Ep #02: Rethinking the VC Model in Africa
Are you curious about the dynamics of venture capital in the African context? In today’s episode, we’re looking at how the traditional VC model is adapting to the unique challenges and opportunities in Africa and exploring the nuances of startup funding and development on the continent.
Listen in as we shed light on the need for a localized approach to venture capital in Africa, discussing the differences in startup environments compared to more established markets like Silicon Valley. We also dive into the intricacies of funding models, the importance of understanding cultural and market differences, and the evolving landscape of African entrepreneurship.
Listen to the Full Episode:
What You'll Learn In Today's Episode:
The adaptation of the VC model to the African market.
Cultural and market differences affecting startups in Africa.
The impact of global talent trends on local startups.
The significance of adaptability and resilience for African entrepreneurs.
The potential for new and emerging business models in Africa.
Ideas Worth Sharing:
"The majority of funding in Africa right now goes to expats from places like the States and Europe." - Nicole Dunn
"In markets like the U.S., the persona or prestige around entrepreneurship looks so different." - Nicole Dunn
"Being a founder in Africa is really a career in defying the odds." - Nicole Dunn
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Episode Transcript
Nicole Dunn: But I think it's also interesting. There was a really good article written a few years ago about the kinds of businesses that you need to succeed in Africa and how those are less like unicorns and more like camels. And there's been a whole lot of interesting animal metaphors–zebras, gazelles–but the basic tenet is that rather than aiming for a multi-billion dollar exit and this growth that all costs model, which is now being questioned, even in places like Silicon Valley, that that might not be appropriate for the African market for a whole host of relevant reasons.
Welcome to the Next Frontier. I'm Nicole Dunn, co-founder and COO at a venture-backed African startup. I'm a VC investor turned startup operator passionate about unlocking untapped entrepreneurial potential in Africa.
Brian Kearney: And I am Brian Kearney, a three-time entrepreneur, nonprofit founder, and angel investor based in the U.S. I am excited about connecting capital to entrepreneurs solving the world's toughest problems.
Nicole Dunn: Join us as we change the narrative on startup investing in emerging markets and help bring the yearly African VC inflows to 20 billion dollars.
Brian Kearney: So you were in the pre-interview, while we were waiting, you were talking a little bit about your trip to the U.S. and kind of the cult of personality idea with the founders. So I wanted to stop really quick and record it so we could use this down the road or now, who knows. But, okay, sorry, what were you saying?
Nicole Dunn: Yeah, I just found it really interesting. So I met up with 83 different founders and CEOs from a pretty diverse FinTech-based portfolio, and there was about a third from the U.S., about a third from LATAM, and then the balance from Europe, Africa, and Asia, and one of the topics that came up was mental health and the stress of being a founder.
And I think there was some really, really interesting and real insights that were surfaced around so many layers, you know, whether the higher incidence of mental health is a causation or correlation with entrepreneur. Is it because the sample selects into entrepreneurship is more prone to those kinds of conditions or is there something innate about being a founder that creates that kind of stress. And I think that could be a conversation all on its own, but meeting the many, very different personalities in the week, I found that in particular founders in the U.S. seem to have a very specific kind of persona or construct around what it means to be a founder, and that persona is very intense, all-consuming, self-sacrificial.
And there's almost an inherent pride around not doing anything to take care of yourself, you know, not eating, wearing the same outfit every day, never sleep. And it was an interesting moment for me to kind of look in the mirror and go, what if that is real and what if that is kind of created based on these Silicon Valley stereotypes and what kind of founder do I want to become as a result?
And so it was interesting to just speak to different founders across the geographies, because, again, surface level, I'm just getting to know these folks. It seemed that it wasn't as pronounced in intensity in geographies like LATAM, Asia, and Europe even though there are a whole other constraints that make being a founder in those markets very, very–
Brian Kearney: It’s objectively harder.
Nicole Dunn: Yeah, exactly. So I do wonder how much of the pressure that founders are feeling is a result of the job because that's absolutely real, but how much of it is striving to be this kind of caricature that doesn't need to be real necessarily.
Brian Kearney: Yeah, that's interesting. I think it's super true too, particularly for the startups that are coming out of Silicon Valley, like you said. Across the U.S. there's other areas who get very little capital allocated to them. Actually, most of the U.S. gets very little capital. It's pretty much Silicon Valley, New York, Boston, pretty much it. And it's very different founders between all of them. Like you look at Midwest founders, and it's a completely different persona, like a hundred percent different.
And it's harder for those people to get funding because the Midwest is very financially conservative by nature. We are where most of the insurance companies in the U.S. were started. It's all based on farming, basically. So we're very fiscally conservative. So we don't have these huge pie-in-the-sky projections, but on average, the startups are more successful, on average.
You might not have the huge moon shots, but it's kind of an interesting thought to how much of that persona is needed for creating these game-changing companies. And how much of it is just like virtue signaling in a way where you're like this is what I'm doing because I'm a good founder, not actually doing what's necessary for the company and for you. That's interesting. How would you say that's different?
Nicole Dunn: Yeah, I think the one is just culture. So this very much fake until you make it Silicon Valley culture that is being questioned a lot more in the current market pullback, but also in light of things like FTX scandals. I don't think we have lent into that to the same extremity and there has been higher levels of scrutiny perhaps where that hasn't been tolerated or hasn't been able to liberate for as long as possible or for as long as it has in maybe more developed markets where you can really sell a story and a show. We also spoke around this before and this culture of narrative in the U.S. where in some cases, I think, or I've experienced people who prioritize narrative over truth, and that becomes very learned for them, right. And it almost seems to become a truth for them that if they say something over and over again that just will become true, and sometimes that can happen.
And that's why people talk about manifesting and all these brilliant kind of concepts, but it doesn't always happen, right. So I think that culturally is not something that we have to the same extent in other parts of the world where there is less of that narrative management that is taught as a skill in business school applications or in even the schooling system.
That's something that was very new to me and very much confronting when I engaged with founders from other parts of the world.
Brian Kearney: That's interesting.
Nicole Dunn: Yeah. I mean, I think I was sharing this with you before that even when you apply for South Africa's most prestigious university, you just submit your grades, you don't submit an essay on yourself.
You don't even introduce yourself. It's part of any interview process. So the work has really got to speak for itself. The results really have to speak for themselves. And I think that drives very different behaviors or priorities or less investment in a skill set like storytelling, which I think is good and bad.
I don't want to mischaracterize my position here, but I think it's also interesting there was a really good article written a few years ago about the kinds of businesses that you need to succeed in Africa and how those are less like unicorns and more like camels. And there's been a whole lot of interesting animal metaphors given–zebras, gazelles. But the basic tenet is that rather than aiming for a multibillion-dollar exit and this growth that all costs model, which is now being questioned, even in places like Silicon Valley, that that might not be appropriate for the African market for a whole host of relevant reasons. One is the markets look very different.
You've got 54 countries, very different regulatory environments. They're fragmented and so individual consumer markets and individual consumer purchasing is relatively small compared to places like the U.S. And so the business models will look very different and you can burn a lot on customer acquisition without seeing the required payback period.
And so that growth model doesn't necessarily work. The second was the capital markets, right? So venture is still emerging and there are still very few investors investing at the series A, B, C onwards level in Africa. And so you cannot just burn cost every month, hoping that or relying on the fact that you may get a follow on funding round to continue the business.
And so that has, in some cases, not all cases, led African founders to prioritize fundamentals and unit economics sooner in their journey than their counterparts in other parts of the world. And in some ways I think that has hindered scale and has made some good businesses fail because they could have if they'd received the capital support to really invest in building that initial capability succeeded, but it has also meant you've got in some ways a cohort of more resilient businesses that may be better placed to win in the venture market that's emerging now.
And then the third is exits. So there's no public market in Africa that looks like the public markets in the U.S., right? Public markets are very underdeveloped in Africa. And so you've really got maybe South Africa, maybe somewhere like Egypt, although both of those somewhat questionable for the scale of a billion-dollar type of exit.
And so it is most likely, as an African startup, you're going to exit in some sort of strategic acquisition and the cap for that is moving and it's still being defined. We've seen some interesting examples like Paystack exiting for 200 million dollars, which is an exciting proof point. We're seeing companies now like Network International potentially being bought for far more than that by a private equity fund, which actually signaled that had been trading below market value, which counted the narrative in a really positive way around an African discount, but the threshold and the expectation around exit might look different. And I think there's so many interesting things to unpack there, therefore, around the kinds of businesses that need to be built in Africa, how founders need to think about building those businesses, and the portfolio construction that investors need to consider when making investments in these markets.
Brian Kearney: That's really interesting. I have a few questions. I guess my first question is what do you think that does to the VC model? Because the entire current VC model is based on growth at all costs, almost all of you are going to fail but a couple of you are gonna be worth a hundred billion dollars, and that's how we make our money. If that puts itself on its head, that makes it a lot harder to get funding in some ways because you have to show traction before you're going to get much funding, especially in Africa, which we've talked about in the past, that really software might not be the most beneficial thing right now on the continent.
But if you're talking hard goods and high capital expenditure, that makes it even harder to raise funding. You're not expecting a certain percentage of your portfolio companies to be a billion-dollar exit. What have you seen the VCs on the continent doing to walk that line and redo the entire model, really?
Nicole Dunn: Yeah, exactly. And this is one of the questions that prompted that article I wrote around is venture capital working for Africa because as you rightly say, venture capital relies on a couple of core assumptions around the ability to achieve outside exits that those will compensate for the high threshold of failure, and that significant economies of scale exist. And I think those are true in some cases for African businesses and will become more true over time as that foundational layer of infrastructure, physical and digital is built out. But it's certainly not true in the majority of cases right now. So that means that venture capital will need to be localized to an African context.
And I don't think we are having nuanced enough conversations around what that might look like and the kind of blended capital instruments that will be required to achieve success, and I think that's one of the things we're unpacking on the show is when you look at the problems in Africa, there's huge opportunity, but those opportunities are not necessarily ones that can be solved through a digital-only solution.
There is not a ubiquity of hardware, and so to enable the value that's something like the Internet of Things can enable on the continent, which has huge relevance in agriculture, which is a huge part of Africa. And I think the role it can play in global food security, as an example, or making manufacturing more efficient and a whole host of other use cases that is, for me, undoubtedly a multi-billion dollar market that can achieve venture returns, but step one is getting hardware to be more ubiquitous and that may not be, and probably isn't a venture backable opportunity set.
And so what we need to think through more holistically is who needs to participate where and how do we take more of an ecosystem lens so that you've got venture debt providers or debt providers who are providing capital at a reasonable cost for business model like hardware that require more frequent capital injections, even at a later stage of that ventures life cycle or that can still achieve above stock market average returns potentially but are going to follow a much more linear growth curve. And there may be a point, an inflection point for some of those businesses where they can incorporate a software or digital-only business line that can change that business’s trajectory from more of a linear business into a venture-backable business. But where we're sitting is, I would say, at the foundational stages of that journey, and if we don't think about this more globally, we're going to end up with a whole lot of subscale software businesses because they didn't have that foundational infrastructure to be able to scale.
Brian Kearney: Yeah, that's interesting. I mean, I think that's kind of true for the entire VC industry. You look at why a venture was started, and it was not necessarily for a SaaS company that has really high margins because honestly, if you're a good SaaS company, you shouldn't need a whole lot of venture capital.
You really shouldn't. Your margins are so high. You should be able to bootstrap it. And if you can't, there's probably something wrong there. And at that point, that founder has to say the same thing you're talking about with debt is do I want to give away 30, 40 percent of my company, or do I want to raise debt where I can compound my growth at a much higher rate than the debt interest payments, and it makes no sense to sell part of my company. But no, that's interesting. And then kind of, I have a few more questions about that, but I want to go back to something before I forget it, that we were talking about a little bit earlier when you were talking about kind of the persona around a founder in the U.S. That's interesting because it's true, but also most of the really successful founders in the U.S. were actually not from the U.S., a lot of them are from Eastern Europe, Africa, LATAM. It's almost like there is something else that unlocks those people when they reach Silicon Valley.
Nicole Dunn: Yes.
Brian Kearney: Doesn't mean it has to be in Silicon Valley to unlock that, but it's interesting to think about what that is. Is it the capital? Because that's easy to fix. Not super easy, but kind of easy. If that's it, that's simple–maybe not easy–there’s a better way to put it. Or is it that culture of taking care of the investors first, not caring about your health, grinding 80-hour weeks?
And I don't agree with all this for the most part, but it's kind of hard to debate the success of it too, because again, well, like Elon is a perfect example. He's a little bit crazy now. And I think part of it actually is from not having sleep. He says he gets three hours of sleep at night.
I'm like, no wonder you're insane, but it's interesting seeing what he was able to do. Would he have been able to do the same thing in South Africa? Probably not. Would he have been very successful? Absolutely. I mean, anyone like that would have been successful no matter where he is, but what about Silicon Valley unlocked that? Do you have any thoughts after meeting some of those founders and seeing that?
Nicole Dunn: I think you've also touched on a really interesting paradox in that many, as you say, of the successful founders in the States are immigrants or not natively American, but the majority of funding in Africa right now goes to expats from places like the States and Europe.
Brian Kearney: Hmm, really?
Nicole Dunn: Yeah. And the thesis behind that has been, and it's worse in some countries than others, I want to cover it. I think in Kenya, it's somewhere in the region of six percent of funding goes to local founders, and the balance goes to expats, right? And so the explanation that has typically emerged is that you've got predominantly foreign capital coming from places like the U.S. and Europe, they're investing somewhere that is unfamiliar to them, unfamiliar markets, unfamiliar problems, potentially unfamiliar business models and so on and so forth.
And so founders that are more familiar or who resonate with them culturally, they went to the same university, they speak in the same accent, whatever it might be, builds a level of trust and credibility that is largely based on bias, unfortunately, but in the context of the unfamiliarity surrounding that, it often drives a different kind of decision making. And I'd never thought about it in this way, but just hearing you talk about the success of immigrants in America, it was interesting to reflect on how those same people are not perhaps similarly rewarded or similarly successful in their own market, and that might be something worth unpacking. But to answer your question more directly around what is it that unlocks perhaps that grit or resilience, I don't know what to call it, in markets like the U.S., I would really be speculating and we're talking about major stereotypes here, but I think one is the persona or prestige around entrepreneurship looks so different in the U.S.
It is still not hugely encouraged as a career path in most African markets, especially if you are smart and educated because the relative risk versus the comfort of working somewhere like a Microsoft or one of the large banks or large telcos is really incomparable and you're often providing for a wider family, a wider community, a wider village even.
And so it's not just your own personal future prosperity that you're gambling with, it's other people's as well. And I think many people understandably choose not to take that gamble and aren't encouraged to think there's also a role model question, right? They haven't seen someone do it in a particular way.
I am sure that the founders working at Flutterwave and Paystack and Andela are similarly, if not more resilient, and have more grit because of the very complex markets that they're working in and the uphill battle that they're facing every time, you know, being a founder in Africa is really a career in defying the odds.
You're fighting with regulation, you're fighting with very difficult market structures, you don't have the same level of capital available to you. The ecosystem of grants and accelerators is still very underdeveloped, and as you say, we've started venture in a time where venture is more about SaaS businesses with high margins, not the Don Valentine era of investing in semiconductors, which is where we're at in the African context, right?
So we need more investors that look like that and really focusing on that model. So I think what I've seen happening in terms of what that means for investor behavior is you have far fewer of these stereotypical spray-and-pray type of funds where there is very little thesis-driven investment where you're investing a lot of small different checks, sort of YC type of model or very generalist funds, and you have funds that are quite concentrated either on a particular region within the continent or on a specific vertical so that they can become really specialized in that particular area, which makes them better at pattern matching across different businesses.
And it exposes them to more concentration risk, but at the same time, they're more likely to find several relatively big successes within that cohort rather than applying a very broad approach. So a really good example of this is someone like Rally Cap who invests in emerging markets exclusively, predominantly Africa and Latin America.
And they have slightly broadened recently, but they started only investing in B2B FinTech business models and API commerce enablement which is super narrow and focused and they've got a brilliant portfolio as a result. They have a really interesting operator-back model where their founders invest back into the funders' LPs and really help build alongside the new founders that come into the portfolio at a later stage, but that's served them really well because they've done one thing.
They've done it very well. And they're able to create this multiply effect of founders in different countries or even different regions who can learn from each other without ever being in a position where they're going to compete.
Brian Kearney: Huh. That's interesting. That makes a lot of sense when we talk about particularly some of the inherent biases. Another one that I think could have something to do with it is that in the venture world in the U.S., you're pretty much forgiven for failing too. And I don't know that those same investors would give the same level of understanding to an African founder who failed, if that makes sense.
And it's unique to the venture industry here too, because every other industry, you are not forgiven for failing. Like I talk to people all the time about the venture industry and it blows their mind. They're like, okay, so they'll put money in your company. The company goes under and then they'll fund your next c–that makes no sense. That's how they are. The venture is more on the founder than it is on the actual company either starting at that time. It might be like, “This one might not work, but your next one will, or the one after that will.” And I wonder if the same view isn't given to founders in Africa.
Nicole Dunn: I think it's another great observation. I mean, culturally just among your close circle, failure is not accepted or celebrated. So I think there is a pressure that founders face in that way, and maybe that drives some people who could be potentially very talented entrepreneurs to opt out and choose a safer route. Again, very early to draw conclusions like this and generalizing hugely, but I also do feel that in markets or regions like Africa, companies and founders aren't given the privilege of being an individual. So if a business model fails or there's corruption or fraud, that's not a Sam Friedman problem, that's a Nigerian founder problem, or that's a X business model problem.
Crypto doesn't work in Africa, you know? And I think that's also something we need to grow out of is affording African entrepreneurs and startups the privilege to be a unique case, to be an individual, and not to prematurely create patterns or generalizations. And so, yeah, and I think it's going to take a bit of time to see a bigger sample set and realize those really are outliers rather than being symptoms of common behavior.
Brian Kearney: Yeah. I agree with that. I think that's kind of common everywhere still though because when you're talking about like FTX, this is a great example. Everyone thinks crypto is a scam now. Everything in crypto is a scam. Well, it's not. He was fraudulent, but when Bernie Madoff was seen as a Ponzi scheme, we're like, “Oh, well finance is a scam, clearly.”
That's not true. So that's interesting. I wonder why that is not the case in Silicon Valley. And they would like to say it's unique to them, but I don't think it is. It's not some geographic this, you know, 40-square mile location is for some reason better at it. I do wonder if it's the networking between the VCs there.
There's interesting things there. There's interesting things with the networking between founders and VCs and employees being able to jump around and you can get the best talent, but that's also very easy now globally because we saw during COVID, you can pretty much get talent from anywhere. So I guess that doesn't explain it either. It's interesting, I don't know.
Nicole Dunn: Yeah. I mean, global talent is an interesting trend. I think it's been great for individuals in Africa. In some ways, I think it's been damaging to startups because you now have to compete with global salaries and until the funding quantum catches up with what a business can raise elsewhere in the world, it's really difficult for local startups to pay global salaries. So there's pros and cons to it, right?
Brian Kearney: Yeah. That's a great view. I never would have thought of that. That makes a lot of sense. Have you seen that in your company?
Nicole Dunn: Yeah, absolutely. I mean we see intermediate developers asking for four to five, sometimes more times what we're paying a senior VP because they've worked at a U.S. startup and the expectation is just so different. And so I talked to a lot of founders now, and a lot of their biggest challenge is around talent strategy and wanting to balance things like in-office versus remote, but if you don't offer remote, you're already counting yourself out of a huge opportunity and talent pool, then layered on that is how do you price and pay people fairly without having to pay everyone an American salary, which very quickly becomes an affordable and accounting for the fact that some people are living in lower cost of living markets like this is a global debate around remote work and how it shifted the job market. But it's quite pronounced, I would say, for founders right now wanting and needing to hire the best that is out there and often they're finding that the best or talent that would have worked potentially in a startup locally are now working for European startups in the same time zone or in some cases startups in the U.S., and I've certainly felt that in what people expect as a basic salary working for a startup.
Brian Kearney: How do you manage that? What does that conversation look like?
Nicole Dunn: Look, I don't think we've solved it. We have been very fortunate to attract local talent based in Africa who want to work specifically on African problems.
And for them, there is some compensating value of working with a team that they can get together with, that culturally resonates, where there's overlap in the hours and is solving for a customer that they can relate to. And so we tried to play that up and make investments in culture building and team building even though we are remote by default, and we've started exploring like what are some of the unique opportunities that remote presents for culture building that on possible in person, and one of them that we did recently was a remote master chef competition, which was quite fun because everyone had a kitchen, right? But you can't do that across the whole team when you're in the office. So trying to get a little bit creative, and we've done the research.
We benchmark salaries both in South Africa, and then in somewhere like the States, and if we can't offer someone a U.S.-linked salary on day one, we will try to show them a progression over time and having very candid conversations around how they want to be incentivized because it's almost taken for granted elsewhere in the world that ESOP or equity is the default way to incentivize someone working in a startup.
But what I've seen Revio, but also at Founders Factory before this, it doesn't resonate in the same way across different African markets and again, that's a big generalization, but for a lot of people, it's a very new concept. They don't know anyone often who's become wealthy through an ESOP scheme or exit, and they've got immediate financial pressure.
They often have this family tax, right, where they're paying for a bigger extended family, and so their preference is very much more money now rather than big money later. And so we are very open in having those conversations with our talent, and we've had to educate our investors quite a lot to say, “Look, we know you don't want us taking out, cash out the business for things like bonuses, but there's certainly selected roles where that makes a lot more sense like sales and customer success,” which I think most people would agree with globally, but even looking at talent that typically would be a good candidate for ESOP like engineering product and saying, “Okay, well, what works better for you? What are you going to find more motivating?” and finding a way to make that work then within the company's capital allocation.
So we've actually landed on not giving everyone ESOP as a default. We have that conversation with them. We've got an unallocated pool. We know what we would be prepared to give each individual role, but we've chosen to have those conversations with the talent instead.
Brian Kearney: Yeah, that is fascinating. Do you not see the same? Well, I mean, the same conversation wouldn't be had by a U.S. startup that wouldn't even factor in the hiring process to not look at equity or look at bonuses instead. That's interesting. I think the mission, that's kind of cool too, and that's a better way for any startup to get talent. Honestly, I saw a couple days ago some metrics on the number of people who stick with a seed stage startup, and it's like four years in, it's 6%, 7% of the same employees are still there.
It's seed-based startups, they were talking about predominantly in the us. Do you see the same numbers being likely in Africa or do you think that another kind of advantage might be that you can compound that talent because they're with you longer? Have you seen that? I'm just kind of shooting in the dark to see if that might be a little different.
Nicole Dunn: Honestly, it's not something that I've looked at. So I would want to check the data. I mean, I can imagine at startups where you've got your one-year cliff, four-year vesting, there's huge churn around the four-year mark, and so it might see different patterns locally, but I don't actually know just yet.
There may be less job hopping locally, just culturally again. There's more, I would say right now, maybe an employee loyalty, but that's starting to change with the kind of younger generation, and I think maybe I'm very pragmatic, but I don't expect people to stay with us their whole lifetime. I think everyone's got an important role to play.
We'd obviously love people to spend a big portion of their career building up Revio, but I don't want people hanging on to get their vested shares at four years, and that being the primary reason they're staying with the company. And then you've given out a share of the company, you know, maybe to someone who wasn't fully committed in the last year or two years that they were there or weren't the right fit. So I think being quite pragmatic around talent mobility and that there are some people who are going to move on and framing your hiring strategy around that, accounting most for that churn, and so making sure you've got as much as possible a pretty robust knowledge management system so you don't feel the impact as much. Yeah, so far, to be fair, we've only been going two years. We've seen very little churn, that is unwanted. We'll have to check back in another two years' time.
Brian Kearney: I think that's already kind of saying something because the data, this was from Carta, so they're tracking actual options grants and the actual data and not what the companies are reporting. It was 36 percent of the company isn't even there to see their one year cliff. So 36 percent gets zero equity, which kind of blows my mind, I guess, saying that I've done that. I did that for one company.
It was to start my own company, but it's interesting. And it shines a little bit of a light on the debate of underpaying people and giving them equity. It's like well, that might just be a good deal for the company because a lot of them aren't going to see it apparently. So that's interesting.
That's it for today. Do you want to learn more about investment opportunities in Africa? Go to nextfrontierpod.com for more episodes, new insights, and the latest trends in the African startup world.