Startups

Why Do Early-Stage African Startups Still Face Major Funding Gaps?

Read more at thefintechtimes.com

Africa is a land of unbridled opportunity for investors willing to work with new businesses, particularly those willing to invest in small and medium enterprises. But for many African startups, investment funding is hard to find. 

Even fintech, which receives a large part of African VC funding, still faces a funding gap compared to its non-African peers. Financial inclusion is not lacking just for individuals in Africa; it is also lacking for businesses.

Africa is a unique investment environment, and addressing the startup funding gap in Africa will take creative solutions. It may also require investors to rethink how they approach investments. Investors must make greater efforts to understand Africa’s intricacies rather than imposing Western business models that simply do not apply. 

The importance of fintech in Africa

Financial inclusion is a substantial issue in Africa. Currently, a majority of the African population is unbanked and lacks access to other standard financial services such as credit and insurance. Fintech offers viable solutions for improving financial inclusion in Africa.

Poverty and lack of financial inclusion exist in a vicious self-reinforcing circle that is difficult to break. While fintech alone cannot solve the poverty dilemma, it can effectively lower many structural barriers to financial inclusion. By doing so, fintech can help break the poverty-inclusion cycle. 

Among the traditional barriers to financial inclusion in Africa are:

  • Affordability – Fintech provides more cost-effective services than traditional banking.
  • Distance – Anytime, anywhere access to financial services via mobile devices and branchless financial institutions helps reduce many logistical barriers to access.
  • Distrust of financial institutions – Fintechs have a tremendous opportunity to develop customer bases among those jaded by scandals at major traditional financial institutions.
  • Financial literacy – Many adults lack sufficient financial literacy to understand their options, and fintechs can help the unbanked build an understanding of financial systems.

Fintech organisations are also helping African citizens protect their money against risks and uncertainty, for example, by providing currency alternatives that resist the economic effects of political instability and political corruption. Nigeria offers a prime illustration. With interest rates soaring in recent years, Nigerians have turned to cryptocurrency as a haven for their savings.

Fintech effects extend into the business world as well. Fintech is making major strides in building SME resources in developing markets. And fintech startups may also help other African startups, even beyond their lending needs. The two primary areas of fintech startup investment in Africa are in payments and credit offerings, which benefit individuals and businesses alike. Providing cost-effective, efficient money transfer is key to continuing to develop businesses in Africa. 

The VC funding gap for African fintechs

With so many opportunities for fintech in Africa, the lack of VC funding is perplexing. Although startup funding has significantly increased in Africa in recent years, African startups across the board are less well-funded than startups anywhere else in the world. According to a recent report, startup seed rounds in Africa significantly lagged behind Asia and South America. At $1.5 million, the average seed round for an African startup was around a third of Indian startups ($4.6 million) and a fourth of Latin American startups ($5.7 million).

The funding reaching Africa is also highly focused, with the vast majority going to only five of the fifty-four African nations. As a result, overall funding numbers overstate the impact of VC funding in Africa. Many African startups lack access to funding simply because of their home country.

Fintech startups are no exception. While accounting for between 25 to 40% of all startup investment in Africa in 2020, fintechs still face difficulties obtaining funding. Total fintech startup investment in Africa in 2020 amounted to a little over $1.3 billion, or around 1.2% of the total $105 billion in fintech startup investing. By comparison, Indian fintech startups received around $3 billion (2.9%), and U.S. fintechs received $76 billion (72.4%).

Although there is no single explanation for funding disparities, a close review of VC funding points to several potential causes.

Treating Africa like Silicon Valley

Many investors make the mistake of treating African startups as if they are just another addition to the U.S. startup landscape. But this approach ignores the intricacies of Africa, as well as its lack of homogeneity. 

To properly understand the opportunities for investment in Africa, investors must take time to understand the African continent and the region in which they are looking to invest. Treating African investments like U.S. companies ignores market realities and diminishes the perceived value of investments.

The unsettling presence of bias

It is unfortunate that bias, whether conscious or unconscious, reduces the participation of minorities in finance. Lack of diversity in hiring and lack of diversity in VC management then translate into lack of diversity in VC investments. And because it is well-known that investors fund businesses with which they relate, lack of diversity and bias translate into funding disparities in Africa.

Bias also impacts funding for women-founded or led startups, who received less than 15% of total startup funding in Africa in 2020. This is despite the fact that sub-Saharan Africa has the highest percentage of female entrepreneurs worldwide at 27%.

Risk issues

Many investors consider African ventures to be inherently riskier than opportunities in other regions of the world. Indeed, many potential investors, particularly US-based investors, see only political instability, wars, totalitarian regimes, threats of nationalisation, health care issues, and violent racial strife and immediately dismiss thoughts of investing. 

Add to that currency risks in countries like Nigeria, where the local currency has been severely devalued, and from the start, there are almost insurmountable emotional barriers to investment.

Even when investors are more analytical and pragmatic and go beyond these initial concerns, issues such as lacking infrastructure can make startup businesses appear less viable. Overcoming these objections to investment may require funding groups to develop new approaches to the risk-reward analysis for African startups.

Creative funding solutions for African fintech startups

All is not lost for African fintech startups. But closing the funding gap may call for recourse to alternative funding sources while the rest of the VC world comes to terms with properly investing in Africa. 

Following on the wave of socially conscious investing, several VC funding groups are now focusing their investments specifically to eliminate financial inclusion disparities. Funds like AfricInvest are infusing large amounts of capital across the continent, and not just in the countries that already receive the bulk of startup investment.

Other funds focus on specific issues, such as funding for a large number of African female entrepreneurs. FirstCheck Africa is helping address gender disparities in VC funding, by providing funding to female-owned businesses and by putting women in charge of the investment decisions.

Another option is for fintech startups to invest their cash reserves in long growth frame assets such as stocks and real estate, which typically results in at least 5% growth after just one year from the initial investment. This is a solid option for startups that want to secure their money while letting it grow, as opposed to just letting that money sit in a bank account. 

Additionally, crowdfunding and microfinance platforms are also investing more and more money in African startups. Many investors interested in assisting African businesses, particularly small businesses and individual entrepreneurs, are putting money into crowdfunding and microfinance platforms as a socially conscious alternative to traditional stock trading.

Investors should take a closer look at African fintech

Without question, fintech has tremendous potential for growth and profit in Africa. Investors should take the time to look at African fintech startups and understand the markets in which they operate. In doing so, these investors will develop a specialised understanding of the political, social and financial environments their startups operate in.

  • Francois Moreau

    Francois is a financial risk analyst by day and a gamer by night. For the last decade, he has worked building financial risk models for multinational banks. He’s also an active tech writer and reviewer of all kinds of gadgets.

Read more at thefintechtimes.com

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