November 3, 2014

Tech start-ups lament dearth of venture capital

Tech start-ups lament dearth of venture capital

The Wired World: A graphic representation of the Internet


Operators in the Nigerian technology ecosystem have decried the dearth of opportunity for early stage investment for tech start-ups planning to break into e-commerce.

The Wired World: A graphic representation of the Internet

The Wired World: A graphic representation of the Internet

Tech start-ups are new technology companies that are in a phase of development and research for markets and many of them are designed to search for repeatable and scalable business model. In Nigeria, many of the start-ups offer new ideas of addressing economic issues which they sell as services using technology.

Operators, who spoke to Financial Vanguard, said lack of investment in ideas that could transform into reputable and profitable ventures in the future is stifling the growth of the ecosystem.

They argue that it will be difficult for the industry to grow since venture capitals, private equity firms and other angel investors in the country at the moment are not willing to invest in new ideas but are ready to fund few start-ups, who have tested the viability of their concepts, scaled up and are already established.

The Co-Founder of Co-Creation Hub, CcHub and Director of its Open Living Labs, Mr. Femi Longe told Financial Vanguard that his experience has revealed that investors are only willing to invest in already established startups whose growth is expected to be steady and rapid.

Co-Creation Hub, which was launched in 2011, is Nigeria’s foremost social innovation centre dedicated to accelerating the application of social capital and technology for economic prosperity in Nigeria.

It recently launched a $500,000 seed investment fund to support early stage start-ups over the next two years. Start-ups will receive sums ranging from $10,000 – $25,000 to support business model experimentation and operations.

Longe noted that tech startups are not meant to absorb high level of investment from the beginning. He said unless investments are made at those early stages, it will continue to be difficult for tech startups that will absorb high level of investment to emerge in the future.

According to him, “Starting and running a business is a continuum. At different stages of the process, different amount of capital is needed. The amount of money you need to prove that an idea will work is not the same as the amount of money you need when you want to scale up.

“Most of the time, the so-called capital they say exists, is for businesses that are already established and expected to grow rapidly. So businesses that are looking for anywhere between a $100,000 and $1 million or more have capital waiting for them.

The problem is that before a business gets to a stage where it will be able to absorb a $100,000 or more, you need early rounds of funding that are smaller, usually amounts ranging from $5000 to $20, 000.

“But then the problem at that stage is that the there is less guarantee that the business will be successful, because they are just testing out the assumptions in the market.

And so most so-called investors shy away from this early stage investment. And because we do not have enough of these early stage investors, it is now hard to get companies that can get to where they can attract and absorb large investment.”

He said the reality about fund availability for tech start-ups is that “there is more funding for established start-ups than there are established start-ups and where the funding gap exist is the early stage investment to get start-ups to be established enough to attract large capital investment.”

In order words, there are lots of funds chasing few established start-ups while many yet to establish start-ups starve of investment.

“The challenge is not from the start-ups,” he observed. “The challenge is from the investors. To put this in context, we need to have a fund stream that can support businesses from the foundation, say with as little as $5000 as proof of concept fund.

For instance, I have an idea but not sure if the idea will be a viable business, I need some money to put it to test.

“In other parts of the world, people could get money from family and friends but in Nigeria, so many people have no family members to give them a million dollar to test-run a business idea that may end up not being successful.

And so if you ask me, the investors need to begin to think of how they can channel their investment into building a pipeline. How can they channel their investment to ideas that are experimental that may or may not be successful? If they become successful, business that ordinarily would not come to life would have been helped to come to life,” he added.

Also speaking, the Chief Executive Officer/President of Shoptomydoor, Nduka Udeh argues that while it may appear that there is more funding available than there is the capacity to absorb them, it is also important to note that private equity firms typically raise funds from their Limited Partners and the availability of funds, as claimed, will depend on the life of the fund and their typical area of interest.

Shoptomydoor is a Nigerian online retailer dedicated to bridging the gap between Nigerian shoppers and global merchants such as Amazon, eBay, Zappos, AliExpress.

He noted that the rise in e-commerce and mobile penetration has increased the number of private equity firms with interest in Nigeria and hence there are more funds available now than a few years ago.

He said, though the fund may be available, the challenge is in meeting the requirements for accessing the funds. He said the nitty-gritty involved comes with extreme high cost that most start-ups cannot meet. According to him, “There are lots that go into accessing funds, and the typical Nigerian environment makes this even harder.

A typical technology start up begins with very little capital either sourced personally by the owners or borrowed from family and friends.

While trying to meet daily business cash flow, it is very difficult to meet the demands of a typical venture firm before funding is made available to a tech start-up.

Business plan challenges

Udeh explained: “For a venture firm to pay attention to any tech start up, such a start up would have to present a solid business plan that shows the growth potential of such a business with facts and figures to substantiate the loan being sought.

Typical venture firms will not invest in businesses for which they will not walk out of in a few years time with a projected minimum of three times their contribution to the firm. Hence a firm wanting to invest $1 million in a start up will be looking for payout in the range of $3 million or more.

“Most technology start ups are headed by Engineers and most do not have the expertise to produce plans that will meet the requirements of most venture capital firms.

Such plans will require the companies to show their present valuation, show data to support their projected sales forecast and be able to perform an economic model of their plan.

The cost of hiring a firm in Nigeria to produce this, typically ranges from N3 million to as high as N8 million when consulting firms are brought in to do the work. Hence this already puts most start ups at a disadvantage as coming up with these funds that does not guarantee eventual funding is difficult.”

Advisory, legal fees too expensive for start-ups

“Other advisory fees will come in that financial advisory companies will charge to help a tech start up navigate potential funding.

These advisory fees come in the form of helping to negotiate the terms sheets, accompanying them on meetings and introducing them directly to the firms that have funds to invest.

All these come in the form of advisory fees that these financial firms will want paid up-front. Hence meeting these fees that range in the N2 million to N3 million with a percentage of the fund at closing also proves a big challenge to a typical start up entity.

“Also legal fees are other fees that can be substantial in negotiating these agreements and can range from a few hundreds of thousands to the millions depending on the firm and experience of the lawyers handling these.

“While the advisory and legal fees can be rolled into the funding and paid by the funders, the business plan development fee cannot, and leads to most good ideas not given a serious thought from day one if not produced and written by a fancy well known firm.

Rolling the advisory and legal fees into the fund also has the effect of reducing the founder’s equity in the company after the funding,” explained Udeh.

Udeh further said that for a typical tech start up to be able to acquire funding they should be willing to give up a lot of equity in their company, which in most cases makes them lose control of what they have built and hence they become employees of their own companies and indirectly of the venture firms.

This is one thing most entrepreneurs are not willing to do as most prefer not to work for anybody, and hence with these conditions, most opt to grow gradually and prefer not to even take the funding.

Another factor, he said, is that, “most tech start-ups don’t even have access to their funding firms, and hence we see a lot of firms and individuals are also gradually sneaking up in Nigeria, promising to help entrepreneurs raise fund, and compelling them to sign off a major part of their equity and huge advisory and management fee in return.

With little or no regulation on this type of activities and without standardisation of the funding process, a lot of entrepreneurs will back out of funding at the last minute when typical term sheets are presented to them.”

Accessing funds

To address these challenges, he said: “Easier access to connect tech start up and venture firms should be encouraged by the government through events and conferences that try to introduce reputable firms with potential good start ups.

In the US and most countries there are quarterly events in Silicon Valley where start ups are invited to pitch their ideas to a panel of tested and trusted venture firms.

Such a set up in Nigeria will definitely bring the two entities together and ensure that start ups are not put either in a situation where they prefer not to take the funds in the first place.

On his part, the Chief Operations Officer of SpacePointe, an online marketplace catering to the needs of the informal sector market in Nigeria, Osato Osayande said the issue to deal with is connecting the start-ups with investors. Investors need access to these start-ups and the start-ups on the other hand need training on how to present themselves in a way that is compelling to the investors.

He said: “Research is key to a start-up owner. There are lots of programs available to help start-ups through their process as well as many online start-up communities where they can learn from people who have been there before them. That being said, as an entrepreneur one should not just sit and await spoon feeding.”

If you do all you can do to get started including making your own financial investment in your business, an investor would be more likely to invest in your start up.”