Are there lessons to be learnt by African VCs from PEs?
Optimising for Higher Returns and Impactful Change in the African Tech Landscape
Dear Visionary Investors in Africa,
In the aftermath of a funding winter that left startups withering, catalyzed by the heavy death in portfolios, thereby creating a bigger gap in VC return strategy, it's time to recalibrate VC investment strategies, exploring the merits and demerits of both venture capital (VC) and private equity (PE) approaches.
A veteran African angel, Victor Asemota, wrote on LinkedIn, about his shift from investing in startups due to how much loss he has made personally investing in African startups using the Silicon Valley “optimism” framework and how he now believes that investments in Africa require a novel approach. As a VC nerd, this prompted a thought to examine the merits of PEs in Africa, as they seem to have returned successfully on many occasions, and then consider if any lessons can be learned.
In today’s newsletter, we will dissect the investment principles that have shaped VCs and PEs, discovering ways VCs can glean from PE wisdom without losing their inherent DNA, ultimately optimizing for superior returns.
Merits and Demerits of VC and PE Investment Principles:
VC Agility: VCs are known for their agility, quick decision-making, and high risk tolerance. The merit lies in the ability to identify and nurture innovative ideas swiftly, supporting early-stage startups to scale rapidly. However, the demerit often surfaces in the form of higher failure rates due to the inherent risk appetite. As alluded to by Victor on LinkedIn, this demerit may seem insignificant for big global funds, but an average local VC fund cannot afford to lose a $2 million investment in one deal, as that may even account for 20% of its total fund size.
PE Pragmatism: PE investors, on the other hand, thrive on pragmatism. They meticulously analyze businesses, prioritize sustainable growth, and engage in hands-on portfolio management. The merit here is the lower failure rate and a focus on value creation. However, these can lead to a slower pace of decision-making, potentially missing out on high-growth opportunities. Since the African tech scene is in its nascent stage, there are fewer deals at the private equity scale; hence, it is important to examine ways some of these merits of PE can be infused into the African VC DNA.
Learning from PE Principles without Losing VC DNA:
Thorough Due Diligence with VC Speed: While PE's due diligence is meticulous, VCs can maintain their agility by adopting a nuanced approach. Swift yet thorough due diligence, focused on identifying startups aligned with the core hierarchy of needs, can minimize the risks associated with impulsive investments.
The message is clear: the African market is not a SaaS market and even needs more than just "tech-enabled" solutions; the real gold lies in understanding the daily struggles and aspirations of everyday Africans. The core hierarchy of needs—food, shelter, health, and financial security—forms the bedrock of the market.
Identifying areas where individuals are likely to spend money and creating comprehensive solutions around these aspects is crucial. This involves reimagining how technology can revolutionize daily life, with a focus on enhancing existing behaviours through innovative, affordable, and accessible business models. Read more on this in our past episode titled; “Rethinking the African Market: No To Fancy Tech, Yes To Actual Everyday Needs”
Strategic Collaborations for VC Synergy: VCs can borrow from the PE playbook by fostering strategic collaborations. However, instead of slowing down the process, VCs can leverage their agility to forge swift collaborations, maximizing synergies without compromising on speed. A VC firm facilitates a quick strategic partnership between a promising ed-tech startup and an established educational institution, creating immediate synergies. The key demands a deep understanding of the hierarchy of needs that underpins the African market and prioritizing solutions that seamlessly integrate into existing systems and enhance daily life, not just disrupt it. The foundation of successful tech ventures in Africa lies in the development of a robust value chain.
Risk Mitigation Strategies with a VC Mindset: PE's risk mitigation strategies can be integrated into the VC model without sacrificing the appetite for innovation. VCs can develop adaptive risk mitigation strategies, allowing for calculated risk-taking while ensuring a more resilient portfolio. VCs need to double down on investing in the platform or portfolio management strategy of their fund with a core focus on risk mitigation and elimination where possible, carefully steering their portcos towards fund returns. This may include strong board supervision, even M&As where required, and improved corporate governance standards, among others.
Long-Term Vision with VC Adaptability: PE's long-term vision can align with VC adaptability. Where the traditional VC quick exits may abound, African VCs may need to optimize for options that prime them to exit at $200 million earlier than sometimes a long wait for the $1 billion return. This means VCs can adopt a flexible approach, nurturing startups for long-term growth while staying agile and adapting to market changes.
Operational Excellence through VC Innovation: VCs can embrace hands-on involvement without compromising on innovation. By actively engaging with portfolio startups and providing support without stifling creativity, VCs can enhance operational excellence while maintaining a culture of innovation.
Optimizing Resource Deployment with VC Creativity: PE's resource optimization can inspire VCs to be more creative in resource deployment. Innovative pricing models, strategic partnerships, and microtransactions can be implemented to address low disposable income without stifling groundbreaking ideas.
Diversification Strategies for VC Resilience: VCs can leverage PE's diversification strategies by strategically diversifying across sectors without losing focus on innovation. A diversified portfolio can enhance resilience while still allowing VCs to capitalize on high-growth opportunities.
Tangible Value Creation Aligned with VC Vision: VCs can borrow from PE's focus on tangible value creation by aligning it with their vision. Emphasizing measurable outcomes and real-world impact can be integrated into the VC model without sacrificing the pursuit of disruptive technologies.
In essence, VCs can learn from the pragmatic approach of PEs without sacrificing their core DNA. It's about finding a harmonious balance where swift decision-making, adaptability, and a commitment to innovation coexist with meticulous due diligence, sustainable growth, and tangible value creation.
By embracing the best of both worlds, VCs can optimize for better returns, contributing not only to financial success but also to transformative impact in the vibrant African market.
Amazing write-up
I particularly love the cross-combination of ideas to create a novel approach to building in Africa