2022 Year End Reflections

Well, this year certainly threw us some curveballs.

The record level of funding that poured into early-stage companies across Africa in 2021 gave reason for continued optimism heading into 2022. Similarly, positive news of Digital Realty’s purchase of a majority stake in Teraco (Africa’s biggest data center builder), which followed news in Q4 2021 that Equinix would buy MainOne (a West Africa data center operator) and that CVC Capital Partners would acquire Unilever’s tea business which included major assets in East Africa, showed that both strategic and financial investors remained interested in well-performing companies in growth sectors throughout the continent. Flutterwave’s $250M round which valued the payments company at $3B was also a major milestone for the ecosystem and was an indication that foreign investors with deeper pockets remained excited about investing in Africa.

However, Russia’s invasion of Ukraine, continued COVID-related disruptions, fuel shortages, catastrophic climate events, rising inflation, depreciating currencies, looming debt defaults, governance and strategy related missteps by a range of early-stage companies, and other maladies made this one of the most challenging years in many of the countries where we invest.

We didn’t share top trends that we were looking for in 2022 at the start of the year. While there are a few themes that ended up playing out as we may have expected, there were many that we did not or could not have anticipated.

1. Continued Rise of Embedded Finance — over the past several years, businesses operating in Africa have come to the realization that one of the most effective ways to increase sales (both B2B and B2C) and increase customer loyalty is by providing those customers with a range of financial services, primarily in the form of short-term loans that allows them to purchase more products/services. These businesses usually engage in recurring transactions with their customers. Therefore, they understand the ebbs and flows of each customer’s business and can leverage information from these repeat transactions to decrease the risk of fraud and default and provide financing solutions that fit their customer’s needs. If done well, embedded financing can be a key contributor to revenue growth, diversification away from the core offering, and customer retention. However, potential pitfalls include accurately assessing and managing the credit risk (especially if this is not the business’ core area of expertise), getting access to affordable capital to on lend, complying with regulatory requirements, building and maintaining the software infrastructure required to quickly make financing decisions, misuse or abuse by the customer, and increased competition for customers when competitors offer similar financial services. Businesses that offer embedded finance as a service are best positioned to benefit from this trend and they could also start to monetize the data they collect from the transactions that they facilitate.
2. Kinks in the Agency Banking Model — Many digital financial institutions in Africa rely on third-party agents to perform banking functions in locations that may not be served by a traditional bank branch. These agents can provide services such as opening accounts, KYC checks, deposits (cash in), withdrawals (cash out), bill payments, loan approvals, and transfers. In exchange for provided these services, the agent usually receives a fee based on the activity, the volume of transactions, and/or the amounts involved. Across Africa, the number of agents that provide these services is growing faster than the total number of transactions that those agents are handling. There are now more than 3 million agents providing financial services throughout the continent and most of those agents do not exclusively serve one institution. As more people become agents, the underlying economics will start to get strained. Each agent will handle fewer transactions and make less in commissions. Agents may be among those negatively affected if Africa truly transitions to a cashless economy (as fans of digital currencies and some governments hope). In order to survive pressure on the agency banking model and improve the economic proposition for agents, both agents and the institutions that leverage them will need to find alternative products and services that those agents can provide to their customers.
3. Here comes the Cavalry — Governments across several countries are starting to take more proactive steps toward spurring the continued growth of their early-stage ecosystem. These efforts include changes to remove barriers, provide incentives for innovation, reduce the cost of regulatory compliance, address currency controls, and create pathways for investors to exit their investments, to establishing investment promotion agencies that help facilitate foreign investment into the country. Some countries have launched innovation funds to invest directly into companies and fund managers. These efforts, like the Nigerian Startup Act and the Rwanda Development Board, combined with efforts being undertaken by development finance institutions and other non-governmental organizations, foundations, and private sector players will add wind to entrepreneurial sails across the continent.
4. Survival of the Fittest — Doing business on the continent requires resourcefulness and adaptability. Entrepreneurs and investors quickly learn that what worked initially may not continue to work past a certain point in the company’s development. Increasingly, original business models are being tested and require adjustments. Concerns about the ability to raise additional funding is also contributing to these shifts. Whether it’s moving from an asset light business model to one that’s more asset heavy (or vice versa), leveraging external partners or insourcing and integrating vertically, cutting under-performing business units or people, and/or scrapping plan A, B and C and moving to plan G, prioritizing profitability over growth, over the past year, we’ve seen a number of companies adjust their plans to reflect the realities of the market(s) in which they’re competing.
5. Show me the Money — observed and anecdotal information indicates that wages for highly skilled technical and managerial level talent have risen more quickly in the past year than they have in prior years. Given the competition for talent, from both established businesses and startups (in Africa and abroad), companies have had to adjust their compensation levels to reflect the new reality and are being forced to offer more attractive compensation packages to attract and retain the talent they need to grow their companies.
6. No Safety in SAFEs — Although they have grown in popularity over the past few years, in part as a result of the growing number of companies across the continent that are being accepted into Y-Combinator, the Simple Agreement for Future Equity (SAFE) instruments do not provide investors with the same level of protections as traditional investment structures (Preferred Equity and Convertible Notes). Entrepreneurs are increasingly raising more capital by issuing additional SAFE instruments (stacking) with different terms, delaying the conversion of SAFE instruments that were previously issued. Whereas some SAFE instruments initially included both a valuation cap and a discount in the event that the financing round that triggered the conversion of the SAFE did not exceed the valuation cap, most companies prefer to use only a valuation cap, and this can lead to situations where earlier stage investors are not appropriately compensated for the risks they took by investing in the company at a relatively early stage compared to later investors. Given the stacking of SAFE instruments, it’s also important to secure Most Favored Nation clauses and put guardrails around the conversion to ensure that the SAFE instrument doesn’t stay outstanding for longer than anticipated.
7. Corporate Governance — several accusations of corporate malfeasance and bad behavior underscored the need to conduct thorough due diligence prior to making an investment and to ensure that proper governance controls are in place to manage the company post-investment.
8. Death by a Thousand Cuts — Looming debt defaults, slower growth, food inflation, fuel shortages, and significant currency depreciation have plagued countries in Africa this year. The International Monetary Fund has determined that 23 countries across the continent are in debt distress or at high risk of being in debt distress. Unlike in the past where lenders to African countries were primarily western governments and multilateral banks, African governments have increasingly relied on loans from Chinese lenders and Eurobonds held by private sector players who may not be as flexible in restructuring loan obligations in the event of a default. Take Ghana for example, who recently defaulted on their loan. Over the past few years, Ghana’s public debt has risen from 56% of GDP in 2016 to somewhere between 84–100% of GDP today. The money that the country borrowed has not generated enough economic growth, tax revenue, or export earnings to pay back the debt comfortably and some projections estimate that servicing external debt consumes all of the revenue that the Ghanaian government collects. Ghana’s GDP growth rate has declined over the past few years and the country has experienced the highest food inflation in Sub-Saharan Africa this year. Demand for fuel has surged across around the world over the course of the last year but global refining capacity fell for the first time in 30-years, leading to shortages that have been felt acutely across several African countries. Sub-Saharan Africa now imports 75% of its fuel, more than any other region, and some countries, like Nigeria (which has the world’s cheapest fuel — $0.42/liter), subsidize the price of fuel. The Nigerian government will spend approximately $12.6B on fuel subsidies this year. These are all factors in why we’ve seen currencies depreciate in countries across the continent over the course of the last year (E.g., the Ghanaian Cedi has depreciated more than 50%). These countries will need to make tough decisions and adjustments to fix the economic hole that they’ve dug for themselves, and it is unclear what impact these changes will have on the early-stage ecosystem.
9. World of Play — Following in the footsteps of Afrobeats, Nollywood, and fine arts by African artists, and building off of the Marvel Cinematic Universe’s success with The Black Panther, a growing number of companies are focused on creating educational animated content for children and games that feature African characters and stories. In addition to the content, creators are hoping to build multichannel brands that appeal to people throughout the continent and in the diaspora.
10. Disrupting the Usual Path to Development — Globalization is being challenged. The stress that COVID-19 has placed on supply chains, delays in and increased costs of shipping manufactured products around the globe, and national security concerns have forced many companies to rethink their outsourcing strategy, how they operate their supply chains, and the potential risks and vulnerabilities of relying heavily on globalization. Many companies are exploring ways to diversify their supply chains by reducing their dependence on a single source of production or by stockpiling inventory. However, some companies have come to the conclusion that the cost-savings associated with offshoring are short-lived and are now looking to bring manufacturing back to their home country or to other countries closer to home. This shift in corporate strategy could drastically impact many African countries’ path to development if labor arbitrage no longer provides a competitive advantage in determining where goods are made.

Despite the many external challenges and obstacles African entrepreneurs faced this year, their resilience was quite remarkable. Facing headwinds from multiple angles, these entrepreneurs and their teams have continued to innovate and pivot their business models to provide products and services to better serve the needs of their customers all while managing capital constraints. As the flow of capital to the continent continues to increase, we hope to see continued growth of companies that are innovating and solving fundamental problems.

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