What Can Explain African Startups’ Short Lifespan?

It’s well-known that 9 out of 10 ventures fail within 5 years of their founding. In Silicon Valley, founders largely ascribe their failures to a lack of market fit and insufficient capital. These are challenges encountered by entrepreneurs globally; African startups face these and many others. Even the most promising startups face a high failure rate: of 10 Ghanaian companies highlighted by Forbes in 2013, for example, only one is still active today. As the continent continues to experience a tech ecosystem boom, we look at some of the biggest barriers to success.

General Business Challenges

Africa is made up of 54 diverse economies, each with policies and ecosystems of different maturity stages. Some countries, like South Africa, have mature legal frameworks with judicial independence and established separation of powers. In others, like Tanzania, regulatory frameworks are still inadequate for venture capital as investors are not sufficiently protected, or are faced with strict restrictions that bar investments in specific sectors. Risk of expropriation and breach of contract deter investors from providing capital to entrepreneurs; more generally, contexts that are subject to arbitrary regulatory changes pose a threat to startup lifespans.

A lacking social security net cultivates a culture of tacit responsibility to subsidise one’s family, either directly or through employment. These distortions add a weight on entrepreneurs’ shoulders that can influence decisions over starting and ending entrepreneurial ventures.

Tech startups are confronted with the additional strain of estimating market size amidst limited infrastructure and misleading digital penetration rates, which:

• Don’t control for differences in technological capability and landscapes between countries;
• Are mismeasured (mobile penetration rates count the number of SIM card subscriptions rather than the number of people with an active phone and proxy servers make it difficult to determine social media users’ location);
• Include single-use technology users rather than looking at Internet usage frequency — daily users are different from monthly users;
• Don’t account for ‘different internets’: dial-up Internet, mobile-based connectivity and metered limitations remain a daily reality in many African countries, leaving many users behind.

While internet penetration rates average 40% for the continent, research has found that only 20% of Africans have regular access to the Internet, and as little as 1.4% have a fixed broadband connection. Deceptive digital penetration rates distort tech entrepreneurs’ perception and understanding of their addressable market base, thus increasing the risk of failure when launching new products or scaling.

Challenges with Access to Finance

Beyond regulatory and developmental barriers, African entrepreneurs also struggle to raise capital. The IFC has estimated that SMEs (accounting for 90% of African businesses) face a financing gap of $331 billion.

According to a 2016 survey, family and friends, grants, and crowdfunding remain the most common sources of funding for young entrepreneurs on the continent — yet income per capita levels in Kenya, one of the more advanced ecosystems on the continent, remain below $3,500 (PPP). Most households are unlikely to fund ventures sustainably.

Even those who can access external investment are faced with inadequate funding; the perceived risk of investing in Africa has meant that businesses face different investor expectations. While seed funding rounds in high-income countries usually support initial market research and fine-tune business models, a majority of African startups had already launched an international expansion (3.1 countries on average) before their first funding round, under pressure to target a broad market and find product/market fit simultaneously. Not only do emerging economies have less developed entrepreneurial ecosystems, they also have less local equity investment: a 2017 Village Capital study found that more than 90% of East African fin-tech funding in the two preceding years went to foreign founders, and most early-stage investors are expats themselves. Market uncertainty and cultural bias have generated a lack of trust in and understanding of African entrepreneurs. There is also doubt over whether African markets are large and mature enough to support venture-scale B2C businesses; many tech startups struggle with getting enough traction, eventually having to pivot to a B2B model. This switch enables startups to be more successful at a smaller scale, and to make use of existing distribution networks. Operating on a B2G basis, whereby a single public contract is large enough to make a company, is also available to well-connected entrepreneurs. Faced with a lack of steady and enthusiastic sources of capital, many startups across Africa are made to adjust their product and customer base according to investor demands, culminating in irregular, sometimes unpredictable business strategies.

In light of the growing momentum countering venture capital (VC) culture in the US, the question of whether traditional VC models are even compatible with African startups remains. In a typical grouping of a VC fund’s 10 companies, the majority will be written off; a couple will pay investments back; one may even double or triple the investment value; but for the fund to make decent returns, at least one has to make 50–100 times its investment. VCs’ exit-oriented rather than profit-oriented strategy does not necessarily make sense in African markets, where limited information about consumers hinders entrepreneurs’ efforts to scale, and exits (when they do occur) rarely exceed $100 million. There is a need to accept the fragmented reality of emerging markets’ startup ecosystems and rethink VC business models accordingly. Calls for investors to replace the unicorn chase with that of gazelles and zebras, which are able to create net jobs more sustainably, seem a much more realistic growth trajectory for Africa’s tech ecosystems.

Importantly, attempts to quantify the value of VC investments vary widely, and are still prone to skepticism; while VC firm Partech estimated a total of $1.163 billion raised in equity for tech startups in 2018, media company Disrupt Africa came up with $334.5 million for the same year. Given the very recent boom of the region’s tech scene, the accompanying analyst reporting, media coverage, and long-run data remain of low quality. Still, as the pace of innovation picks up across the continent, there is a need to rethink both the metrics used to measure digitalisation as well as traditional startup funding models to better suit the reality of African entrepreneurs’ needs.

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Image: “Girls in ICT Day 2019” by ITU Pictures is licensed under CC BY-NC-SA 2.0