Hope or Hype? Opportunities and Challenges for Africa’s Startups

11.30.15

Hope or Hype? Opportunities and Challenges for Africa’s Startups

11.30.15
Michael Blann via New Yorker

By Andrew Manners for Global Risk Insights

As the global economy continues its sluggish recovery and emerging markets stutter, investors are looking further afield for newfound opportunities. And with well over a billion people, a growing middle class, an educated elite, and established trading capitals including Lagos, Johannesburg, and Nairobi, it’s no surprise many are turning their attention to Africa and its lucrative frontier markets.

Now home to some of the world’s fastest growing economies, the continent is quickly shirking its reputation as a basket case financially.

Earlier this year, in fact, Bob Geldof, whose Live Aid campaign helped raised millions for relief efforts in Africa in the mid-1980s, declared that, ‘they don’t have to die in vast numbers before we pay attention… the potential rewards are far greater than anywhere else.’ The rock star turned activist is putting his money where mouth is, too, channeling much of his personal fortune into an Ethiopian rose farming venture and spearheading a private-equity push into the region.

Geldof’s dealings are symbolic of the change sweeping much of Africa today; whereas countries such as Ethiopia, Kenya and Nigeria were magnets for charity – including Geldof’s – not long ago, today they are attracting some of the world’s leading dealmakers looking to cash in on the diverse opportunities and impressive financial returns on offer. Increasingly, these investors are looking beyond the traditional industries of commodities, manufacturing and agriculture.

For those willing to take on more risk, Africa’s startups have become enticing prospects. Buoyed by a rapidly expanding mobile network, increasing internet penetration, and a growing middle class with increased spending power, startups in Africa have already seen a number of funding rounds and acquisitions. With large growth potential, individual “angel” investors and larger venture capitalists will be keenly watching how these new startups fair.

Yet despite the enthusiasm of Geldof and others, Africa’s investment climate remains shaky, not least for high-risk enterprises such as startups. Widespread corruption, complex regulatory regimes, long due diligence processes, limited access to finance, and ongoing political insecurity are but some of the challenges facing investors in Africa today.

For those investing in African startups, therefore, it is essential to remain aware of the major obstacles today. The biggest obstacles facing startups are considered below.

Lack of Business Experience and Knowhow

Despite their enthusiasm, the majority of African entrepreneurs lack the formal education and background their western counterparts have enjoyed. This inevitably means such entrepreneurs are inexperienced and, oftentimes, they struggle with key areas such as the fundraising process.

This may become especially apparent if the fundraising or investment processes are cross-border, negating a standardized legal framework.

For the same reasons, finding staff that have the knowhow to help fledgling companies succeed can also prove difficult. Writing for Scidev.net, Irene Frieshenhahn claims that ‘Sub-Saharan Africa’s higher education system has expanded massively since the 1970s. Student enrolments across all levels grew from 200,000 about 40 years ago to an estimated ten million today.’

But, she says, the same can’t be said for Africa’s tertiary education system, which continues to lag behind. That means that, unlike the US, finding the right people for the right job can be a tricky task. As a recent Forbes article concludes, ‘shortage of local talent is by far the largest problem in Africa. Both at the lower end, because of lack of training and illiteracy, and at the upper end, because the shortage of managerial expertise creates huge competition for talent and commands salaries for managers even larger than that in developed economies.’

Operating Costs and Procedures

Startups in Africa also face high operating costs. According to Global Risk Insights, service costs in Africa are extremely high and the price of electricity and internet connection can be exorbitant. In places such as South Africa, rising costs can eat away at turnover.

In fact, a recent report by the South African government found that ‘escalating operating costs have dampened profit growth since the 2009 recession.’ Citing a rise in employment and purchasing costs, it added that ‘the share of turnover available as profit has decreased over time.’

Operating procedures also remain burdensome. According to the TMF Group, an Amsterdam-based consultancy, getting electricity is a huge concern for businesses in South Africa and can take upwards of 200 days, which includes a string of lengthy procedures.

Similar instances are commonplace across Africa, with public utility companies notorious for their delays and poor service. Auxiliary services, meanwhile, including power, water, transport and supplies, are often inexplicably absent, making doing business impossible in some areas.

Complex Regulatory Procedures

Government regulations and tax laws also make investing in Africa difficult. The continent has made sweeping regulatory reforms in recent years in a bid to ease the burden on investors, but challenges remain. Unlike the US and UK, there are no tax incentives for angel investors, while local investors face insecurities about legal and tax frameworks.

Foreign investors, meanwhile, often need a local contact, or “sponsor,” in order to legally invest in many Africa countries. In addition, investors remain unsure about whether they can withdraw money from a country after making certain capital transactions.

Such trends have had a negative effect on investor sentiment in Africa. As Vinny Lingham, an angel investor says, ‘In South Africa, investor confidence in the government and the exchange rate is waning… Government policies are preventing foreign investors from actively backing South African startups in a meaningful way.’

Access to capital

Given these issues, it is not surprising investors often shy away from startups in Africa. Yet this often meanas startups face the addition problem of being unable to access and obtain capital, with many finding it impossible to gain enough funding, even with western support.

While many new companies are successful in raising tens or even hundreds of thousands of dollars initially, the challenge for entrepreneurs and investors is to grow their companies to a size where they become viable prospects for larger capital funds to snap up. So far, that isn’t happening, and investors and venture capitalists, if they are investing in Africa, are continuing to pursue the well-trodden roads that promise smaller but more stable returns.

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