By many standards, the venture capital industry in Nigeria is still emergent, especially if one considers the size of the deals, number of funds and sophistication of investors in the market. Accordingly, the federal government must promote venture capital activity in Nigeria as a strategic policy initiative, and in order to promote innovation and enterprise among the most productive segment of its population.
As part of that process, the federal government should strategically engage all the stakeholders in the industry’s value chain. This is particularly important at this time given the increasing flow and value of foreign investments into the venture capital space in Nigeria, a trend which, in our view, holds the promise that Nigerian startups can unleash a revolution of wealth creation and rapid economic growth in a sustainable manner. Our proposition is that local development finance institutions (DFIs) are critical stakeholders in the value chain and have a significant role to play in Nigeria’s venture capital industry.
It is in this context that the decision by the board of Nigeria’s Bank of Industry (BOI) to be an investor in the first social innovation fund out of Nigeria is commendable. In a financing mix of both local and foreign investors, the BOI – alongside Venture Garden Group and Omidyar Network – is committing up to $230,000 to a $1m social innovation fund promoted by Nigeria’s foremost startup incubator, CCHub.
It is interesting to note that the fund will be managed onshore. Also noteworthy, is the fact that the fund aims to invest in early-stage tech companies that demonstrate an ability to solve a social problem – think of a company that converts heaps of refuse to clothing, shelter or other usable material.
Global trends
The decision of the board of the BOI accords with trends we see in the international venture capital space, tending towards an overall increase in the portfolio allocation by international DFIs to early-stage fund managers and ventures. This July, the board of directors of the International Finance Corporation (IFC) will be meeting to consider making a $10m commitment to Algebra Ventures Fund, which will target technology and technology-based startups in Egypt, and the broader Middle East and North Africa region.
Similarly, the European Investment Bank is considering making a $10m commitment to TLcom’s Tide Fund, a planned $100m venture capital fund, which will invest in entrepreneurs and enterprises that are leveraging technology.
Recently, it was announced that the IFC has decided to double its venture capital portfolio to $1bn to spur innovation in emerging markets. One of the companies in the IFC’s venture capital portfolio is Andela, co-founded by a Nigerian. The company recently received $24m in a series B funding in a round led by the Chan Zuckerberg Initiative.
Availability of risk finance
Growing trends in this space should bring to focus debates around how DFIs in Nigeria can be used to grow Nigeria’s venture capital industry strategically, especially with regard to the risk finance to the industry.
There is, in our view, a shortage of risk finance to high-growth tech and e-commerce startups especially when one considers the rapid increase in the number of Nigerian tech start-ups with scalable business models. The majority of, if not all, the financing currently available from local DFIs is debt-linked and sewn with requirements that venture companies will find hand to fulfil.
More of the risk financing available has been from foreign venture capital, incubators and angel investors who focus on Africa. On the local scene, the Lagos Angel Network and the African Business Angels Network are gathering a more enduring appetite for early-stage risk.
Also, a growing network of solo angels, incubators and corporate venture funds in Lagos and Abuja hold the promise of soaking up some of the demand that is available in the market. Nonetheless, we think that a sizeable portion of the market is underserved in terms of the availability of risk finance. Nigeria’s venture capital industry will require a sustained injection of risk capital, and local DFIs are, in our view, better positioned to close this gap as, by their nature, DFIs have a higher risk tolerance and longer investment horizons and are able to take up investments in sectors where the private sector finds it difficult to invest.
DFIs: which roles?
The active involvement of local DFIs in the venture capital space can help grow the industry in a number of ways. First, there is empirical evidence that lends credence to the theory that increased portfolio allocations by local DFIs to early-stage ventures or venture capital fund managers can catalyse and help attract and mobilise other sources of capital.
In addition to helping mobilise other sources of capital, the involvement of DFIs can help provide the much-needed management support and hands-on experience that can help commercialise entrepreneurial vision. Second, DFIs can help in promoting and entrenching environmental, social and governance (ESG) compliance across the board, thereby promoting the adoption of sound business practice, an imperative which will also give comfort to potential limited partners.
We think that the current state of play presents a good opportunity for local DFIs to expand the range of financial products available to Nigerian startups, by increasing allocations to Nigeria’s venture capital sector either through dedicated venture capital funds or through participations in privately-managed venture capital funds.
Legal restrictions?
It is important, however, to situate the foregoing within the extant legal framework for DFIs in Nigeria, especially because there are a number of provisions contained in the Central Bank of Nigeria’s regulatory and supervisory guidelines for DFIs that have a bearing on a DFI’s level of exposure to the venture capital patch in Nigeria.
For instance, local DFIs may invest in a startup business only up to a 10% of shareholders’ funds unimpaired by losses. DFIs are also limited to a maximum 25% holding in any enterprise. While we take the view that the current thresholds are fairly acceptable given the state of development of the industry, we note that the guidelines do not define the term “startup business”. In our view, it is important to define that phrase as its meaning is not immediately obvious and is capable of multiple interpretations. Businesses at different stages can qualify as a startup business depending on the indices used.
More importantly, the wording of the guidelines suggests strongly that DFIs can only take up equity directly in startup businesses as opposed to taking up participating interests in third-party managed venture capital funds, a prospect which we think may hinder the growth of the venture capital industry in Nigeria.
Going forward
Nigeria’s DFIs would also have to do more in terms of building capacity to complement a possible increased allocation to early-stage ventures and as part of own value-creation strategy.
In addition to building capacity in terms of evaluating, structuring and negotiating new equity, venture-type transactions, it will be important to develop venture capital investment strategies that are not only reflective of commercial realities but can also help to mitigate possible risks in a downside event.
Although there are usually contractual remedies available to a portfolio company or to a fund in the event of a time default, DFIs can make a lot more progress in terms of improving internal disbursements processes for commitments made.
Overall, allocations to the venture space will have to be in the form of patient capital, an investment strategy which has now overtaking the traditional venture capital as a source of investment for tech start-ups in mature markets.
This is an edited version of an article first published by Proshareng