Supporting the African tech ecosystem requires a mixed approach, with capital only one part of the solution

Equity capital is an important cog in the flywheel of the African tech ecosystem. However, it is not the defining ingredient that drives innovative entrepreneurship in the continent’s different markets. The continent’s founders need a variety of capital sources underpinned by
a broader ecosystem of players that may not be directly linked to the ecosystem but who influence its success.

This point of view emerged during a conversation between Nicola Galombik, Executive Director at Yellowwoods Holdings, Meïssa Gueye, Emerging Markets VC Investor at the International Finance Corporation, and Bongani Sithole, CEO at Founders Factory Africa, who acted as moderator.

The trio were speaking during a recording of the Not So Secret Sauce Podcast Live, hosted at Founders Factory Africa’s Johannesburg office on Tuesday, 23 April. The topic for the live podcast was New Financing Models to Better Support the African Startup Ecosystem.

“A large part of the capital our group deploys is through procurement. We have big operating businesses that procure things every day. Those supply and value chains are massive. You take Nandos’ supply chain in agriculture, you take the insurance businesses, and supply
chains in automotive,” Galombik explained.

“I mentioned those because it’s a bit of an anathema when you are thinking about the startup ecosystem and entrepreneurship and then talking about big corporate procurement. But, these actually are value chains and a key part of what will finance these businesses and what these businesses require for growth.”

While corporations may not represent a startup’s primary source of long-term revenue, their large and sprawling value chains are part of the wider ecosystem and, in Galombik’s view, verticals in their own right. For founders and entrepreneurs, it is important to understand how “these verticals land, how they grow and what makes sense for them to grow.”

On growing the entrepreneur pool itself, Galombik emphasised that it meant enlarging the pools from where entrepreneurs emerged – such as people with entry-level digital skills. South Africa only produces 20,000 people a year with entry-level digital skills, which does not provide a wide base for innovators to emerge since only a fraction of that pool become entrepreneurs who pursue an identified opportunity.

Founders require mixed support because funding is used to identify a business model

Another point highlighted was how capital can be complemented by other forms of support and the different funding models that the continent’s ecosystem has relied on thus far.

Sithole highlighted that Founders Factory Africa was established in 2018 on the premise that “capital in itself is not the whole story”. Their approach to building businesses combined funding with hands-on support, with capital as one aspect of that support.

“I think for many reasons, COVID has changed the dynamics. If you look at the last two years [2022 onwards], there has been an almost 40% depreciation of capital coming into the ecosystem to support entrepreneurship, and especially the tech ecosystem,” Sithole said.

“The second thing we have learned is that many African entrepreneurs actually use growth capital to search for a business model. By the time they’re trying to figure out and put a product into the market, they’ve run out of money, and they don’t necessarily have enough fundamentals to showcase in the market [to attract further investment].”

Debt capital is arguably underutilised in the African tech ecosystem

Sithole’s observation fed into a question asked by an audience member on a funding instrument that had found success elsewhere but not necessarily in Africa: venture debt. Venture debt is a funding instrument that is founder-friendly and geared towards supporting
early-stage startups to scale.

For Gueye, venture debt is a proven and effective way to support startups on the continent. Yet, from his perspective, it seemed to be almost “taboo”. In markets comparable to Africa, such as Latin America and Southeast Asia, and specific ecosystems, such as the Philippines, Mexico, and Brazil, venture debt plays a central role because it helps engineer “the right type of [founder] accountability.”

“As much as people do not like it, [venture debt] is profitable on this continent. There are companies that can achieve 10 to 15% interest on debt,” Gueye said. For founders, capital comes with conditions, but based on the engagements he’s had with startups in Africa’s different ecosystems, they are receptive to the concept. The patience that debt capital gave to founders could not be underestimated.

“A lot of the time, what founders think about is dilution. They do not want to be diluted. ‘Well, how about structuring a convertible that allows you to get your capital now and not be diluted with a low valuation?’. Let’s start that conversation.”

Sithole followed by sharing that the grant capital distributed by Founders Factory Africa later converted into debt when a startup reached a priced round. This approach provided startups with runway the opportunity to build quickly and focus on attaining product market fit. When success is found, they can then pay back that debt.

As the discussion drew to a close, Galombik left the audience with a thought to consider. “I think we have to think about return expectations, the blends on that, and the patience of capital. DFIs, governments, and banks are all players with different roles to play in that process. How can we blend them? You have to get to a critical mass of success. Success is contagious. But, we must define success in a limited way. We have to broaden the definition of who is succeeding.”