Two years ago, LelapaFund embarked on a project that had been brewing for some time: opening access to investments in African start-ups. African start-ups were the hottest deals on the frontier markets horizon, and our plan was to give small investors like ourselves a chance to buy shares in them. This would involve a new regulatory framework, a slick online marketplace supporting distance investing, and, of course, a community of top-notch entrepreneurs and investors.
The project’s guiding rationale was that using technology to reduce deal transaction costs would catalyse equity investments in the sub $1mn investment space. Famously known amongst development economists as the “missing middle”, this deal size is too big for microfinance, too small for private equity, and, as we like to add, too weird for banks.
Fast forward to today, and that end goal has not changed. Our approach to investing in Africa has, however, been flattened and rebuilt several times through interactions with over 500 small businesses. We grappled with tough questions, like knowing what balance to strike between quality and quantity of deals, whether we should be imposing European venture capital standards on lesser developed local markets, and how we could, or should, reconcile the goal of broad financial inclusion with the exigencies of equity capital.
Somewhere between coaching groups of sixty entrepreneurs in our living room in Nairobi on equity finance basics, and stuffing our suitcases with products to gauge investor interest in Paris, we defined our role as an intermediary. In parallel, we spearheaded the development of a regulatory framework for equity crowdfunding in East Africa, so that African angels may invest in local businesses with appropriate risk awareness, protection and shareholder rights.
This process led us to build cost-efficient products that focus not only on deal execution, but on the pre-deal work required to get companies structured so that financial and impact returns are maximised. Small funds, which we call Venture Partners, can now access opportunities where significant due diligence has already been undertaken by our team, and drive further in-depth analyses using our collaborative tool, LelapaFLOW. Small investors will be able to access deals anchored by a Venture Partner through our syndication platform at www.lelapafund.com.
Whereas other platforms focus on high volumes of lightly vetted deals, LelapaFund sources high-potential companies that are most likely to raise several rounds of capital on its platform. The flexibility of LelapaFLOW allows development finance institutions and investors, be they impact or finance-oriented, to share the burden of rigorous due diligence while ensuring blended returns outcomes aligned with their respective mandates.
If that was too much jargon for you, here are a few tips for investing at the “coalface of risk” in early-stage African ventures:
- Tech start-ups are not as hot as you think. The vast majority are not investable, leaving you to fight your way into overpriced, overhyped deals. Look towards value-adding agribusinesses, and consumer goods/services companies tapping into new consumer habits. Many of them are solving inefficiencies in their supply chains and distribution channels just to get their product to market, at times leveraging new technologies such as mobile payments to enable or enhance their operations.
- Know how much you’re willing to pay to play. Ask an angel investor or small fund what the total transaction cost of their last deal was, and you might be hard-pressed to find an answer. For VCs entering the small deal space, making a first $500k investment can easily cost 15%-25% of that amount. For angels, the need to pay attention to your sourcing, due diligence and legal costs is far greater. Consider investing through a platform or angel network to split those costs.
- Co-invest to learn faster. You will often be told to “co-invest to share risk”, but what does that really mean? For first-time investors, it means that you learn about actual and perceived risks by comparing and analyzing many companies within and across sectors, instead of picking one company and focusing all your time on trying to de-risk it perfectly. In addition, leveraging the trusted networks and primary data of a local partner will ensure you don’t burn all your cash – and motivation – on your first deal.
- Your skills and networks are worth more than your money. As with any early-stage investment, creating value is an all-hands-on-deck job. Small funds and angel investors are likely to have minority stakes, but this must not discourage active participation of shareholders, from giving product feedback, helping find and hire talent, to giving tutorials where there is a skills gap in the management team. Crucially, shareholders must hold companies to account, so that good governance distinguishes them from competitors when it comes to exit opportunities.
In practice, none of the above is particularly straightforward. Investors must also heed the usual advice of avoiding over reliance on data, reducing exposure to government corruption and limiting the use of local courts for dispute settlement. Getting your first deal done is likely to take twice or three times as long as expected, and it is important that first-time funds’ operations are as lean as possible through that first deal cycle.
On the flip side, helping build young companies in such fast-moving economies is terrifically rewarding on a personal level, and for many individual investors is a refreshing change from the low-impact positions they might hold in large financial institutions, corporates or consultancy firms.
Thanks to new regulations and technology, many more investors can now experience being a shareholder in an African venture. Such an opportunity perhaps provides as much value through insight into the genesis of markets established on different cultural norms and capitalistic models as it does through its potential for high financial returns. We hope that you will derive both in 2017.
Wishing you a brave new year,
The Lelapa Team