There is a significant connection between the erroneous valuation of startups and their failures. As a matter of fact, a couple of these startups haven’t done any transactions and yet claim bogus valuations. Most venture capitalists (VCs) fail to do proper diligence and are bothered by the next capital raise.
David Adeleke, co-founder and CEO of Zeeh Africa
Just recently, the African tech ecosystem was thrown into a conversation on the longevity of startups and their products and the role VCs play in the eventual outcome of some of these startups that emerge like the next best thing, only to close up shop when it’s least expected.
Of course, that conversation was borne out of the most recent collapse, or perhaps, the shutdown of the Ghanaian fintech, Dash, which had raised $86.1 million in five years and attracted big-name investors. In fact, the startup had raised $32.8 million in a seed round in 2021, which was the second largest seed round for an African startup in that year.
But Dash isn’t the first, and neither does this writer think it is going to be the last African startup to fold, not because I am a prophet of doom. Just about a few weeks ago, genomics startup 54Gene also winded down its operations, signalling a dramatic fall from grace after securing $45 million in funding across three funding rounds.
There are traceable causes linked to the mismanagement of funds and the high cost of overhead. This has now manifested itself openly as a dubious wage bill for founders managing these companies. This article would rather focus on the problem than the symptoms, seeing that these “set of founders” do not function in isolation, nor are they unanswerable to people who have invested so much in them.
VCs, and the problem of valuation of African startups
In recent years, the African tech startup scene has witnessed a remarkable surge in innovation and entrepreneurship. From fintech to healthtech, e-commerce to agri-tech, the continent is buzzing with promising startups looking to solve critical problems and revolutionise industries. However, beneath the surface of this exciting growth lies a troubling trend: the disconnect between the soaring expectations of venture capital (VC) firms and the harsh realities faced by these budding enterprises.
VC firms, fueled by a desire for high returns, often enter the African startup arena with sky-high expectations. They seek startups with astronomical valuations and expect rapid returns on their investments. While it’s natural for investors to aim for profitable opportunities, these lofty expectations can sometimes lead to a mismatch between what startups can deliver and what VCs anticipate, ultimately causing more harm than good to the ecosystem.
A recent tweet by Subomi Plumptre, the CEO of Volition Cap, an asset management company, probably put this issue into more perspective. See below.
It is obvious from this post that there is apparently a disconnect between the expectations of investors, their interests, and the realities of some of these startups. Speaking to this, the founder and CEO of Zeeh Africa, David Adeleke asserts that he believes there is enormous pressure from investors on African startups to scale quickly in quite an unstable market.
“Some VC firms put pressure on startups to scale quickly, and they have a short-term focus. However, market realities do not accommodate such expectations. Hence, VC firms should start focusing on long-term sustainability and provide clear communications with startups,” David says.
Africa’s tech startups, while filled with potential, often face numerous challenges that can hinder their growth. Out of the many challenges, market unpredictability is one major obstacle they must navigate. Consequently, achieving the sky-high valuations expected by VCs becomes an arduous task, even for the most promising companies.
Under the weight of these expectations, startups feel the pressure to inflate their valuations to attract investment. When these valuations don’t align with their actual growth and market potential, it sets the stage for disappointment. When the expected returns don’t materialise as quickly as VCs hope, startups find themselves in precarious situations. The pressure to meet unrealistic expectations can force startups to take shortcuts, compromise their long-term sustainability, or even pivot away from their original mission in pursuit of profitability.
The consequences are profound. Startups that fail to meet these inflated expectations often find themselves on the brink of closure, depriving the ecosystem of innovation and causing financial losses for both founders and investors, but ultimately, the customers become the losers. The repercussions ripple through the industry, eroding trust and making it even more challenging for new startups to secure funding. It’s a vicious cycle that threatens to stifle the very innovation that VC firms should nurture.
However, from an investor’s point of view, a startup’s growth expectations are far greater than those of the traditionally-driven enterprises, hence the investor’s optimism.
“I really do not think that VCs are pressuring founders to overstate their valuations. Most of the VCs investing in Africa are mostly used to the American way of investing and are definitely working based on existential models more so for the fact that valuing a tech startup is often exponential following the fact that it is believed that the rate of growth for a tech startup is far greater than a traditionally focused business,” said David Lanre Messan, Chief Venture Builder at FirstFounders.
Game of bloated numbers: founders are guilty as charged
“…as a matter of fact, a couple of these startups haven’t even done any transactions, and yet they claim bogus valuations.”
David Adeleke
The actuality of this statement has become what has characterised the African tech ecosystem. In Dash’s case, the startup claimed to have processed transactions worth $1 billion and said it had acquired a million users from Ghana, Nigeria, and Kenya. Those numbers represented a 5-fold increase in its users in only five months. Only to be called out a few months later by two publications.
“…a lot of startups with bourgeoisie valuations have no candid justification for those valuations except that they want to be like every other startup and hence will cook up the numbers to fit the due diligence that the VCs do. VCs generally believe that African markets have the numbers; hence, if a startup presents a total addressable market to justify the valuation, it is believable…” David Lanre Messan.
But then, there is the question of what the investors who sit on the board of directors do. Are investors just only after the profits and not also after how the numbers come about, or perhaps, where is the ‘due’ in the diligence?
Investors need to be more decentralized in their approach to investing and step out of the idea of just introductions and data-room due diligence. They should vet market size and opportunity; obtainable market justification; metrics for growth; finances; and the team before investing in any startup.
David Lanre Messan
The dollar conundrum
A closer look into the problem of bloated numbers reveals the fingerprints of VCs’ expectation for African startups to report their revenues in a foreign currency, usually dollars, even when their users do not transact with them in dollars. This is quite contrary to other ecosystems, where they report their revenues in the local currencies.
In fact, some African startups have listed as foreign companies to access investments, citing a stable market as their basis of operation despite their target users being Africans. Although evident that the Nigerian market, just like some other African markets like Ghana is quite volatile, given some macroeconomic challenges, it is important that VCs recognise this and take it into consideration in investing in African startups.
Finally,
The key to a thriving African tech startup ecosystem lies in bridging this gap between expectations and reality. VC firms must recognise the unique challenges that African startups face and adjust their expectations accordingly. Realistic valuations, patient capital, and long-term support can go a long way in helping these startups grow sustainably and make meaningful contributions to their respective sectors.
As Jason Njoku, the founder and CEO of IROKO Partners puts it, founders also ought to be mindful of recognising their shortcomings and playing to their strengths.
But more importantly, it is crucial for venture capitalists and startup founders to have a mutual understanding of their position in the market to develop a successful and sustainable product. The product should aim to solve a problem and generate profit from solving that problem, rather than focusing solely on making a profit.
In conclusion, the African tech startup ecosystem is teeming with potential, but the misalignment of expectations between VC firms and startups can hinder its progress. It’s crucial for investors to adopt a more nuanced approach, one that acknowledges the challenges inherent in the African market while still supporting and nurturing innovation. Only then can we ensure that the ecosystem flourishes, creating lasting positive impacts for both startups and the continent as a whole.
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