Africa has been described as having an entrepreneurial spirit. However, many of these entrepreneurs have difficulty accessing investors willing to or capable of funding their ventures.
According to John Causey, an Africa investment and business specialist, a lack of local investors means many startups are turning to the international investment scene for funding. Causey, who was previously an associate at Morgan Stanley in the US before taking up a position at African-focused investment advisory firm Clifftop Colony Capital Partners, said investing in African startups is not always attractive to international investors.
He explained that it is important to understand the deterrents through the eyes of international investors who are looking for a high return on investment, not just a social impact.
“You are not going to be able to solve the problem until you see what the problems actually are,” he told an audience at AfricaCom in Cape Town, South Africa last month.
1. Exchange controls
Capital controls are enforced to keep money in a country and in South Africa, for example, strong exchange controls make it difficult and expensive for investors to move money out of the country.
“If you invest from overseas, if you want to pull your money out, if you want to sell the company, you are going to be subject to exchange controls and taxes and all this red tapes,” explained Causey.
This year, South African entrepreneur, investor and multi-millionaire Mark Shuttleworth said it cost him less to travel to outer space than it did for him to move his money out of South Africa. He reportedly had to pay a 10% exit levy of R250m (more US$30m at the time) for moving his fortune out of the country.
2. Understanding requires time and resources
Adequate understanding and investment in an African company requires on-the-ground assistance and time, and Causey said this can be expensive to achieve.
“Compounding that, the deal size in [South Africa] and some other African markets tends to be somewhat smaller. And why does that matter? Well, it matters because if you are flying to and from Munich, if you are spending three weeks here and might need expensive hotels and then you have to shoot up to Kenya and then you have to hire local people, you have to hire local attorneys… it’s very expensive to get that understanding so that is a huge problem.”
3. Small markets
South Africa’s GDP is roughly the same size as the US state of North Carolina’s GDP, according to Causey. “Even if they say your idea is going to dominate the South African market share, [and] even if you do, you are dominating a relatively small market on the international stage.”
4. Proven track record and few assets
Another problem, he added, is that there have not been many examples of large exits in Africa.
“People treat the Fundamo exit as if it’s a big deal but internationally it’s not a huge transaction. I think it was a $110m exit, which is nice, but you need to have a lot more of those to really attract investors.”
5. Deal size is typically small
Causey said the average fund size in the US for venture capital funds is roughly $200m.
“If you look at the KPMG report that just came out in South Africa – which is the economic superpower of this continent – I think it was like R1m for seed [funding], and the average investment was about US$1m. These are relatively small transactions so you see how that makes a difference.”
Another reason cited by Causey is the perception and ignorance foreign investors have of Africa.
“How many people who have travelled overseas get the strange questions about Africa,” asked Causey. “Like, ‘what if a tiger eats me?’”
7. The African story is the future, not the present
“The cold fact of the matter is investors are interested in Africa for the future return that can [happen],” explained Causey. “It’s kind of all based on the McKinsey report of what may happen in the future. So if you look at a company like Nike… it’s the 136th largest US company and the revenues of Nike are the same as total US exports to the African continent.”
If you look at this from a US investor’s perspective, said Causey, investing in Africa is really about the potential it has for returns in the future, not at present.
“The current state of [US] Africa trade is the same as our 136th largest company,” he continued. “Africa trade is one tenth of 1% of the US GDP. Even if you double our US Africa trade, the US is looking at one fifth of 1% of the US GDP. It’s not a huge difference. So everybody is looking at this [Africa investment] for the future impact but it still hasn’t been proven that it actually works.”
8. Difficult regulations
“Some of [South Africa’s] regulations are difficult to understand… and if you do want to make a debt investment, which most Europeans do want to do… every time the interest payments are made from the South African venture to the foreign investor, it’s got to go through all these controls and all this red tape. It’s really a joke and it makes debt funding, which Europe likes to do, almost off the table,” Causey said.
He added that another problem is the intellectual property (IP) tax. “So if you develop a company in South Africa and then you want to sell that company or list it on a foreign exchange, you have got to pay massive IP tax on the current valuation of that company,” he explained.
“So what you are finding is that a lot of European and US firms that are making investments have pulled that IP out of a country and put it in a country like Mauritius or the Isle of Man. And they are growing that IP outside the country of South Africa. So South Africa is losing IP partly for these reasons. It’s really bad and even the major banks [in South Africa], they have run all their international transactions out of Mauritius.”
Source: How We Made It In Africa