BACK THE CHEETAH CODE

Investors Don’t Get African Opportunities – here’s why.

The Business of VCs

Very quietly, over the past few weeks the word ‘bubble’ has crept back into the English language as it relates to the investment/silicon valley/tech scene. This is because there have been some staggering valuations, startling exits, and incredible hype for companies that seem to defy common sense. Well, they seem to defy common sense because they do.

In a recent article published by the New York Times entitled “Disruptions: With No Revenue, an Illusion of Value“, Nick Bilton makes the argument that startups that have revenue (meaning they actually add value to someone who’s willing to pay for what they offer) are at a disadvantage when it comes to getting funded. The reason being, he argues, is that investors prefer to build valuation metrics on less tangible things like hype, user traction and perceived market opportunity. This is validated by serial entrepreneur/investor Paul Kedrosky who states, “It serves the interest of the investors who can come up with whatever valuation they want when there are no revenues. Once there is no revenue, there is no science, and it all just becomes finger in the wind valuations.”

Those ‘finger in the wind’ valuations tend to skew high for startups with the right network of investors and individuals involved.

Value vs. Venture

So getting back to my point, this investment thesis is in direct conflict with investments needed in developing nations where the only thing that matters is real value and hype is utterly irrelevant. So why would an African tech entrepreneur expect interest from these types of VCs? They probably shouldn’t.

In the ‘Global North’ (as Western nations prefer to refer to themselves) where GDP growth remains all but flat it’s the opposite, investors know there’re only a few ways to create real value for society. But those ways are tough, big problems that the State frequently intervenes in solving. For instance, alternative energy markets and clean transportation. We’ve already established that GDP growth is relatively flat here, so actually in Western nations the easier game to play is not to add value to society, but to either create the illusion of value for shareholders, or to simply disrupt other industries (essentially moving value from one place to another).

If you don’t believe this, let’s do some simple math. What would the GDP of America be if Facebook didn’t exist? After all, Facebook only has around 1000 employees and about $2 billion dollars in revenue. Yet, it has a $150 billion valuation. Alternatively, the collapse of General Motors almost sank the USA’s economy and it employs over 75,000 people operating on $150 billion dollars in revenue. One produces a lot of ‘likes’. The other produces a lot of physical product that in turn enables other industry. One employs those with a highly specialized skill honed at elite universities with a starting salary of $60k at the lowest, with the vast majority of non-executive making at least $80k or more. The other, General Motors if you aren’t following, employs people with less specialized skills that could be acquired at any US university, at a starting salary of $30k, with the vast majority of non-executive staff making in the realm of $60k. So the answer to the question of ‘What would the GDP of America be if Facebook didn’t exist?’ is: pretty much the same. Again, the faltering of GM nearly caused the implosion of the American economy (given how much revenue it accounts for and how many industries it touches).

But aside from the net worth of the millionaires and billionaires that run and work for it, Facebook doesn’t directly produce anything that can be commoditized by anyone, other than Facebook. Alternatively, if you buy a GM car, ride it for a few years, and sell it, although you may not have completely commoditized what they produced, their products have in effect added value to the world multiple times. First for the company that made it (General Motors), then the car dealer that sold it to you, then you, then whoever you sold it to, and whoever they sold it to, and so on and so on.

The Circle of Wealth

Tangible goods have finite value, which although may diminish over time, will never hit absolute zero. I can go to a landfill tomorrow, dig up some random junk from 1932 and sell it to ‘someone’ for ‘something’ – an antique dealer, a flea market, groups that recycle waste for profit etc. But what can I do with my five years of Facebook history? I can’t commoditize it any way, even if Facebook can. A few companies like Klout and Kred have figured out ways of commoditizing social activity, but it’s debatable how sustainable their models are.

This is not to say that intangible value is completely worthless, it just means that companies that commoditize intangible value largely rely upon investors to fuel growth until they get to a point where they are acquired for a multiple of what those investors have put in up to that point. This is what makes intangible value seem like it creates real value, when in fact all that’s occurred is a redistribution of wealth – from one company that has excess of cash – to a smaller company that has an excess of shareholders.

When you look at companies like Google, they are incredibly good at turning the actual value they offer other industries into healthy profit margins. When you look at companies like Facebook, Twitter, Instagram, and Pinterest, they are incredibly good at turning a steady traction of users, attention, and coverage by the press into actual value for themselves, by getting investors to pump more and more cash in to fuel growth. When these companies go public, there is increased pressure to either keep growth (and thus hype strong) or to actually start generating the kind of revenue that justifies the valuations of investors. Those investors control funds that have been created by a few wealthy individuals, but mostly other companies, usually companies that produce something of actual value seeking return on their investments.

So in a really odd way, the holy grail of investment is creating things of perceived value over things that have actual, measurable value, because it allows said investors to essentially move wealth back and forth without diluting their market. Occasionally there’s a rare moment where there is an absolutely massive exit that makes it all worthwhile (ex. Andressen-Horowitz cashing out at $78 million on a $250,000 investment into Instagram). But that money didn’t come from thin air, it came from venture capitalists. Those VCs got it from their funds, and their funds got it from companies that produce tangible goods or services seeking to maximize profits by putting money into such funds. As you can see it’s not that difficult, it’s brilliant, but very much circular in terms of where value comes from and where it ends up.

A Simple Science

So why don’t these types of investors take risks on African market opportunities? For starters, there’s the usual explanations: there’s not enough money to make it worth their while, the political and legal environments aren’t reliable enough, or the societies themselves aren’t stable enough. Then there’s other excuses like: there’s not enough talent to sustain growth, the cost of doing business is too high, or locality – they like to keep investments close and these countries are simply too far. But the real reason, it seems, is that in developing countries nothing is more necessary than something they’d rather avoid – absolute, measurable value.

When it comes to profit, many modern VCs simply aren’t interested unless that profit comes in the form of their exit from the business. For those who don’t know, ‘to exit’ means to sell the stock acquired through their investment in a company to another party. This usually comes in the form of someone else either buying them out directly, or buying the company they’ve invested in, effectively buying all the stock at a new price – when the investor bought it at an older (cheaper) price.

So if investors from the Global North are used to playing a game where the only things that matter are perceived value, why on earth would they ever enter markets where everything has to be measured in terms of actual value? It’s a simple science: stay away.

The Inverse Problem

NGOS, Charities, and traditional Philanthropists actually compound the problem immensely. With most of the wealthiest investment funds in the world looking to keep up a game of illusions and ‘wealth remixing’, Philanthropists are playing a different game.

For one, they are largely funded by thier governments (groups like USAID). The ones that aren’t are funded by private foundations and individual donors (groups like the Bill & Melinda Gates Foundation). Both types of Philanthropists (Governments and Donors) think in terms of absolute value but for them that value equates societal impact. These types of investors (after all Philanthropists are investing in something too) are looking for results like reduced infant mortality rate, improved test scores at schools, and a greater standard of living for the poorest.

They tend to measure success using globally understood milestones like the Millennium Development Goals, or relative measurements of progress like ‘reduced corruption’. Thus, the value they seek by is the inverse of what Venture Capitalists seek – societal impact versus and intangible (perceived) impact.

What’s missing is that neither of these groups (VCs or Philanthropists) are interested in the actual, measurable, impact created by businesses that maybe don’t have any direct social impact but that do create actual jobs from revenue. Even the few investors who claim to be interested in investing in African businesses make the mistake of looking for either: a quick exit based on intangible value (ie. selling the company quickly to someone else), or societal impact that may or may not be tied to a sustainability model. There’s nothing wrong with either scenario, great companies are built and invested in from both spaces. But there is a gap, and it lies with those companies that simply want to to be great, long-lasting, bottom-line focused companies.

Where do they find capital to scale to keep doing what they do? In Western societies this gap is filled by banks who offer debt (loans or lines of credit) to consumers. In developing countries, this is still a problem for small business owners. Local banks don’t operate with enough liquidity to make such investments profitable and foreign banks find the markets to risky (in comparison to their less risky, highly profitable investments abroad) to even consider it.

I suppose you might be thinking that ‘microfinance’ was going to be the silver bullet that killed this beast? Well, microfinance certainly gives access to capital to the very poor, which has immeasurable positive economic impact on society. But there are negative impacts as well. Since debt is such a foreign concept (funds accessed through microfinance methods are almost always loans) the costs of taking such loans are quantifiable, while defaults have consequences (as they should). Some societal norms make it the case that women taking out loans are put at risk by envious husbands who simply take the money and spend it recreationally. Still, however helpful or detrimental micro-financing is, at loans of an average of a few hundred dollars, it doesn’t reach the most important business class of the population: local SME’s that increasingly employ the burgeoning African middle class.

Local Investors Remain Silent

You would think that given the failure of foreign investors to see the opportunity that relatively small amounts of cash could have on these societies, and the failure of Philanthropists to see the business opportunity, that local investors would be well-poised to fill the gap. Not so.

Local investors are so desperate to cling to their wealth that they tend to give their money to foreign funds for management. Or in the scenario where they feel guilty about their success or maybe philanthropic in their own right, they donate to non-profits to help acheive social impact. In that regard the local African multi-millionaire is no more knowledgable about these issues than any foreign investor would be!

Et tu, Diaspora?

Make no mistake, the African diaspora has 100% filled this gap for decades. A businessman working on wallstreet hears from his cousin in Nigeria that they need a few thousand dollars to grow their company, so he sends it; a brother who’s expatriated sends money to his younger sibling to help them start up a hair salon; the parent who works for a foreign embassy pumps money into their child’s aspirations of building the first Pan-African social network. I’ve witnessed each of these stories first-hand, they aren’t anecdotal. Remittances are great, for some people. What they aren’t is systematic and scalable, and so they are almost irrelevant.

The power of the Venture Capital industry, and likewise the Philanthropic/Non-Profit industry, is that they are in fact industries. They have been orchestrated to create jobs and wealth for huge portions of society. While the ephemeral diaspora is a great thing, it is unorganized, haphazard, and unreliable at scale.

In an article published on The Sojourner Project, A. Conerly Coleman writes, “Diaspora aid has surpassed international aid on the continent of Africa.” She then goes on to make the case that Africa ‘doesn’t need international Aid.’ Until someone can organize remittances into something that looks more like a Venture fund or even more like a Multi-national Aid agency, I’m afraid to say such thoughts are simply wishful thinking.

Whether you’re for developmental aid, or against it, at least we mostly understand how it’s distributed and it’s also non-tribal. Remittances are useless for someone starting a business in Lagos, Nigeria when they have no family who’s ever moved abroad. And they are even less likely to be successful in finding money if they start asking other random families from, say, Kampala, Uganda.

I do have huge hopes that someone will crack this problem. Companies like VC4Africa, Afrilabs and MYC4 have come close but we’d all be incredibly naive to proclaim the problem as solved.

The Middle is Still Missing

Five years ago all of this was as much of a problem as it is now. There is still no fund (that I’m aware of) that invests in African companies which lack an obvious social focus, or that that won’t result in relatively quick exits. The idea of patient capital popularized by Jacqueline Novogratz couldn’t be less-so when it somes to African SMEs. It’s often the opposite – more like a strict, catholic nun waiting with a yard stick to smack the hands of any African venture that should dare to do anything…well…normal.

Disclosure: I’ve been working for years at this problem through my ventures Appfrica and Apps4Africa, as well as the projects with others I’m involved in AfriLabs and HiveColab. As a result, I have made or participated in several investments into African SMEs professionally. However, I as an individual don’t command the kind of wealth that a fund would. The challenge is to make such things happen on a larger scale, in order to spread such opportunities around to more than just a few.