By Risana Zitha, Managing Director and Head of Africa at DAI Magister
Prior to 2022, African growth companies had begun raising $50m+ equity rounds regularly for the first time in history, mainly in fintech but increasingly in sectors such as logistics, education, and healthcare. Since the market downturn, those large rounds have slowed to a trickle, even though today there are more African companies than ever before who are truly “eligible” to raise that kind of capital.
This growing cohort, alongside a larger group aiming to raise rounds in excess of $25 million, share the common question, “what will I need to look like now to aspire to raise that kind of funding to continue growing?”. The question is even more pressing today since many successful businesses have already raised internal “bridge” rounds from existing shareholders and now must look externally for new capital. Furthermore, the present downturn presents unique opportunities for growth while others are contracting.
Drawing on from our work advising 10+ companies across the continent aiming to secure larger rounds, we have distilled essential insights from the market, and observed the strategies companies are employing to position themselves best to be eligible for that kind of capital in the next 12-18 months. The insights below are a subjective guide, informed by our deep experience in the market today.
Of course, profitability
This is now a “given” in the current market, but even this is nuanced. Exactly what does “profitability” mean for a company to be eligible to raise a large round?
In general, this entails reduced current losses and a clear trajectory toward break-even within the next 6-9 months. But this is not the whole story. With a path to profitability comes the implicit question from investors, “show me how profitable the business can be longer term”.
We find many eligible companies are focused on the near-term path to break-even and less so on what the underlying profitability is longer term. Often this is just expressed as a “hockey stick:” future growth in revenue and EBITDA over the next five years or so, often to unrealistically high levels. But here we find many African companies have a great story to tell. Having built a business to a certain size, they often can command margins higher than anywhere else while still delivering products or services at competitive prices.
The reason? Building in Africa costs far more than elsewhere, but the cost of operations once built is often far less. Adding staff is much lower cost, as are basic costs like rent for locations etc. Many African companies can point to, and more importantly “prove” high, persistent EBITDA margins in a very few years’ time, often much higher than in developed markets. Think of it as the benefit of fragmentation and disorganisation. In chaotic markets (which most African markets still are), available margins are often much higher, and serious competition much lower. We always suggest companies show a detailed picture of what their profitability would look like steady state (e.g., without continued growth investment) 2-3 years after a potential investment, once they’ve scaled to a certain size. Very often this picture is surprising to investors, and surprisingly attractive.
Capital efficiency metrics
The resurgence of investor interest in capital efficiency, underscores the importance of maximising the growth a company can achieve for every $ of new investment. However, African companies looking to raise large rounds face a conundrum.
Historically, their capital efficiency metrics often appear unfavourable due to the substantial setup costs common in Africa. Solar companies need to build lines of supply, healthcare companies need to build distribution, even education-tech companies often need to build their own schools. But going forward, this picture changes radically. A transformative shift occurs once the initial groundwork is completed, enabling companies to yield higher margins for every new $ of revenue. Communicating this concept convincingly to investors, although challenging, is instrumental in securing larger rounds.
One can use the analogy of real-estate; if you own hundreds of residential units outright, rental income is nearly pure profit. So, the trick is not to rely on historic capital efficiency, which most likely looks unfavourable, but FUTURE capital efficiency and the pure profitability stemming from prior foundational work. Communicating this concept to investors, although challenging and in our experience, not only possible to do, but essential in raising a larger round today.
Large $’s = Pan-African, period
Two or three years ago, companies could raise large rounds with a promise cross-border expansion. Today, investors predominately favour companies with a broader, pan-African presence.
The simple reason is that investors committing to a $50m+ round, or even a $30m+ round, are working backwards from a $250-$500m minimum exit in a few years’ time. For any African company to be acquired for $500m in real cash requires a full African ‘platform’ business in whatever sector the company competes in. In short, it needs to become very strategic to a buyer, and deliver to that buyer “Africa on a plate.” So, today, investors require that they already clearly see how those manifest not on the drawing board, but in actual execution. A rule of thumb for raising over $50 million involves maintaining around 60-70% of revenue in the home market, with the remainder originating from other markets. This strategy minimises risk, mitigating the impact of foreign exchange fluctuations and political developments in any single country.
A complete team
Two years ago, an African company may have been able to raise $25m or $50m and promise to build out the C-suite. However, today, securing $50m or more now demands a fully established team. There’s no denying the importance of the CFO in large fundraises, notably in Africa. But for $50m of capital to convert into an African company today, investors require not only a strong CFO, but must also have competent commercial, technical, and strategic leadership functions in place. While temporarily remote or part-time talent acquisition is feasible, a clear roadmap to fully integrating the team is essential – ready to build revenue and value. Ultimately, two years ago investors backed founders, today they back teams built around strong founders. Founders should evolve into leaders first, founders second, steering companies away from overreliance on a single individual. Without this transition, most eligible African success stories simply won’t be able to raise the large rounds they need to win.
Strangely, simplicity
Africa’s complicated landscape often results in complex business structures. While multiple revenue streams, diverse assets, even different ownerships in different subsidiaries might be necessary, large investments now favour more streamlined, and ‘purer’ business models than a few years ago. This transition poses challenges for many. For instance, companies that organise supply chains for basic products often need to add financing to increase margins. Similarly, solar companies often need to expand their sources of financing, while Fintechs who handle merchant payments often find they need short-term trade finance to maximise the value of the merchant base they have built. So, the requirement for simplicity often cuts against commercially-sound complexity.
Navigating this dichotomy requires a strategic approach. Frequently, the solution lies in effective presentation. Today more than ever, simplicity = value. A lot of the work we do with larger African growth companies revolves around presenting what is complicated simply. It’s important to note that simplification does not equal simplicity. While a business model might inherently involve complexity, companies often hinder themselves by not presenting this complexity in a clear manner. What you might be proud of (such as being able to develop multiple different lines of business at an early stage), investors in $50m+ rounds will pay less for, assuming they are convinced to invest at all.
Finally, a willing cap table
We find that earlier-stage investors in many African companies are still showing resistance in embracing the changes required to raise $50m+ in the current market. By this we don’t mean valuation being lower; it’s widely understood that today’s valuations are not of 2021, and this trend is expected to continue.
What we mean are the shifts in governance practices that are required to accommodate larger incoming investors. A basic example is the shift from investor-driven governance to board-driven governance. In earlier-stage companies, investors often have strong rights, voting together as a class or individually. To mirror that, boards are often a reflection of shareholder ownership percentages. Today, raising larger rounds generally means shifting that approach entirely to board governance, where the board has decision making power over a far broader range of issues, and investor rights are restricted to major decisions like selling the company.
Inevitably, raising a larger round will mean some early-stage investors relinquishing their positions on the board, and therefore lose the governance rights they fought so hard for only a very few years ago. It is by no means an easy transition, and investor reticence is completely understandable. But it’s also the case that this reticence simply does not work to raise a large round today. And it is unrealistic that early-stage investors can “require” that a new investor buys them out if they step down from the board. Many $50m+ round investors prefer to direct all their funds into the company’s growth rather than spend precious $ buying out early shareholders.
Prior to fundraising efforts, African companies should agree internally on the shift to board governance, so everyone understands what that will likely look like post-funding. Even better, companies can already begin moving to board governance, shifting responsibilities to the board and away from shareholders. We recognise that this process can be challenging, but it is a necessary and integral part of the journey.
Overall, our view is that capital will start flowing again into African growth companies from later this year. Numerous high-quality companies, more reasonable valuations and increasing number of companies achieving break-even or profitability contribute to this optimism. Additionally, we are seeing major macro disruptions such as elections in Kenya, economic dislocation in Nigeria starting to normalize, so that by year end we believe the macro picture will revert to a steady (enough) state to stimulate greater investment. With the right strategic adaptations, and a focused effort on putting the pieces in place to be fully eligible for $50m+, or $30m+ funding rounds, we believe most eligible African growth companies will succeed raising the next key round for growth.
Africa still represents the hardest, but also the largest, untapped market opportunity on earth.