Why most startups lose out on capital investments

Local institutional investors are key in unlocking the start-up scene but have over the years, failed to make a major impact.

This is because they stay away from young and innovative firms that are deemed risky and instead opt for low-risk investments, including government bonds. 

This is unlike the practice globally, where large money managers such as pension funds and insurance companies pump billions of shillings or dollars into high-growth century capital assets.

Shying from start-ups has been attributed to a lack of familiarity with the industry and an overemphasis on the sector’s perceived risks rather than its portfolio-wide returns. 

This has in turn resulted in the African venture capital market continuing to struggle with a lack of liquidity.

Head of the European Investment Bank’s Regional Hub for Eastern Africa Edward Claessen noted that while Africa’s startup ecosystem is brimming with potential, fueled by a young, dynamic population and a surge of innovation in high-growth sectors like fintech and climate solutions, it faced a severe lack of capital.

He said local institutional investors needed to increase their role in venture capital firms that then invest in start-ups, but noted that the government needed to play a role in putting in place an enabling framework and incentivising investors to put money in the sector 

“There is no lack of ideas or opportunities; there is a lack of capital,” he said.

Claessen, who spoke last week on The Standard Group’s Spice FM, explained that companies managing large amounts of money have, throughout the years steered away from what they perceive as risky investments, opting to put money in “safer” areas such as lending to the government.

“What I would love to see in Kenya is big companies, such as the pension funds, insurance companies and asset managers, putting little money in risk capital. They prefer risk-averse or safer investments.”

“That is very different in other parts of the world. If we could find ways to attract those big money managers to put some of their money, even one per cent of what they manage, would make a huge difference.”

Claessen noted that the impact that institutional investors can have in the start-up scene is seen in EIB’s Boost Africa initiative, which has leveraged on its €78 million (Sh13.23 billion) junior tranche to unlock over €382 million (Sh58 billion) in private foreign investment. 

Through the initiative, EIB and the African Development Bank (AfDB) have invested in six venture capital firms, some of them domiciled in Kenya, which have then invested in start-ups in Kenya and the region.

He noted this initiative has attracted more funding from private investors. 

“What we are trying to do with this programme is to grow the venture capital market further, to make it more liquid and provide more capital. We cannot do it on our own. What we need to do is attract other investors to provide this liquidity,” he said.

Claessen however, noted that the continent’s own vast financial reserves remain sidelined as institutional investors, including pension funds and insurance companies, stayed away from funding.

He said that while it may appear like the local start-up sector is littered with failures, there are equally many start-ups that are fast-growing and offering good returns. 

“It is also seen as risky. There are always stories about companies that have gone bankrupt. While there are no guarantees, investing in more funds, spreading your risk over tens, hundreds of companies… if you have a diverse portfolio, you will make a return while supporting entrepreneurs.”

He called for familiarisation for big money managers in Kenya to get acquainted with the sector because the risks are more perceived than real.

“If you look at South Africa, there are plenty of big companies investing in private equity and venture capital and South African companies are investing in funds based in Kenya. In Europe, the US and Asia, this is happening all the time,” he noted.

“The opportunities in Africa are huge, and some of the outliers are doing very well. If people have found a way to offer a product that is needed in the market, we see fast growth in these companies. By investing in a number of companies and spreading the risk, you can have a well-performing portfolio. If you just look at the one or two companies that go bankrupt, that blurs the picture about how the sector works.”

He said the government, too, could incentivise players who are investing in innovative start-ups that provide solutions to challenges that Kenyans face every day.

“Some government incentives would be good… to incentivise money managers to look at the local economy and the start-ups. It might be easier for pension funds to buy infrastructure funds issued by the government or something that looks very safe but that does not necessarily support the private sector,” he said.

“There are different ways to incentivise, including taking away some of the risks, such as investing in a junior tranche whereby the government can do this through setting up its own investment vehicle to do tax breaks, but also a stable and predictable regulatory framework.”