Why SA startups have reasons for optimism in 2020 despite slow funding growth in 2019

South African tech startup funding saw slower growth than elsewhere in 2019, lagging behind continental rivals such as Kenya, Nigeria and Egypt. But a major investment early in 2020 suggests there are still reasons for optimism.

According to the annual African Tech Startups Funding Report released last month by Disrupt Africa, South Africa placed second – behind Egypt – in 2019 in terms of startups funded, but dropped to fourth place for funds secured.  

The US$73 million banked by South African companies over the course of the year was up 21.8 per cent on the previous year, but this was steady rather than spectacular growth that was bettered elsewhere. The numbers also suggest that while South African startups are not struggling to access capital at early stages, rounds of US$10 million and above are easier to come by in places like Nairobi or Lagos.

Missing money

This is certainly the view of Craig McLeod, formerly a venture capitalist and currently chief executive officer (CEO) of website creation tool Build.

“There is capital available for very early stage. As you move to late seed there are maybe only a handful of VCs worth speaking too, probably four by my count. This makes for a very small pond,” he told Disrupt Africa.

Clive Butkow, CEO of VC firm Kalon Venture Partners, which backs high-growth South African tech companies, slightly disagrees over cash available at early stages, but says there is a clear lack of “true Series A” funding.

“We have a severe shortage of angel and seed capital to help get the businesses off the ground. Once a business has proven product market fit and is ready to scale and requires growth capital, a pre-Series A round, we have sufficient capital,” he said. 

“We do not have sufficient capital when a business is looking for a true Series A raise capital of a few million US dollars.”

Who is holding back?

Regardless of exactly where the gap is, who is not investing? International or local investors? And why not? Butkow says many US-based investors only like to invest “within a 20 kilometre radius of their office”, and hence anything international is a non-starter. 

That challenge is not unique to South African startups, however, but local regulations hardly encourage investors to take the country seriously.

“I have witnessed when an entrepreneur does get interest from an international investor some of the IP laws and foreign exchange can become a bottleneck,” Butkow said.

“There is still an allergic reaction from many US-based VCs to invest in South Africa-domiciled companies.”

Local investors are also missing.

“We are a failing economy bordering on junk status. What that means is there is not a huge number of a high net worth individuals contributing to the top three funds, nor do most of them keep their money in-country or want to bring it back in-country,” McLeod said.

“This in turn leaves them with very little capital to invest into funds and less to deploy. Raising outside of South Africa in the US, UAE or Asia has proven to be much easier, at least from most of my network and my own experience.”

SA founders must do better, and some already have

It is easy to blame investor apathy and economic conditions for the relatively small amount of funding available to South African startups, but founders must also take their share of the blame. McLeod says many have wildly unrealistic expectations when it comes to fundraising. 

“You may have the next billion dollar idea, but until it has got its first US$50-200 million in revenue it’s probably not worth that,” he said. 

“Keep your asks humble and relevant to your stage of investment, and have a plan for how you will spend that money along with matching KPIs that would get you well into your next round of funding. So that means at least 24 to 36 months runway.”

There was some very good news for the South African tech startup scene last month, however, as field sales management platform Skynamo raised a US$30 million Series A round from leading US-based software investor Five Elms Capital. This round was far bigger than any other secured by a South African tech startup to date.

Skynamo CEO Sam Clarke said securing such an investment as a South African company had involved “many challenges”. 

“Not many capital partners in South Africa can write cheques of this size for high growth tech companies. This necessarily means that you are looking abroad to either the UK, EU or US. And that means that South African exchange controls and double taxation agreements all come into play.” 

Overcoming challenges like this, Clarke said, are things that companies from other markets just do not need to deal with. 

“Luckily we got the right lawyers early on to help us understand what can and can’t be done. We literally had to renegotiate commercial terms of the investment to accommodate these things,” he said.

Positive validation

Nonetheless, Clarke believes securing the investment is positive validation for South Africa as a tech hub.

“It just goes to show again that South African technology can be right up there with the best in the world. We have so many technology companies doing this every day. It is really a sector where South African startups shine,” he said.

Startups need more support, however, both financial and non-financial.

“To a large extent Skynamo got lucky that the market segment we started serving in South Africa also exists abroad. But if we could help local entrepreneurs with international market research so that they can start their businesses with internationalisation in mind we would see more success,” said Clarke.

Even if this were the case, however, securing funding is never easy. Butkow, aside from wanting portfolio companies to target large addressable markets both in South Africa and globally, is looking for standout solutions that break the mould.

“They require a tech solution that is unique and disruptive and ten times better then other products in the same sector. They require a moat around the castle,” he said.

Some, like Skynamo, have managed this to the extent they have attracted significant funding rounds similar to those we have seen in Kenya and Nigeria. More will need to do so if South Africa is to avoid falling further behind these markets in terms of startup funding.

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Written by Sekyen Jessica

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