and a $23.7 million Series B round for Twiga Foods, a Kenyan food logistics start-up. It also seems that the large corporate venture arms and sovereign wealth funds are also beginning to show interest in venturing in Africa.
The appearance of large, well established players indicates that the African start-up ecosystem is beginning to mature. There is though much still to do in terms of entrepreneur education and easing access to finance. But these early investments, although still small in numbers, act as a signal to a broader group of global investors and help change the narrative that African companies are ‘too risky for mainstream venture capital’. This can only have positive consequences for economic growth and development across the continent.