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Financing Innovation in Africa: The Last Middle

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Monday, January 16, 2017 1.42PM / Olubunmi Abayomi-Olukunle* 

A cloud does not know why it moves in just such a direction and at such a speed ……It feels an impulsion…. This is the place to go now. But the sky knows the reasons and the patterns behind all clouds, and you will know, too, when you lift yourself high enough to see beyond horizons...Richard Bach

In many respects, 2016 was a remarkable year for technology, innovation and high-growth companies in Nigeria.  In addition to the interest shown by a variety of venture capital, private equity and strategic investors in high-growth companies in Nigeria, it is now very clear that two of the most influential technology blocs in the world, the BAT bloc, consisting of Baidu, Alibaba and Tencent and the GAFA bloc, consisting of Google, Amazon, Facebook, Apple are interested in high-growth Nigerian companies and in opportunities in Nigeria’s rapidly evolving ecosystem, albeit with different entry strategies. Earlier in 2016, Andela closed a USD

24 million in a Series B round which included Facebook and Google Ventures. IrokoTv was reported to have closed a USD19 million round from France-based Canal Plus. Recently, Paystack, an online payments company, closed a USD1.3M seed funding from local and international investors which included Tencent and Comcast. Paystack’s raise is the second highest amount ever to be raised by a Nigerian start-up as seed investment. More than in previous years, 2016 recorded a lot more deals in the USD1million seed financing zone. - A bunch of other deals in that category were deliberately stealth -. Without a doubt, Nigeria is now firmly on the global innovation technology map. Compared to previous years, 2016 saw greater financial commitment from the Nigerian government to the entrepreneurial landscape.

The year also witnessed the highest level of angel investment and corporate venturing activity with a good number of corporate innovation programs already initiated and now in full swing. In 2016, the Lagos Angel Network launched its DealDay – a pitch day for Nigerian start-ups - where it commits up to N50million to 3 start-ups through its syndicates every quarter. The Nigerian government bankrolled a number of accelerator programs, demo day events and also earmarked N500, 000,000 million for disbursement as grants to qualifying start-ups.

Nigeria recently announced a partnership with the World Bank Group and a number of development finance institutions on the release of 1.3. Billion dollars for the take-off of an SME focused development bank in Nigeria. The International Finance Corporation and European Investment Bank have also announced plans scout deals in Nigeria’s rapidly evolving tech ecosystem.  The message is strikingly clear: -more money is available for truly innovative and disruptive high-growth companies -.
 
The Big Bet in the Last Middle
We would take a bet that 2017 is on course to be the best year ever for venture capital fund raising and for innovation, technology and high-growth businesses. Yet, there is still a wide financing gap in the local market and there is a huge chance that an increasing pile of dry powder may not translate into deal flow. That gap, contrary to the popular view, is not a mere financing gap, neither is it merely, a failure or lack of availability of the traditional demand-side initiatives. There is a gaping absence of a professionally managed venture capital market in Nigeria.


A professionally managed venture capital market is crucial for economic development because professional VCs come with a critical mass, consisting of capital and business/networking intelligence which directly focus on entrepreneurs, who are the driving force behind indigenous innovation. Also, a professionally managed VC market will almost naturally create a solid pipeline for later-stage private equity, further deepening allocation of capital and local private capital markets. Unfortunately, there exists an absence of venture capital firms that possess that critical mass, the network and the managerial experience to effectively partner with or assist high-growth companies to solve big problems that are prevalent locally and to create truly profitable solutions. On the other hand, it is now beyond argument, that early-stage Nigerian tech companies desperately need substantial support with the management and commercialization of their ideas to scale their companies and to negotiate a positive liquidity event for investors. 

Although the Securities and Exchange Commission (SEC) issued venture capital regulations regulating local funds several years ago, there is yet no local VC fund registered at the SEC in Nigeria. The vast majority of private capital merchants are private equity firms and there are less than a handful of venture capital firms in the country. Nigeria has no official policy document on venture capital and regulators are yet to acknowledge the gaping absence and usefulness of a professionally managed venture capital market and the need to use intelligent regulation as a tool for cultivating market activity. 

The Evidence of History

We find evidence of a realization by governments in developed VC markets that publicly-run entities may lack the commercial orientation and expertise to provide the quality of management support needed to support early-stage companies or to turn R&D efforts into commercially viable products. In these jurisdictions, this realization has informed a review of and shift in the role of government in individual approaches to developing venture capital market and a preference for an approach that enables the Government to serve as a catalyst for venture capital activity and to create an attractive environment for venture capital business and managers to thrive. Perhaps, the evolution of Israel’s venture capital industry best illustrates this point. In 1991, there was no venture capital industry in Israel.  After, initiating a number of programs directed at improving the R&D capabilities of new Israeli companies and taking strategic steps to expose Israeli innovation to American market through the Binational Industrial Research and Development Foundation (BIRD) initiative, the Israeli Government realized that, although start-ups in Israel at that time were successful in R&D, they were not successful in growing companies as they had no experience building companies and did not understand the business development, funding and commercialization process, well enough. Subsequently, a bunch of bureaucrats at the Ministry of Finance in Israel came up with an idea for a program called Yozma. The Yozma program is widely believed to be the catalyst that created Israel’s flourishing venture capital industry and marked the beginning of professionally managed venture capital market in Israel.

The Americans Came

The object of the Yozma was to strategically entice professional VC firms from the United States to develop the local VC market. It was believed that American VCs will provide aspiring Israeli VCs and entrepreneurs with not only capital but more importantly, with the commercial know-how and VC fund management expertise for venture capital business. Yozma therefore adopted a co-funding structure pursuant to which the Isreali government set aside a USD100 million to establish five VC funds of USD20million. The key attractive terms of each fund is as follows: (a) Each fund was constituted by 3 parties, namely, an Israeli venture capitalist in training, a foreign venture capital firm, and an Israeli investment company or bank (b) VC firms were to raise USD16 million in order to get the government’s USD8 million (c) The government will retain a 40% stake in a fund but will give the VCs the opportunity to buy the government’s 40% out cheaply, plus annual interest- after 5 years, if the VC fund was successful. Israel also implemented a number of tax and regulatory changes, all conceived to drive foreign VC investment and activity in Israel. Yozma turned out to be a huge, landmark success. The Americans came. As Erel Margalit, one of Israel's top managers of Israeli startups, puts it, “Venture Capital was the match that sparked fire.”

The ten Yozma funds created between 1992 and 1997 raised over $200 million with the help of government funding and all the funds were bought out or privatized within five yearsas planned. (Dan Senor and Saul Singer, 2009). Together, the funds now manage over $3 billion of capital and support hundreds of new Israeli companies. Today, an estimated 60 venture capital groups are active in Israel with over USD14billion under management. All major multinationals and tech companies invest in Israel. Israel has more companies listed on New York Stock Exchanges (NYSE, AMEX, NASDAQ) than any other country except the United States and China. The country has the world's highest per capita count of engineers and the highest density of high-tech start-ups - nearly 4,000 in a country of seven million people. Israel is the world’s leader in the percentage of the economy spent on research and development and High-tech now contributes approximately 50% of exports.

In 2008, per capita venture capital investments in Israel were 2.5. times greater than in the United States, more than 30 times greater than in Europe, 80 times greater than in China, and 350 times greater in India. Comparing, absolute numbers, Israel – a country of just 7.1 million people – attracted close to USD2 billion in VC, as much as flowed to the United Kingdom’s 61 million citizens or to the 145 million people living in Germany and France combined (Dan Senor and Saul Singer, 2009). Despite fighting several wars and an intense period of terrorist attack, Israel’s share of the global venture capital market actually doubled on occasion.

Critical aspects of the Yozma program have been replicated in Singapore, South Korea, Canada, Ireland, Australia and Japan. In 2008, Ireland launched a €500 million innovation fund. The fund was decidedly structured to attract co-financing opportunities from foreign venture capitalists. Admittedly, a number of other approaches may be implemented in developing a professionally managed venture capital market. Brazil implemented a series of panels on VC funds, to assess VC funds and provide advice on how to improve. Following some of the recommendations of this panel, Brazil organized forums and training workshops with the intention of educating investors, start-up owners and researchers on VC, diligence and other relevant topics. The first phase of Inovar (which was the project conceived to drive growth in the Brazilian VC market) was so successful that a second phase, 'Inovar II' was initiated in 2007, a year after the first phase. The forums, panels and training sessions, which still occur regularly, cost of the Brazilian government up to $13 million for both phases and facilitated more than $1 billion in investment (Leamon and Lerner, 2012: 17). One of the most significant values of the Inovar program was how it was able to forge "necessary inter-personal relationship network between researchers, investors and start-ups" (Castro, 2012). Brazil also implemented strategic tax and regulatory reforms. For instance, a 2006 Brazilian law reduced taxes on income made with VC by foreign investors to zero, provided the foreign VCs get taxed at least at 20% in their home countries.

Africa's Centre for the Study of Venture Capital and Private Equity

This year, we are partnering with a global private equity firm to endow Africa’s first Centre for the Study of Venture Capital and Private Equity in one of Nigeria’s prestigious universities. The mission of the Centre will be to disseminate core knowledge of entrepreneurial finance, venture capital and private equity investment.

The Centre will also on a continuous basis conduct pertinent research and gather data on the venture capital investment landscape in Nigeria with the objective of becoming the leading source of accurate, comprehensive, and focused information on Nigeria’s evolving venture capital industry. The Centre will also advocate for policies and legislations that will create an enabling environment for venture capital to thrive.

Heed Regulator. Heed.
Nigerian Regulators definitely have a major role to play. Nigeria has to strategically court professional VC knowledge from VC capitals all over the world. The country needs to review its venture capital and private equity rules and implement tax, immigration, corporate and securities law reforms that are strategic to the growth of a professional venture capital industry.

Crucially, the innovation value chain in Nigeria has to be completely de-politicized and independently monitored, if any meaningful progress will be made in 2017 and beyond. In 2011, Nigeria reportedly set up a USD10million ICT Innovation Fund and reportedly launched another 300 billion innovation fund in 2016.

Not much has been heard of these funds and there are indications that the government may have failed to follow through with its commitment to these funds or is merely paying lip service. Nigeria needs to focus on workable structures, strategically open up its innovation value chain to the world and muster the political will to follow through.

*Olubunmi Abayomi-Olukunle is a Barrister & Solicitor of the Supreme Court of Nigeria and Partner, Private Equity ,Venture Capital & Emerging Companies with Balogun Harold Legal. He can be reached vide www.balogunharold.com |  olu@balogunharold.com  | +234-806-081-7371

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