Funding Your Startup: A Realistic Look Beyond Venture Capital

Introduction

The African startup ecosystem is burgeoning with potential and innovation. However, the journey to securing funding remains challenging for many entrepreneurs. Despite the growing interest from venture capital (VC) firms, the gap between startups seeking funding and those actually receiving it remains significant. According to the 2023 Africa Tech Venture Capital Report by Partech Partners, African startups raised $2.3 billion in venture capital across 473 equity deals. This figure pales in comparison to the thousands of startups vying for attention. This disparity underscores a persistent reality: not every promising business will secure venture capital, and this gap is likely to persist due to the inherent nature of the VC model and market dynamics.

Capital is the lifeblood of business growth. It enables innovation, scales operations, and drives competitive advantage. However, the capital ecosystem in Africa is complex, and understanding it is crucial for entrepreneurs looking to navigate their funding journey successfully.

The Power Law: The Venture Capital Playbook

Venture capitalists operate under a unique playbook often characterised by what is known as the "power law." As highlighted in Sebastian Mallaby’s book, The Power Law: Venture Capital and the Making of the New Future, the power law dictates that a small number of investments will yield the majority of returns. This model shapes how VCs think and assess potential investments.

VCs are in search of outliers—startups that have the potential to generate exponential returns. This means they are often less interested in solid, steadily growing businesses and more focused on those with the potential for explosive growth. The venture capital model thrives on risk, with the expectation that while many investments may fail, the success of a few will more than compensate for the losses. This approach influences their evaluation criteria, favouring startups with scalable business models, large addressable markets, and the potential for rapid growth.

Mallaby eloquently captures this in his book, stating, "Venture capital is not a game of winners and losers; it's a game of winners and a multitude of those who didn't win big enough." This philosophy drives VCs to seek out businesses that can disrupt markets and achieve significant scale.

Why Venture Capital Might Not Be Right for You

While venture capital can be a powerful catalyst for growth, it is not a one-size-fits-all solution. Understanding the characteristics of VC-backable businesses is crucial. A good business, in a general sense, is one that is profitable or on a clear path to profitability, has healthy unit economics, creates value for all stakeholders, and has the potential for sustained growth. However, not all good businesses are suitable for venture capital.

VC-backable businesses typically exhibit certain traits:

• Scalability: The ability to rapidly scale operations and reach a large market.
• High-Growth Potential: Prospects for exponential growth and market disruption.
• Large Addressable Market: A significant and accessible market that the business can tap into.
• Innovative Edge: Unique value propositions or technological innovations that differentiate the business.

Businesses that do not align with these criteria may find it challenging to attract VC funding. Moreover, forcing a business model to fit the VC mould can be detrimental. Raising venture capital comes with expectations of rapid growth and high returns, which can strain a business not inherently designed for such pressures. This misalignment can lead to strategic missteps, financial stress, and, ultimately, failure.

It is essential for entrepreneurs to critically assess whether their business model and growth trajectory align with the demands of venture capital. If not, alternative funding routes may be more suitable and sustainable.

No Venture Capital ≠ No Capital

The absence of venture capital does not equate to an absence of funding opportunities. Africa’s financial landscape offers other alternatives for good businesses seeking capital, each with its pros and cons:

Revenue-Based Financing

Revenue-based financing (RBF) provides capital in exchange for a percentage of future revenues. This model aligns investor returns with business performance, offering flexibility in repayment terms.

How They Benefit Businesses

RBF offers flexibility as repayments are tied to revenue, meaning businesses pay more when they earn more and less when they earn less. This reduces financial pressure during low-revenue periods and aligns investor interests with the business’s success.

How Businesses Can Access Them

Businesses can access RBF by approaching specialised financing firms that offer this model. The application process typically involves sharing financial details and revenue projections. The terms of the financing will be negotiated based on the business’ revenue potential.

Examples of Financiers

• Lighter Capital: Provides revenue-based financing primarily to tech startups.
• Flow48: Offers RBF to businesses in the Middle East and Africa.
• Uncap: Focuses on providing RBF to businesses in Sub-Saharan Africa.

Risks and Challenges

RBF is best suited for businesses with predictable revenue streams, and businesses may end up paying more than traditional debt if their revenues grow rapidly. The percentage of revenue committed can also reduce the cash available for other operational needs. Moreover, this form of financing can be less accessible for businesses without a proven revenue history.

Invoice Financing

Invoice financing allows businesses to borrow against their outstanding invoices, providing immediate cash flow based on future payments from customers.

How They Benefit Businesses

Invoice financing improves cash flow, enabling businesses to meet operational expenses and invest in growth without waiting for customers to pay their invoices. It’s particularly useful for businesses with long payment cycles or seasonal revenue.

How Businesses Can Access Them

Businesses can access invoice financing by working with financial institutions or fintech companies that specialize in this area. The process involves submitting outstanding invoices to the financier, who then advances a percentage of the invoice value.

Examples of Financiers

• Capsa: Provides invoice financing solutions for African SMEs.
• Bridgement: Offers invoice financing to small and medium-sized businesses in South Africa.
• Zuvy: Specializes in invoice finance for businesses.

Real-Life Example

A construction company in Nigeria — Lafmob Contractors — used invoice financing from Capsa to cover operational costs.

Risks and Challenges

The cost of invoice financing includes fees and interest, which can be high, reducing overall profitability. Over-reliance on invoice financing can also indicate underlying cash flow issues. Additionally, if customers delay payments or default, the business may still be liable to the financier, potentially leading to financial strain.

Crowdfunding

Crowdfunding involves raising small amounts of money from a large number of people, typically via online platforms. It can take various forms, including rewards-based, equity-based, and donation-based crowdfunding.

How They Benefit Businesses

Crowdfunding can validate business ideas, build a customer base, and generate early-stage funding without giving up equity or accruing debt. It also provides market exposure and can attract additional investors.

How Businesses Can Access Them

Businesses can access crowdfunding by creating a campaign on a crowdfunding platform. The campaign should include a compelling story, a detailed description of the product or service, and a clear explanation of how the funds will be used. Effective marketing and engagement with potential backers are crucial.

Examples of Financiers

• Kickstarter: Focuses on creative projects and offers rewards-based crowdfunding.
• GoFundMe: Primarily used for personal and charitable causes.
• Thundafund: A leading crowdfunding platform in Africa, supporting various types of projects.

Real-Life Example

A South African startup, Aerosphere developing advanced wearable technology, successfully raised funds for one of its products — Aerosphere MKII — through Thundafund. The campaign not only provided the necessary capital but also generated significant media coverage and customer interest.

Risks and Challenges

Crowdfunding requires significant effort in marketing and community engagement to reach funding goals. Failing to meet the funding target can result in receiving none of the pledged funds (in some platforms' all-or-nothing models). Additionally, fulfilling rewards or equity promises can be challenging and costly, potentially leading to dissatisfied backers if expectations are not met.

Loans

Loans involve borrowing money that must be repaid over time with interest. They can be obtained from traditional banks, microfinance institutions, or other financial entities.

How They Benefit Businesses

Loans provide businesses with the capital needed for growth, expansion, and operational expenses. Unlike equity financing, loans do not dilute ownership, allowing founders to retain control of their companies.

How Businesses Can Access Them

Businesses can access loans by applying directly to financial institutions. The application process usually requires a solid business plan, financial statements, and sometimes collateral. Creditworthiness and the ability to repay are key factors lenders consider.

Examples of Financiers

• Standard Bank Group: Provides business loans across multiple African countries.
• Equity Bank: Known for offering micro-loans and SME financing in East Africa.
• Fluna: Provides export financing to African exporters.

Real-Life Example

Fluna provided loans and market information to Complete Farmer in Ghana to facilitate the exportation of agricultural products from Ghana to other continents. 

Risks and Challenges

Loans must be repaid with interest, which can strain cash flow, especially for businesses with unpredictable revenues. Failure to meet repayment obligations can lead to penalties, increased interest rates, and potential legal actions. Additionally, loans often require collateral, putting business assets at risk if the loan cannot be repaid.

Grants

Grants are non-repayable funds provided by governments, non-profits, and international organisations to support specific projects or initiatives. They are essentially “gifts” of money that do not require repayment.

How They Benefit Businesses

Grants are particularly beneficial for businesses focused on social impact, innovation, or development goals. They provide essential funding without the burden of debt or the need to give up equity. This can be crucial for early-stage startups needing to develop their products or services without financial strain.

How Businesses Can Access Them

Businesses can access grants by applying through various grant programs. The application process typically involves submitting a proposal outlining the business's goals, how the grant will be used, and the expected impact. It’s essential to align the business’s mission with the grant provider’s objectives.

Examples of Financiers

• Tony Elumelu Foundation: Offers the Tony Elumelu Entrepreneurship Program, which provides grants and mentorship to African entrepreneurs.
• Mastercard Foundation: Awards grants to businesses solving Africa’s youth employment challenge.
• Africa Enterprise Challenge Fund (AECF): Provides grants to businesses focused on agriculture and renewable energy.

Real-Life Example

Mastercard Foundation awarded Jobberman a grant to see 5 million young people, at least 50% young women, trained and enabled to secure dignified work, with 3 million linked to employment opportunities across multiple sectors including agriculture, digital and the creative sectors within five years.

Risks and Challenges

Grants can be highly competitive, with many applicants vying for limited funds. The application process can be time-consuming and require significant effort, with no guarantee of success. Additionally, grants often come with specific conditions or reporting requirements that must be adhered to, which can add administrative burdens.

Emerging Trends and Future Outlook

The funding landscape in Africa is evolving, with emerging trends reshaping how businesses access capital. The rise of fintech platforms is making financing more accessible and transparent, offering innovative solutions like peer-to-peer lending and blockchain-based fundraising. Additionally, social impact investing is gaining traction, with investors increasingly interested in funding businesses that deliver positive social and environmental outcomes alongside financial returns.

Cryptocurrency and decentralised finance (DeFi) are also emerging as alternative funding avenues, providing new ways for startups to raise capital outside traditional financial systems. While still in the early stages, these technologies offer potential benefits, including reduced transaction costs and increased financial inclusion.

As an entrepreneur, stay informed about these trends and explore how you can leverage new financing opportunities to support your business growth.

Conclusion

The pursuit of capital is a critical aspect of business growth, particularly in the dynamic and evolving African startup ecosystem. While venture capital remains a significant source of funding, it is not the only path to success. Understanding the diverse funding landscape and exploring alternative options such as grants, loans, crowdfunding, revenue-based financing, and invoice financing can provide entrepreneurs with the necessary resources to scale their businesses sustainably.

Entrepreneurs must carefully evaluate their business models and growth strategies to determine the most suitable funding sources. By leveraging the right mix of capital and staying attuned to emerging trends, African startups can thrive and contribute to the continent's economic development and innovation landscape.