African tech startups can ride out the global cash crunch, but they must position themselves to scale efficiently rather than pursue growth at all costs.
According to the eighth edition of the annual African Tech Startups Funding Report released by Disrupt Africa in January, a total of 633 African tech startups raised a combined US$3,333,071,000 over the course of 2022, a record in both respects.
Yet the latest episode of Disrupt Podcast’s “The month in VC” series, produced in partnership with Katapult Africa, Kalon Venture Partners, and Hlayisani Capital, focused largely on the collapse in investor confidence globally, and why Africa should now be bracing itself for a new era of capital scarcity.
Why the sudden concern, however? And why has Africa continued to post record funding figures even as globally investment is falling? Brett Commaille of Hlayisani Capital said the continent tends to lag when it comes to global financial trends, particularly in the VC space.
“Because we’ve got quite a small base that we are operating off, it’s not necessarily hard to either outperform or to drop within that small base. You can have one or two large transactions that can make quite a difference. The same as when numbers were really picking up and getting exciting, it took a while to feed through here. There’s going to be a natural lag in terms of the scarcity hitting this side,” he said.
That said, there is already some evidence of it. Disrupt Africa reported earlier this week that startup funding in Africa fell by 57.2 per cent in the first quarter of 2023 compared to the same period in 2022. Eighty-seven startups secured funding in Q1, less than half the number (175) that had done so by this time last year. And those startups have between them taken in a combined US$649,303,000, down from US$1,515,556,000 by April 1, 2022.
Commaille thinks this capital scarcity will further hit in the second half of the year, as both local and international funding sources dry up, for different reasons.
“We’ve had too many negative global signs for it not to affect us. What we need in Africa is for traditional fund managers to take VC seriously, and it’s hard for them to do that when their counterparts internationally have such negative sentiment,” he said.
“And those international players who perhaps were looking for more opportunity by coming to the continent may now be a little more reticent. So I think that’s going to hit us, I think we’d be naive to think that it wouldn’t.”
Commaille does not think the scarcity of capital will have a devastating effect on the African tech space. Yet it does change the way ventures operate. Two years ago, raising money was relatively easy, and startups could afford to pursue relentless growth. Now, that is not the case, and startups need to change how they operate. Clive Butkow, of Kalon Venture Partners, agreed.
“During this downturn, it is about efficient growth. It is about capital efficiency. It is not about just driving growth. Yes, growth is important, but it is not the only thing that is important. The important thing now is to either get to free cash flow, or show that you have a path to profitability,” he said.
This, Butkow said, is the route to raising further capital in the current climate.
“If you get to free cash flow, or you have a path to profitability, there will be another cheque down the line for you, because that is what VCs are looking for, that one per cent of companies out there. And there will be capital for those top companies,” he said.
Commaille said it is still possible for startups to grow, but they must be shrewd about how they are using their resources.
“We’re talking about driving growth, but making sure you’re spending your money in the right way. So if you’re experimenting in terms of how you will drive growth, whether that is through partnerships or through teams, you’re not trying to launch 10 countries at the same time. It’s about maybe one or two, making sure that you get your approach correct, and then scaling that,” he said.
“So I think companies need to be shrewd in how they select what they are going to do, and once they test that that is a workable strategy, then you can boost and really invest behind that. But you’ve got to make sure that you are not running a bunch of experiments at the same time that can leave you without cash, especially if none of them work.”
For those that don’t manage to grow more efficiently, troubling times lie ahead.
“I think what we are going to see, probably by the end of this year, is a lot of companies going bust. Because they raised a lot of capital at high valuations, they’ve been growing fast, and they’ve just been spending, spending, and spending,” Butkow said.
“Now they are trying to curtail that – you’ve seen the amount of cuts there have been at technology businesses. People are now realising that growth at all costs is not the mantra you have to follow, because that’s a mantra to drive yourself off a cliff. Some of them are going to be too late, they are trying to react too late.”
Commaille believes it is the better-funded ventures who are the ones that will face the biggest challenges.
“If you’ve been taking some of the bigger rounds, your investors are likely those from international markets. It is harder to find the larger sums, the larger funding rounds, just from the continent, so the more exposed you are to international funding rounds, and the larger your funding requirements, the more likely you are to need to be pulling back and setting your cash to last longer,” he said.
Butkow said he wants his portfolio companies to have as much runway as possible, to ensure they survive to see the light at the end of the tunnel.
“I like our companies to be at 24 months minimum, preferably 36 months. This crunch we are going through now, the bad times we are going through now, hopefully will be all over in 24-36 months. I’m not saying we’ll be back to the good old days of 2021, but we’ll be back to normalised days where there will be capital and good companies will be able to raise at a good valuation.”
