The evolving landscape of PE/VC funding in Africa

Small and medium enterprises (SMEs) are the backbone of the global economy, and, in the developing world, they account for 90% of the private sector and create more than 50% of jobs in their corresponding economies [www.csis.org]. In Africa, according to the African Development Bank (AfDB), SMEs account for more than 90% of businesses and almost 80% of employment. Of the 60 million registered companies in Africa, some 50 million are SMEs, with 17 million in Nigeria alone. They form the backbone of the economies, producing about half of countries’ GDPs (in Ghana it’s as much as 70%) [www.stias.ac.za].

It is readily acknowledged that the key to Africa’s economic growth lies in the development of this sector, which has the potential to transition the economy from low-income to middle-income status. [UN Economic Report on Africa, 2020]. Yet, despite their significance, SMEs face a massive $4.5 trillion credit gap, impeding their growth and hindering poverty reduction efforts. This means that roughly half of the small businesses on the continent cannot access the financing they need.

As we work in and are passionate about investment in Africa, we wanted to take some time to explore the reality of private equity (PE) and venture capital (VC) funding in Africa, diving into the sources and destinations of financing, along with the challenges encountered by SMEs and local PE/VC firms. Through a thorough analysis of investment data and expert insights, it becomes evident that despite notable advancements, there remains a demand for more capital-seekers ready for investment and a broader spectrum of investors. Moreover, the significance of governance and the role played by banks, development finance institutions (DFIs), and fintech companies in tackling the funding gap and propelling sustainable development in Africa’s entrepreneurial ecosystem is underscored.

Investment in Africa 2022 – Unlocking potential
According to Briter Bridges’ Africa Investment Report 2022, African start-ups secured approximately $5.4 billion in total funding across more than 975 deals, showcasing positive growth trends. However, when compared to the global PE/VC investment total of $483 billion, Africa’s share accounts for only around 0.7% to 1%. Moreover, the distribution of capital is heavily skewed, with a few mega-deals dominating the funding landscape. Nigeria, Kenya, Egypt and South Africa attracted the majority of PE/VC investments, primarily in sectors such as fintech, cleantech, logistics, mobility and e-commerce.

Despite the promising growth, African SMEs and start-ups still face challenges in accessing PE/VC funding. One significant obstacle is the limited availability of early-stage funding. While there is an increasing number of angel investors and seed-stage funds, the gap between seed and Series A funding remains significant. SMEs and start-ups often struggle to secure the necessary follow-on investments to scale their operations. This gap indicates the need for more active participation from local PE/VC firms and the development of a robust ecosystem that supports start-ups at various stages of growth.

Challenges faced by African PE/VC companies
Raising funds for non-mainstream sectors in Africa remains highly challenging. The local PE/VC landscape is still predominantly influenced by non-African CEOs, and accessing PE/VC funding requires extensive networking, pitching and targeting of the right investors. A recent report by Africa Venture Capital highlights limited access to family funds and angel investors, unconscious bias during investment decision-making and the lack of appropriate networks as major obstacles faced by local investors. To bridge the funding gap, there is a need for increased collaboration between local and non-African PE/VC firms.

Another challenge is the perception of risk associated with investing in African SMEs and start-ups. Many international investors perceive Africa as a high-risk market due to factors such as political instability, regulatory uncertainties and infrastructural deficiencies. To attract more investment, African SMEs and start-ups and PE/VC firms need to proactively address these concerns by showcasing strong governance practices, transparent financial reporting and clear growth strategies. Building trust and confidence among investors is crucial for attracting long-term capital inflows.

The role of governance and market readiness
To attract investments, SMEs in Africa must prioritise governance, transparency and market readiness. Many SMEs operate informally and lack proper financial records and governance structures, making them less appealing to investors. While PE/VC firms play a role in investment readiness, SMEs need to formalize their operations and adopt governance systems. This not only attracts larger investments, but also allows access to smaller injections of capital from hybrid finance, debt financing and loans. By embracing debt financing, start-ups in sectors like fintech and cleantech are broadening their options and attracting more diverse capital providers.

Governments also play a vital role in supporting entrepreneurship, private equity (PE) and venture capital (VC) investments. By implementing policies that encourage entrepreneurship, reducing regulatory burdens and providing tax incentives, governments can create an enabling environment for start-ups and investors. Furthermore, strengthening partnerships between banks, development finance institutions (DFIs) and fintech companies can enhance access to finance and bridge the funding gap.

Why is this significant for impact investors like Brightmore Capital?
The evolving landscape of PE/VC funding in Africa holds significant relevance for impact investors operating in the region. Impact investors, who prioritise both financial returns and positive social and environmental outcomes, can play a crucial role in addressing the funding gap and driving sustainable development in Africa. By channeling their investments into African start-ups and SMEs, impact investors can support innovative solutions to the continent’s pressing challenges, such as poverty reduction, access to basic services, climate change and job creation.

Key sectors that attract PE/VC funding in Africa include fintech, cleantech, logistics, mobility, and e-commerce, which align with many impact investors’ focus areas. In addition to the traction that early-stage enterprises need to attain, certain qualitative elements are also paramount to render a company a viable and attractive PE/VC investment target. “Governance, transparency, and the ability to build a good team are things that are commonly taken for granted, but are crucially important,” says Dmitry Fotiyev, Co-Founder and Partner of Brightmore Capital, “too often they are either forgotten about, or de-prioritised in the rush to ‘hack’ growth. For us, their absence can easily derail an otherwise attractive deal.” Thus, PE/VC investors conduct a truly 360-degree scan of all elements that create for a successful SME that has the potential to be a “regional champion”.

By actively participating in the African PE/VC ecosystem, impact investors contribute to inclusive economic growth, social progress, and environmental sustainability in the region, whilst generating financial returns. Furthermore, collaboration between local impact investors and local and international PE/VC firms can foster knowledge exchange, capacity building and the development of tailored investment approaches that consider the unique needs and challenges of African entrepreneurs. Together we have the potential to drive positive change and make a lasting impact on Africa’s entrepreneurial landscape and its pursuit of sustainable development.

In conclusion, while Africa’s PE/VC landscape is evolving positively, challenges remain in narrowing the funding gap for SMEs. African SMEs and start-ups need to enhance market readiness and prioritise governance to attract more investment. Local PE/VC firms must overcome obstacles such as limited access to funding, unconscious bias and the dominance of non-African CEOs. Collaboration between local and international PE/VC firms can foster a more inclusive and supportive ecosystem. Additionally, governments should continue to implement policies that facilitate entrepreneurship and incentivise investors. The financial system in Africa needs to accelerate diversification to build a full range of financial institutions and products tailored to the specific needs of the business ecosystem. Inadequate finance hinders private sector development in Africa. Thus, innovations by banks and non-bank financial institutions, including financial technology (fintech) firms, are needed to respond to private sector financing challenges. By addressing these challenges and nurturing a robust PE/VC ecosystem, Africa can unlock its entrepreneurial potential and drive sustainable economic growth for years to come.

Referenced and supporting sources:

[www.csis.org] Supporting Small and Medium Enterprises in Sub-Saharan Africa through Blended Finance | www.csis.org

[stias.ac.za | Marcus Fedder] Can Fintech help to close the financing gap for small and medium size enterprises in Africa | www.stias.ac.za

[Briter Bridges] Africa Investment Report 2022 | briterbridges.com

[Africa Venture Capital] Where does the funding go? | Africa Venture Capital / Shell Report

[UN Economic Report on Africa 2020] Innovative Finance for Private Sector Development in Africa