COVID-19 and tech startup funding – how bad will it be?

COVID-19 and tech startup funding – how bad will it be?

For now, all thoughts are on managing the spread of the COVID-19 pandemic, with national lockdowns in place to try and get the virus under control. Yet the ramifications of the crisis for African tech startups could be felt for years to come.

The number of COVID-19 cases globally has passed the two million mark, with almost 150,000 people dead. Africa has around 20,000 cases, but there are fears the continent has yet to see the worst of the crisis.

The COVID-19 crisis will not be over once the health aspect of it has been overcome, however. It has already prompted a global economic crisis on a par with the Great Depression, and in Africa, and the continent’s growing startup ecosystems, the likely economic impact of the virus and associated lockdown will be felt for some time.

Though African tech smashed funding records in 2019, with 311 startups securing over US$490 million worth of investment, according to the annual African Tech Startups Funding Report compiled by Disrupt Africa, one key area in which startups may lose out in a post-coronavirus world is in terms of investment.

But is it likely to be the case that the global economic downturn set in motion by COVID-19 will mean less funding for African tech companies?

Should we expect to see a decline in funding for tech companies post-COVID?

The answer to this question is a resounding “yes”. Clive Butkow, chief executive officer (CEO) of South African Section 12J venture capital (VC) company Kalon Venture Partners, says VC investments into tech companies will be reduced as the amount of liquidity is reduced.

“The reduced liquidity will result from many LPs pulling back on their commitments as well as not making new commitments. Venture capitalists will focus on their current investments and on ensuring they have sufficient cash flow to see out the crisis,” he said.

“It will become harder for entrepreneurs to raise capital and where there is an opportunity to raise, the term sheets will be at lower valuations and worse terms then entrepreneurs are used to. The next many months and years are going to be a buyer’s market and not a seller’s market.”

Nnena Nkongho, principal at the DiGAME Investment Company, says past precedent suggests investments will decline in number and size.

“Global transaction volumes in venture capital declined during 2008/2009, and there is no reason to suggest that a more acute environment of supply and demand recession coupled with a public health crisis wouldn’t lead to the same,” she said.

This decline, according to Mike Mompi, CEO at early-stage fund Enza Capital, will be driven by capital providers seeking clarity on how this new normal, defined by COVID-19, will impact both the immediate prospects of potential investees and the longer-term economic prospects of some of Africa’s growth markets.

“Most African economies with tech ecosystems are supportive of their ecosystems but lack the same financial resources to effectively bridge deserving tech startups through this period,” he said.

How hard will Africa be hit?

The lack of financial resources within African ecosystems will be felt especially by startups as it is likely the continent will suffer more than most from the fallout in the VC community. Nkongho says the rapid changes currently taking place are also leading to a reassessment of markets for venture-backed businesses and exits for venture capitalists and, therefore, “drastic re-assessments of value”.

“In this context we expect that companies and GPs alike should expect that it will be more challenging to raise capital,” she said.

“Not only should we expect extended fundraising cycles, but we should also expect capital providers, especially ones that have a global versus an Africa-only remit, to find allocating to Africa more challenging as material public and private market declines have increased the relative attractiveness of more developed markets versus the risk-adjusted returns one expects in African private markets.”

The venture capital industry, meanwhile, is also adjusting to executing transactions in a post-COVID-19 environment, adapting their investment processes to ones less reliant on in-person engagement.

“Until this adaptation happens, I believe that this will be an additional factor supporting reduced deal volumes in the African VC investing space,” Nkongho said.

For how long will raising funding be this much of a challenge, and who will suffer most?

Nobody can predict how long the coronavirus-inspired lockdowns across the world will remain in place for, or whether they will lead to enough of a decline in new cases for COVID-19 to be considered “beaten”. Predicting the duration of the economic fallout is therefore extremely difficult, but investors certainly don’t expect it to be over quickly.

“Just as the impact of SARS-CoV-2 has been much deeper and longer-lasting than most of us could have imagined at the start of the year, the economic ramifications will be as well. Specifically, we believe that many African economies may be hit hard here, and the negative implications may last from two to five years,” Mompi said.

It is slightly easier to predict what sectors will suffer the most. Some spaces, like e-health, for example, may receive enough of a boost to be able to ride out the impending storm. Non-essential verticals like luxury and lifestyle will be badly hit, as will areas such as travel. In other spaces, the full extent of the impact is less clear.

“Most fintech startups will feel the effects differently,” said Olu Oyinsan, partner at VC fund Oui Capital. “For example, lending is expected to take a bigger hit with a swell in non-performing loans due to unemployment, and payments may enjoy a boost in the number of transactions due to an increase in e-commerce and non-cash transactions.”

Mompi said technology may be seen as a winner here, as adoption of emerging tech-based solutions is likely to be accelerated.

“The effective ones will last beyond the crisis. Within technology, however, companies providing non-essential products or services, ones involved in travel, tourism, and hospitality, and others requiring more than five humans to be in any one physical location may find that they struggle to work through this crisis without fundamental shifts in their strategy or approach,” he said.

Are any African tech ecosystems more vulnerable than others?

The recession will be global, and the investment squeeze felt across Africa, but some markets may be more at risk than others.

With an increasingly attractive investment landscape, exceptional talent, and a large population, Nigeria has fast become a hotspot for tech founders and investors. But Mompi said the country is likely to be one of the hardest hit.

“It has rightly produced some fantastic success stories, and it will surely produce more. Unfortunately, this year will very likely see a Naira devaluation in an already inflationary environment, which will be driven in large part by lower oil prices and lower foreign reserves,” he said.

“The knock-on economic effects will be severe on what is already an impressive but relatively fragile economy.”

Another country likely to be hit hard, Mompi believes, is South Africa, where serious economic challenges existed prior to the impact from COVID-19. Butkow agrees.

“I believe it will take South Africa many years to recover from the virus, and from a tech business perspective we unfortunately will see the death of many small businesses and innovation-led tech startups, both VC-funded and bootstrapped,” he said.

Is there any good news?

There may yet be some positives to come out of the downturn, though not many. Muthoni Wachira, investment lead for Africa at EWB Ventures, said the funding gap created by the COVID-19 crisis and associated recession will filled by business angels, from the continent and the diaspora.

“For high net worth individuals and amateur investor groups that are bold and nimble, possess deep expertise, and recognise the outsized returns potential, it will be an opportunity,” she said.

It has been said that nothing can create change like a crisis, and Wachira does expect some positive developments.

“We expect to see a resurgence of industry in Africa and the accelerated implementation of the African Continental Free Trade Area agreement, which will aid in job creation and the recovery of economies,” she said.

“We also expect to see African diaspora returning to the continent and using their skills, knowledge and financial capital to foster inclusive socio-economic development through technology innovation and entrepreneurship. This will ultimately lead to a reduced dependency on foreign aid, foreign direct investments and remittances.”

Nkongho said there may also be an advantage for early-stage companies in the current climate, as opposed to those already far down the VC road.

“Earlier, seed-stage opportunities may be more resilient in a declining environment, as the decision to invest is more focused on VC evaluation of market and team versus more quantitative execution metrics that may be more difficult to achieve in negative economic growth environments,” she said.

Mompi, who says Enza Capital will continue investing through the crisis, said though it is true that the riskiest assets suffer the most in a downturn, he was still optimistic on the whole space in general.

“In conversations with founders in our portfolio as well as with those who will be joining our portfolio in the coming months, we continue to be impressed with the leadership, perseverance, and determination they have shown,” he said.

“Venture investment and building early-stage companies is not a space in which median-level performance is celebrated. Founders as well as investors are looking for exceptions which can be found at the margins. There will continue to be exceptions at the margins, and we will continue to support them. In the short-term average performance may suffer, but as with the global economy as a whole it will recover and we will get back in line with the African growth narrative.”


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