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Cross-Ecosystem Grinding

#1

Why do African startups get dropped by EU/US investors?

Sean Obedih from New Gen Angels asked me to share this internal note I shared with The Africa Prize alumni in advance of their visit to London. He pointed out this is a typical conversation that happens behind closed doors, and thought my angle here might help inspire a useful discussion in around African startup funding.

From Sean:

We are working with Salim and the Africa prize winners and this blog post is to be taken into the context of someone who has seen both sides of the equation when it comes to scaling startups!

I’ve had several experiences helping African entrepreneurs raise funds (usually high-risk debt) with foreign investors, which often ends frustratingly watching good intentions on both sides just fizzle out.

I was sharing my concern with my dad, a Tanzanian accountant and investor, who moved to Canada in the 80’s. He said, talk to them like you’re talking to your younger brothers, with love but being direct.

So here goes. I’d love your feedback on this, and any experiences you could share where your lessons learned could help others.

Cross-Ecosystem Grinding

Through our work with tech companies in Europe, Asia and Africa, I’ve seen this pattern whenever first-timers try to raise money outside of their home community, whether that’s crossing between cultures, geographies or types of financing. Whenever these connect, like gears operating at different speeds, they tend to grind rather than sync up.

Established ecosystem develop tiers

In places with an established, multi-tier investment ecosystem, like San Francisco, New York or London, startup investors know who will likely invest in you in your next investment round. So they can specialise in a stage of investment confident that the next stage is covered. The rounds are even labeled: Seed, A-Round, B-Round… Seed round investors have an idea which A-Round investors will follow them, A-Rund investors know which B-Round investors will follow, etc.

Small business investors getting into tech startups

In new startup communities, those later-stage investors aren’t there, so startups who want to grow fast though venture capital need to leave.

There, early-stage investors tend to operate on more of a linear growth paradigm since that’s how they’ll see their returns. It’s more like small business funding, than high-growth startup funding. There’s a different way to get a return, a different way to manage a portfolio, and a different way to asses risk.

High growth doesn’t always mean Venture Capital

But there are notable exceptions. Outside of Silicon Valley and its emulators, there are lots of high-growth companies that take off without venture capital. They use customer revenue, prepayments or debt instead. These are the quiet local unicorns we never hear about in Europe and Africa. Look at Meltwater (Norway) and Interswitch (Nigeria).

Sub-Saharan Africa sees tech companies grow through a type of funding that’s fairly mythical in Silicon Valley - revenue. African consumers see mobile money and prepay services as normal. Plus, African startups have access to grants instead of seed funding.

What isn’t obvious to African founders is that this environment often puts African startups in a less needy situation than their Western counterparts. The natural tendency is to grow from seed grants to debt, since the growth limiter for scaling up is working capital, rather than runway capital.

In a nutshell, London startup investors manage high-growth, high-risk portfolios that move from through 3 to 4 rounds of increasing investment, extending the runway of the startup each time. African startups tend to get grants early on, and establish revenue which gives them unlimited runway, so borrow to increase their working capital in order to grow.

So bringing African startups to raise funding in London presents another case where cross-ecosystem grind is occurring. The two paradigms don’t match up, and so neither do the negotiation styles.

Sidebar: Funding Gaps

For the African startups I’ve helped, I’ve noticed a funding gap between grants and debt, roughly between 50k USD on the top end for most grants, and the 250k USD minimum for debt funders.

London had a similar funding gap a few years ago, when seed stage was around 15k GBP and the next investment tier was closer to 500k GBP. (That gap was closed by combination of European investment in accelerators, and UK government tax relief for seed stage investors up to 100K GBP, with a few established international investors like Index, providing the later stage tiers.)

The grinding issues tend to arise across these funding gaps because that’s when founders travel to raise investment.

Zooming in, why do these negotiations fail in practice?

What I’ve seen when introducing African startups to European investors is negotiations tend to quickly deteriorate into marketplace haggling, rather than staying on the big picture ambition where everybody makes money.

This puts investors off - they don’t have the time for this, and they can easily just invest their money elsewhere, leaving the entrepreneurs wondering why a lot of investors enquire, but in the end leave quietly without making a contribution.

So to help bridge these perspectives, here’s a metaphor in the form of a fable:

The Bridge Builders Fable

It all started with three bridge-builders, competing to cross the mighty rivers.

Those rivers had held back the trading people for so long but the time of prosperity was coming. The traders were ready to expand around the world. And they needed the bridge-builders. They needed engineers to give them better ways.

The first bridge-builder saved her money from trading, and worked tirelessly on her bridge. She negotiated well at each step, getting the best price for wood and screws. But the bridge collapsed before it was ever complete. Some of the materials were of poor quality and her focus on conserving her savings had distracted her from ensuring structural integrity.

The second bridge-builder knew she could double her resources by working with the foreign road-layers, who had profits to invest. She negotiated with one road-layer after another, making sure that she would get the most profit from the tolls. But when her bridge was complete, the road-layer had no more money to continue his road, so the bridge lead nowhere.

The third bridge-builder stayed focused on her main goal - she wanted her people to prosper. She worked with the road-layers, asking one to help with the bridge, the others to continue roads to different towns on the other side. When she negotiated, she made sure everyone made money in the long-run and was also focused on quality.

At first, the third bridge-builder was worried about competition. She was working with the suppliers that the first bridge-builder had rejected for being too expensive, and was dealing with road-layers who were making too much profit from her work. What if they succeeded with their bridges and had more money than her?

But the third-bridge builder was thinking bigger. She wasn’t just thinking about her first bridge, but many bridges after that. That’s what it would take for her and her people to really prosper. Trying to take all the profits from just one bridge seemed a waste of time. She would make more money overall with more bridges, and could only do that with a network of prosperous suppliers supporting her, and road-layers funding her – and everyone making money.

My recent attempts to help African startups raise debt in Europe

I’ve gone from very excited about a company, even helping them raise while I’m on holiday and putting my own money and reputation on the line for them, to a polite but firm decline – all within a few weeks. My trust and confidence erodes so quickly because we go from open and reactive, working together, to the startup withholding information in order to try and haggle a better deal. I’ll literally ask a strategic question and get a counter-offer instead of an answer.

This leaves me without enough information to make an informed investment decision, and it takes me too much time to try and get that information with this back-and-forth. I thought I was dealing with the third bridge-builder, but as soon as I took out my wallet, the conversation more like with the first bridge-builder. Granted, I’m not a professional investor – I’m always emotionally disappointed that I can’t help my friend at that point. But it makes no sense to invest so I pass.

In some cases, founders I support start asking me questions they could answer themselves, undervaluing my time. That’s a clear sign that I need to get out of that situation. It feels to me like they’re still thinking of funding like grants, rather than transitioning to the next stage. There’s this expectation that I should help them and even invest my money for free.

An unspoken truth: When you meet an investor, they will never ask, “why should I bother?” but they’ll always think it. It’s up to you to answer that question without them asking. In mature ecosystems, they’re also used to dealing with the third bridge-builder, so acting like the first two is going to get you politely declined.

Advice when seeking investment from a mature startup ecosystem

So this is my advice to those coming to London to raise (or any other mature startup investment ecosystem):

  1. You need to understand some investment basics to talk to an investor. Know the difference between pre- and post-money valuations. Understand why convertible debt and [tag along rights ] ( http://www.investopedia.com/terms/t/tagalongrights.asp) exist.

  2. Really take on board that if you are asking an investor to give you money, that your business must make them money first, and you second. You get the extra profits after they are paid back. This is even more true if you want debt instead of equity. So taking investors mean you must be ambitious in your growth! This is how you find a common goal. The bigger you think, the more money everybody makes. There’s more to go around and the conversation moves from splitting the pie, to growing the pie.

  3. Always consider the investor’s point of view, and run the calculations as they will. Look at the risk as they will. Consider what it costs them to work with you, and what needs to happen so they see a return on investment. Ask why they’re interested in you, how much time they have for making a deal, where you fit in their portfolio and what similar investments they’ve made (and why). Consider what it will take for an investor to exit. Consider how and to whom they will exit.

  4. Treat them as long-term partners, as you would any other business partner, because they are. Know that you won’t leave your first visit with a cheque - this all about relationship building. Investors look at lines not dots. Our best investors will be the ones who give you more than money, like a true partner.

  5. Be honest about your progress and your numbers because they will find out soon enough, and it’s best to start the relationship with openness. Investors treat companies differently depending on their stage. Their expectations change accordingly. Being clear about your current stage and traction let’s them respond appropriately. Overselling yourself means you’ll face heavier scrutiny that you’re not prepared for, and the investor will simply walk.

Some practical tips