In today’s challenging economic landscape, the world of venture capital (VC) is undergoing a transformation that goes beyond the pursuit of financial gain.
A round table discussion, “How we solve for funding in early-stage VCs”, at the SA Innovation Summit 2023, brought together a diverse group of stakeholders to explore ways to bridge the gap between Fund of Funds (Limited Partners or LPs) and Venture Capital Firms (VCs) in Africa.
The central theme that resonated throughout the conversation was the importance of generating value beyond investment returns.
Audrey Verhaeghe, CEO of Anza Capital, says a serious problem in Africa is a lack of early-stage funding. “Capital allocators are applying an old model to an emerging class. In this emerging asset class, 80%, maybe even 90%, are first-time fund managers.
They look different, they are often female-owned or black-owned; they don’t have track records and exits under their belts. Yet the banks, the DFIs, the family offices only want to invest in second-time fund managers or people who can prove exits. There is an urgent need for a new way of looking at the emerging asset class because the old mindset is collapsing the system.”
Against the backdrop of a 64% decline in VC capital raising in the two years leading up to the second quarter of 2023, the session delved into the key barriers dissuading LPs from allocating further resources to VCs.
These obstacles included macroeconomic conditions, extended investment exit timelines, insufficient track records, and limited familiarity with emerging markets within the industry.
Keet van Zyl, the co-founder and CEO of Knife Capital, an organization known for successfully exiting 10 companies, shed light on the challenging economic conditions that hamper VC fundraising efforts.
Van Zyl also highlighted the concept of ‘exit paralysis’, where prolonged exit periods, currently averaging around 8.5 years, have begun to prompt asset allocators to consider alternative, less risky investment classes, such as real estate or stocks.
Konanani Rashamuse, from the Department of Science and Innovation, emphasised the need for collaboration and leveraging each other’s strengths to foster ecosystem growth amid these financial constraints.
When questioned by the roundtable facilitator, Karabo Modingwane from Grindstone, about potential policy reforms or interventions, Rashamuse said that government’s role was to “cushion the ecosystem”.
He outlined two government interventions. The first is to provide risk capital in the ecosystem and, as part of the innovation fund, the department has done that.
“We realised that in order for this ecosystem to be viable and sustainable we needed to provide some risk capital.”
The second has to do with impact investing. “It is primarily about economic returns but there are other key imperatives that we have to take into account,” he said, such as diversity in terms of gender and race. “If we want to entrench that in the ecosystem, we have to take the risk … We have vested interests. One of them is that if we want to have an impact, in terms of job creation and transformation, we need to find the best way to do that,” said Rashamuse.
Providing an international perspective, Kadir Gungor, Executive Chairman of Sustainable Impact, a Dubai-based family office-backed VC firm, stressed the significance of impact alongside regulatory and market entry considerations.
Gungor explained that the fund he represents prioritises investments that add value to humanity and address critical issues while generating economic returns.
Catherine Young of Grindstone Ventures pointed to the Harvard Business Review Study 2021’s finding that truly diverse businesses are likely to make 2.5 times better returns than businesses that are not.
Young, who is partner at Grindstone, an accelerator that has graduated 128 companies, added that we need to become intentional about impact in SA. We should start at the beginning, she said, “when we are recruiting startups for funding, evaluating them, and all the way through” so that impact is “not a last tick in a box”.
Tishanya Naidoo, Principal, Venture Capital at 27Four Investments, said that VC, with its focus on problem-solving, is inherently impactful. “The first questions you ask are: what is your problem and how are you solving it? That inherently entrenches impact in VC.”
She added that what would take that to the next level was effective monitoring of impact post-investment. The “more we prove out the impact in the VC space, the more we build a database and evidence of impact”, the more we will see capital flows.
Stakeholders from various sectors, including government, the private sector, and local and foreign investors, concurred on the need for a focus on impact, which would play a pivotal role in closing the funding gap.
Audrey Verhaeghe, CEO of Anza Capital, gave a clear view on the opportunity costs of not closing the gap and investing in early-stage start-ups: “Pre-seed to Series A funding is the beginning of industrialisation. Never mind the job creation that you lose out on, this is where new ideas are, the creative energy that builds the knowledge economy.
“If you don’t invest in the early stage, you lose that capability in your economy. You are creating a big gap, which makes you an import economy instead of an export economy. We are not solving our own problems. That is a massive opportunity cost if we don’t get this right.”