Why Africa needs “venture banking”
Most of us may be familiar with the typical business bank. Names like Barclays,Ecobank, Standard Bank and others come to mind . These traditional banks loan money based on your demonstrated ability to pay them back with interest out of current cash flows. There are many options these banks use including lines of credit, overdraft protection, business loans and more.
Venture Banks are a unique type of bank that offer services primarily to venture capital backed firms. Silicon Valley Bank and Square 1 Bank are two great examples. They get most of their clients through venture capital deals and VCs often make having a relationship with a venture bank part of their investment requirements.
Venture banks serve venture backed companies that may not yet have sufficient cash flow to service a traditional loan. They build upon the relationship that the company has with its VCs and make loans for equipment, accounts receivable or other purposes.
Venture banks also differ from traditional business banks because they will typically have warrants for the purchase of stock in addition to a traditional interest rate. Warrants allow the venture bank to be compensated for their risk by sharing in the upside their companies enjoy when they have an IPO or are acquired by a larger company.
So why Africa and why now?
While Africa had been largely ignored pre 2008 because it is too complex and too risky by Private equity and venture capital houses ,venture banks have actually preferred to set up partnerships in China and India but not Africa . That’s about to change because the amount capital flowing into Africa through PE deals is at highest level than it has ever been which is currently a wasted opportunity .
This means that there is a tremendous business case to service loans,deposits ,working capital and other day to day services required by fast growing companies that traditional banking business models aren’t built to handle . So they end up having to pay very high fees and using other offshore banking services which are safer but very costly.
We need to design a better banking ecosystem and we believe that venture banking is a critical part of that landscape . Our goal is to rethink business banking and build a full stack modern venture bank that puts the entrepreneurs at the center of our product and processes.
Putting this in African context given the increase of venture capital inflows a venture bank servicing these clients is a no brainer. Sobek Venture Bank is here to service the most ambitious African entrepreneurs. Services range from raising venture debt,growth capital , M&A advisory ,wealth management etc.
We have three key pillars: Modern technology, a clear obsession with customer experience and lastly a full banking licence will be sought in the long run to truly create a venture bank of the future.
A clear indicator is Abraaj Group Ltd, the Dubai-based emerging markets buyout firm, recently raised $375 million for its North Africa private equity fund as investor appetite for the region grows.
The closing of the new fund brings the amount that Abraaj has raised for African investments to $1.4 billion this year, Abraaj also raised $990 million for its third sub-Saharan Africa fund in April. The North Africa fund will make investments in mid-market businesses in Algeria, Morocco and Tunisia in industries including health care, education, consumer goods and logistics.
Funds raised in the Middle East and North Africa rose last year to $1.23 billion, the highest level since 2008, according to a report by the MENA Private Equity Association earlier this month. Rising asset values have helped boost buyout activity in the region, with Abraaj last year losing a bidding war for Egyptian snack-maker Bisco Misr to Kellogg Co according to Bloomberg !
We have recently seen the creation of challenger banks here in the UK such as Atom Bank and other full stack banks such as Mondo so this isn’t out of the ordinary to be building a bank in 2015 . We have been working on this project for over 15 months and the support we got from the professionals in this field has been extraordinary.
The impact of having a bank designed for entrepreneurs by entrepreneurs is powerful beyond measure.
The projected figures for VC funding to African startups for 2018 currently stands at $608M but it could be as much as a $1B for that period according to the authors of The Next Africa
So how does one create a bank?
The application process for becoming a bank in the UK is now simpler . Under BOE and FCA rules, a new entrant can hold as little as £1 million in capital initially. An applicant needs common equity Tier 1 capital of 4.5 percent of risk-weighted assets, significantly less than the 9.5 percent required under the old rules that still apply to existing banks but we are most likely going to incorporate in Kenya as we are talking to regulators and advisory board to find the best way forward.
Why focus on Venture Debt,Venture funding ?
According to DealRoom Venture debt can be a good addition or alternative to common equity in some circumstances. It can provide liquidity to a company when break-even is within sight but not yet reached, to finance working capital, invest in growth, or other purposes such as an acquisition.
The main benefit of debt (compared with equity) is of course less dilution to the shareholders. The main drawback of debt is of course the additional risk associated with financial leverage. Aside from this text book trade-off between equity and debt, there are some other important considerations:
(a) Attracting a venture loan is a much faster process than attracting equity from a VC. The “yes” or “no” comes shorter after having reviewed the basic info. Think 1–2 months instead of 3–6 months due diligence.
(b) The probability of success is higher than with equity: circa 25% of venture loan processes eventually lead to a an actual loan, while less than 5% of venture capital deal processes eventually lead to an equity deal (source: Dealroom research).
A company does not necessarily need to be cash-flow positive in order to qualify for venture debt financing. However, there should be a clear, realistic path to profitability. The cash-flow break-even point should be achieved within the initial period of the financing term (at least within 1/3). The company is expected to generate sufficient cash-flow to service interest and principal even in a very conservative scenario.
Venture loans are commonly structured along the following lines (variations do exist):
(i) Repayment within 3-years in equal payment amounts or adjusted to the company’s business plan (for instance, sometimes an initial repayment holiday can be negotiated). Contrary to a bank loan, there is no standard contract, and therefore some venture lenders can be flexible and are willing to adjust the terms of the loan to the specific needs of the business.
(ii) Typically 8–14% total interest (depending on the business risk and the market environment).
(iii) Equity upside to the loan provider in the form of a warrant. The amount of equity is usually tied to the size of the loan (typically 10–20% of the loan amount) and size of the business, which can amount to equity ownership of a few percentage-points.
(iv) Venture loans are often provided alongside new equity coming into the company to reduce the financial leverage, provide security for the loan, and increase founder/shareholder skin-in-the-game.
If this is an area of interest to you or you just want to be involved in this impactful project please contact us , we are looking for Investors, supporters,partners and ambassadors or follow our tweeter page on the link below and be part of this exciting journey .
We are getting some fantastic feedback ,please keep them coming:
Further reading:
2 . AVCA Spotlight on North Africa Private Equity
3. Broadening horizons: How do private equity investors create value?
Video: We face forward: The Ecobank Story
Events: Mergermarket Deal Drivers Africa Forum
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