Startup Lagos

25-Feb-2025

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Next Wave: Unlocking Alternative Funding Streams for African Startups 2 months ago

Venture Capital (VC) has traditionally been viewed as the premier funding model for high-growth startups. However, securing VC funding remains a significant challenge for most African founders. In 2024, African startups raised $3.2 billion across over 182 equity and debt funding deals. A disproportionate amount of this funding went to a select few tech-heavy startups in key markets like Kenya, Nigeria, South Africa, and Egypt, leaving numerous promising businesses unfunded. In a landscape where VC funding is often perceived as the only path to success, the question arises: can African startups scale effectively without it?

The Limits of VC Cheques in Africa

Asset-light and high-growth sectors such as e-commerce and fintech have historically favored traditional VC models, which rely on high valuations and the potential for rapid exits through acquisitions or IPOs. Between 2019 and 2023, fintech and e-commerce companies accounted for 75% of total funding to African founders. Despite increasing interest from Africa-focused VCs in crucial sectors like agritech and health tech, these sectors often clash with investors' expectations of rapid growth and quick exits.

Systemic and cultural factors further limit access to VC funding for many African founders. In countries like Kenya, investors tend to favor expatriate-owned startups or those founded by Western-educated Kenyans, while local entrepreneurs without such advantages often struggle. The emphasis on tech-driven scalability has also marginalized businesses that support the majority of African economies, including agriculture, manufacturing, logistics, and local commerce.

VC firms typically target exits within five to seven years, a timeline that may not align with the realities of African markets. While some venture-backed startups achieve an exit in as little as two years, most take around six years and five funding rounds to reach an Initial Public Offering (IPO).

Unlike the more homogeneous markets of the US or Europe, Africa comprises 54 fragmented countries with varying regulations and often dysfunctional regional economic blocs like the EAC, ECOWAS, and SADC. This fragmentation makes cross-border scaling a bureaucratic and costly endeavor, which can deter VCs seeking quick expansion.

The widespread low-income levels across much of Africa translate to lower consumer spending and profit margins for local businesses, hindering growth for startups targeting mass-market consumers. Approximately 35% of Africa's 1.4 billion+ population lives below the global extreme poverty line of $1.90 per day.

Another challenge is the scarcity of local investor networks. With most VCs investing in Africa being foreign, a disconnect often exists between the operational realities of regional economies and investors' expectations, although some investors demonstrate a strong understanding of the continent.

Given these hurdles, African founders should explore alternative funding options that align with the continent's unique realities. From revenue-based financing to grants from development agencies, these approaches may hold the key to fostering a more sustainable and inclusive startup ecosystem in Africa, moving beyond the sometimes unrealistic expectations of VCs. These alternative models prioritize sustainability, enabling founders to scale their businesses at a pace that matches market conditions.

Thriving Without VC Backing

Contrary to the prevailing belief that startups cannot scale without VC funding, companies such as Kenya's BitPesa (now AZA Finance) and Pesapal have demonstrated otherwise. Pesapal, a payments service provider, has built a successful business through strategic partnerships with banks and mobile money platforms, focusing on sustainable revenue growth rather than relying on external funding. In an industry where VC-backed fintechs have struggled to gain traction, Pesapal has achieved steady growth by prioritizing cash flow and profitability.

Some well-funded, VC-backed competitors burned through cash by expanding into multiple markets to meet investor expectations. Others, like Lidya and KopoKopo, eventually pivoted or downsized due to unsustainable cost structures. In contrast, BitPesa adopted an organic expansion strategy, leveraging partnerships with established brands instead of burning investor capital. This approach allowed the company to prioritize long-term profitability over short-term high valuations.

In various media interviews, Agosta Liko, Pesapal co-founder, has claimed the company is profitable, though without disclosing specific details. Pesapal has deployed over 30,000 POS machines in Kenya, outpacing commercial banks. According to the Central Bank of Kenya (CBK), there are 56,000 POS terminals in the country, indicating that Pesapal controls over half of the market. Today, Pesapal processes over a million transactions daily across Kenya, Uganda, Tanzania, Rwanda, and Zambia.

In its early years, Cellulant relied on grants and corporate partnerships before eventually securing institutional investment. These examples illustrate that African startups can explore alternative funding models such as bootstrapping, strategic alliances, grants, and revenue-based financing, which support long-term growth without the pressures associated with VC funding.

Instead of relinquishing equity, founders can raise capital tied to their revenues. While revenue-based financing (RBF) remains relatively unexplored by most African entrepreneurs, it can be a favorable model, especially in industries with stable income streams. Under this model, investors receive a share of revenues until they reach an agreed-upon amount, typically three to five times the principal investment. South Africa's Linea Capital has begun offering startups funding through this model, promising a non-dilutive, collateral-light funding structure compared to the VC option. By linking repayments to a company's revenue growth rather than fixed schedules (as with loans), RBF enables founders to scale sustainably.

Ethiopia's Cooperative Bank of Oromia is piloting RBF for small businesses, offering loans of up to $1,700. In a market with limited foreign investment and stringent collateral requirements for bank loans, Cooperative Bank's experiment could provide entrepreneurs with access to capital that aligns with their needs. Its success suggests that RBF could be a viable alternative for African founders seeking to fund their ventures.

Companies like Kenya's Little Cab, a ride-hailing service, have successfully raised revenue-linked funding, which accommodates their growth models rather than imposing VC scaling pressures. Despite fierce competition from VC-backed ride-hailing apps like Uber and Bolt, Little Cab has carved out a niche in the market, becoming a favorite among corporate clients. The company reports having over 5,000 corporate members, including leading banks and telcos, a segment that Uber has struggled to penetrate in the Kenyan market.

Large companies, including banks, telcos, and FMCGs, are increasingly seeking partnerships with innovative startups. Such arrangements provide startups with market access, capital, and operational support—resources that some VCs may not offer. For example, Safaricom's M-Pesa has partnered with startups like KopoKopo and Payless to expand its payment solutions. These agreements between startups and established brands offer founders credibility and operational support that money alone cannot buy.

Startups offering solutions that address social problems can leverage mobile-based crowdfunding platforms like M-Changa or impact investment funds such as Acumen. Community-driven funding models and impact investment funds are filling the gaps left by traditional banking systems with rigid collateral requirements and VCs. Large corporations and foundations owned by wealthy Africans have also established platforms to fund small businesses, such as the Tony Elumelu Foundation, which claims to have disbursed over $100 million to more than 18,000 entrepreneurs across Africa.

While traditional bank financing has been largely inaccessible to most startups due to high-interest rates and rigid collateral requirements, some lenders have since relaxed their rules. Banks like Kenya's Equity Bank and Nigeria's Access Bank have introduced SME-friendly solutions with flexible repayment plans that can accommodate startup growth cycles.

Grants and development financing from multilateral agencies like the World Bank, African Development Bank, and USAID often provide grants to startups in sectors such as education, healthcare, and clean energy—areas that align with their development objectives. Such financing is invaluable for founders addressing social challenges that may not yield quick returns after substantial investments.

Shifting the Narrative

The VC model is not the only viable funding option for African startups. While it has proven effective in the Silicon Valley context, some investors have not fully adapted to the realities of Africa. Therefore, the central question is not whether African founders can secure more VC funding, but whether they should rely entirely on it. Alternative funding models like crowdfunding and bootstrapping offer something VCs often cannot: sustainability, independence, and a laser focus on solving real-world problems rather than chasing higher valuations.

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