In Africa’s Venture Ecosystem, Leading Rounds Matters

Last Wednesday morning, a morning like most others these days, I settled down with my coffee in front of my COVID-induced “work-from-home” office and dialed into my first virtual meeting of the day — an introductory call with an entrepreneur who was eager to explain to me the inner workings of her business. As our allotted time neared its end, I steered us toward the conversation’s inevitable final topic: fundraising. I asked her how much she was raising, and she was quick to respond: “Two million dollars, US.” … “And how much of that have you already raised?” I continued. “Well, we have interested investors who want to invest as much as $2.5 million. Our raise has gone really well so far. …[insert long pause]… But, if I’m being honest, there is a problem: we don’t have a lead investor, and that $2.5 million is only interested if we find a lead; they told us they want someone who ‘knows Africa’ and aren’t comfortable without it.”

For the entrepreneurs building businesses in Africa who are reading this, this will be the least revolutionary thing they hear or read this week, this month or this year. At this point in time in the development of the African entrepreneurship ecosystem, this entrepreneur’s final sentiment in our conversation echoes across the continent. I will hear it dozens upon dozens of times this year, and my friends and colleagues hundreds of times more.

So, then, why don’t more early-stage funders actually lead rounds in Africa, and why is that a problem? Let’s first take a short detour into the different ways that early-stage investors work.

Our current fund at VestedWorld is what is sometimes called a “conviction strategy” fund: we will invest in a small(ish) number of portfolio companies, and work alongside those founders relentlessly to help them build their young startups into enterprises that match their bold, ambitious visions. To gain conviction to invest in each one of these companies, we start by meeting hundreds of entrepreneurs per year, and then meticulously track them over periods of as long as 1–2 years to observe how they tackle obstacles, perform under stress, and see what kind of talent they attract to come along with them on their journey. When the company is ready to raise a round that fits our mandate (generally, pre-Series A and Series A), we do extensive due diligence, and our diligence memos extolling our investment thesis, takeaways from interviews with experts, and plans to support the company run close to 100 pages long (* for those entrepreneurs reading this, don’t worry, most of that is on us and generally our process runs smoothly, just ask our portfolio companies!). Then we “vouch” for the company with other investors, and assist them in raising capital until their round is completely full. Because of the strategy we run, we are limited to investing (generally leading rounds) into 3–5 companies per year.

The opposite strategy, an “index” strategy, seeks to invest in a large(ish) number of companies (as many as 3x+ more), often (but not always) at smaller check sizes, and only when another fund is leading the investment round and has established terms. Why, then, is this so much more common?

Four reasons come immediately to mind:

1. It is de rigueur to talk about venture capital as an investment strategy of trying to “pick a big winner” — having one investment in the portfolio that does so incredibly well that the fund’s investment returns are successful. An index strategy, almost by its very nature, will have a shorter-tailed distribution, but will have a higher chance of having a “big winner” (though with a smaller stake). The hope is that the win is big enough that the stake doesn’t matter.
2. As much as the venture capital industry hates to admit it, “good press” is beneficial to our businesses — with limited partners, entrepreneurs, and other investors — and often the spotlight of being “an investor” in the latest hot company never shines bright enough to reveal that the investor in question was an insignificant part of a larger round that was led by another fund who put hundreds of hours into bringing the syndicate together on terms that worked for investors and the entrepreneur(s).
3. Leading rounds takes a ton of work, which is difficult for the many small-team funds on the continent, and requires that you put your “reputational” neck very far out there for every investment you do. Why take that risk when, by building a network of other investors, you can often swoop into attractive investment rounds that are pre-packaged and ready to go, with the blame going on the lead investor when things go wrong?
4. Lastly, index investors typically don’t have to worry about significant “closing” risk. As many entrepreneurs (and investors) know viscerally, the difference between raising a full $2 million, and falling short at $1.5 million, can be success or failure. If you are a lead investor, and you put your money in first, there often isn’t a guarantee that the rest of the capital will come in. Index investors often sidestep this risk by only subscribing to fully or near-fully subscribed rounds.

Even though some of these reasons are based on sound judgement, it is, in my view, absolutely critical to have more funds like ours leading rounds into early-stage companies in Africa. I will share a few reasons, but they are manifold:

1. It is obvious, but is worth repeating: If no one is leading rounds, the entire ecosystem falls apart.
2. The plain truth is that the amount of capital held by funds who lead rounds is paltry compared with the dry powder of funds who are more passive (like index funds); what this means practically is that there are millions upon millions of dollars waiting in the wings, ready to be allocated to African startups, that is well deserved by those entrepreneurs, that will never get allocated to them if someone doesn’t do the work and lead the round.
3. Moreover, building a business in Africa (important note: I really only know about a half-dozen markets in East and West Africa, so forgive me for extrapolating here) can be incredibly difficult, and every investor-backed entrepreneur deserves an investor who is their “first call” when something goes wrong, when their mental health is suffering, or when they need advice or access to someone outside of their own network. Lead investors, in my experience, almost always play this role, due to the close bond that is created by the process I mentioned above.