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30 September 2022 / Jaye Louise Sergeant and Federica Irene Falomi

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The year 2021 was a record year for tech startups in Africa, with nearly 2.15 billion USD in investment capital?directed to the sector ^[1]. This amounts to a 206% increase over 2020 investment figures ^[2]. However, much of this growth has been taking place in Nigeria, Kenya, Morroco, Tunisia, Egypt and South Africa. The Global Startup Ecosystem Index Report 2022 found that South Africa at 49^th is still the only African country in the global top 50 national startup ecosystems ^[3]. Angola, Rwanda, Senegal and Somalia are the only African least developed countries (LDCs) in the top 100^[4].

The majority of startup ecosystems in African LDCs are nascent or evolving, meaning that although there is initial activity such as startup hubs, startups and government initiatives, startups from the ecosystem have not yet led to substantial job generation nor have been able to penetrate foreign markets extensively^[5]. The Technology Bank’s upcoming research, including a literature review, survey and interviews, looked at the main challenges and opportunities for startup support organizations ^[6]?in African LDCs and has identified the four trends below.

Firstly, government involvement and engagement?are?indisputable for innovation ecosystems to mature. In the absence of LDC governments making proactive efforts to create enabling and encouraging policies, challenges around connectivity, infrastructure, and ease of doing business can easily snuff out and counterweigh the drive, motivation and potential of young entrepreneurs.

Secondly, stakeholders such as governments, startups and startup support organizations in nascent and evolving ecosystems leverage connections with other governments, startup support organizations and startups, either regionally or globally, to share best practices across countries and access knowledge to speed up their development pathway.

The third identified trend is that currently, it is difficult for startups at both incubation and acceleration stages to readily access funding that is adequate in allowing them to move forward, but not beyond their capabilities to practically absorb.

Finally, from our preliminary findings, it seems startups are overly focusing on fintech in response to an increased availability of private funding in this sector. ?However, fintech has rarely had?such a primary role in the National Development Plans, thus raising the question of how to improve entrepreneurial?incentives to enhance the alignment and positive contribution of the private sector to national development objectives.

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Trend 1: How is the policy landscape supporting?entrepreneurship?

The role of government is clear. This includes specific and clear legislation for government-supported incubators and accelerators, to innovation organizations being in direct contact with relevant government departments. In ecosystems where governments are actively and positively involved in their innovation ecosystems, more innovation organizations have a greater ability to work cohesively together.

There are now many examples from across Africa of startup legislation in countries such as Tunisia (2018), Senegal (2019) and Ethiopia (2020), the principles of which can be applied more generally. Particular areas of focus include intellectual property, tax breaks or exceptions and incentives to encourage trading across borders with other local economies. This could potentially be extended to include incentives to set up businesses beyond the main urban areas, to also allow such opportunities to reach people in smaller centers and rural areas. Essentially, what is crucial is that the legislation, if it does not actively encourage startups to take risks, at the very least does not constrain their efforts. The absence of government involvement, on the other hand, limits the potential of catalyzing elements of an ecosystem such as standardization, utilization of public-private partnerships and tapping into academic know-how^[7]. Our research shows that where such activity is absent, this appears to correlate to fewer organizations and less startup activity.

Governments should put adequate efforts to promote an environment conducive?to entrepreneurship development, through appropriate regulatory reform, infrastructure development, and investment in human capital and skills development. Strong political will in the LDCs is also essential to fast-track implementation of the African Free Common Trade Area (AfCFTA), which will in turn facilitate startups’ engagement in cross-border trade.

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Trend 2: Importance of cross-country sharing and knowledge dissemination to speed up the development process

Many of the more mature innovation support organisations in African LDCs, particularly in proactive nascent and evolving ecosystems, were often linked with startup support organizations from more mature ecosystems in neighbouring countries, and sometimes in Europe and the US. As an organization from South Sudan acknowledged in one of the interviews, the existence of fast-moving ecosystems in the region (e.g., Kenya and Uganda) presents opportunities to envision development?trajectories and take follow up action.

Startups, startup support organizations, governments and innovation stakeholders more broadly can play a part in this. Wherever possible, events and conferences for best practice sharing, knowledge dissemination, mentorship and inspiration should be incentivized. In addition, international support to platforms such as umbrella organizations and communities of entrepreneurs could contribute to strengthening?existing experience and consolidating?cross-country and particularly South-South learning.

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Trend 3: What finance are startups in African LDCs accessing at the moment?

Lack of access to finance and seed funding is a key issue for startups and the organizations that support them in African LDCs, with over 90 per cent of survey respondents reporting it as a primary concern. Many interviewees said there was funding available either for a few hundred US dollars up to approximately 10,000 USD, or for 100,000 USD and over. However, they often argued that a higher investment size may not be appropriate for the current ecosystem’s development level, as startups are rarely able to absorb such capital due to their small business scale. Rather, such larger amounts may become more usable at acceleration or post-acceleration stage. The biggest gap in the market is that there is not much funding available in the middle range, e.g., within the 20,000-100,000 USD range.

There is a burgeoning venture capital scene slowly establishing itself in African LDCs and the potential for investors to increase their investments. At present, due to factors such as low investor confidence, shareholder governance and trade freedom, the venture capital market’s potential in such countries remains relatively unexplored. When surveyed, only 13 per cent of respondents cited venture capital or angel investment funds as key sources of funding for startups. Some nascent ecosystems such as Benin, Madagascar and Mozambique have no such funds as of yet. Alternative funding sources are also constrained. Conditions such as needing property for collateral mean?that many entrepreneurs (particularly women) do not meet the requirements to access funding from formal financial institutions such as banks.

On the public side, while there are government-funded incubators and accelerators in some African LDCs such as Ethiopia, Rwanda and Sierra Leone, the current government funding for startups or startup support organizations is seen as limited: only 20 per cent of our survey respondents indicated it as one of the three main sources of funding.

Personal or borrowing from friends and family appears to be the fallback option for many entrepreneurs across African LDCs, with 65 per cent of survey respondents describing these sources as the second and third main sources of funding for startups. The NGO and development sector, startup support organizations included, are primary sources of funding for startups in the majority of African LDCs’ ecosystems, both nascent and evolving. When asked to select the top three sources of funding for startups, 70 per cent of respondents said grants and 40 per cent said direct support from startup support organizations.

Formal institutions such as banks, venture capital funds and angel investments need firstly to make such financing feasibly accessible to startups, taking into account requirements such as collateral, documentation and guarantor requirements. To maximise potential and effectiveness, they also need to target the amount as enough for a startup to genuinely accelerate, but not beyond their capacity to actively absorb. The majority of survey respondents put this optimum range as between 20,000 and 100,000 USD.

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Trend 4: Is the funding focus on fintech startups proportionate to their economic and social return?

The fintech sector has received considerable attention in the last few years, particularly in terms of funding. Developing economies, ‘by broadening access to finance through digital means (fintech), can unlock productivity and investment, reduce poverty, empower women, and help build stronger institutions with less corruption—all while providing a profitable, sustainable business opportunity for financial service providers’?^[8].?There are 40 per cent of survey respondents indicated fintech as one of the sectors with the largest concentration of startups in their country, while 75 per cent indicated agriculture. Accordingly, the main areas of focus for startup support organizations are agriculture (indicated by 50 per cent of the respondents as one of the three main sectors), environment (40 per cent), and health (35 per cent). A large proportion indicated they are sector agnostic (35 per cent). Fintech, tourism and fashion were also mentioned regularly. The priorities of the survey quite closely reflect the priorities of the National Development Plans of many LDCs. As seen also in the Technology Bank’s Technology Needs Assessments, governments tend to prioritise food and water security (agriculture), health, education and environments above fintech and financial inclusion.

African fintech has seen a growing interest from investors, receiving just over 1 billion USD in 2021, nearly half of the total money invested in the continent ^[9]. As Paul Akiwumi put forward in our recent LDC Insight #3: Digitalization as a driver of structural transformation in African LDCs, focus and funding towards fintech can potentially be of aid in helping African LDCs diversify their economies away from reliance on single sectors such as agriculture or commodities towards economies with greater capacity for value addition, e.g.,?tech or knowledge-based economies ^[10]. However, the focus of the private sector and international development community on fintech as an all-encompassing solution needs to be balanced ^[11]. More discussion is needed on how to support successful transitions to long term, stable micro, small and medium-sized enterprises, reducing the rate of failure and potential displacement of existing businesses ^[12]. This is important because while there are clear steps towards incentivising entrepreneurs towards micro, small and medium-sized enterprises, if this is not accompanied by an increase in local demand simultaneously, the result may simply be the redistribution of existing demand among a larger number of participants in the market. In other words, while the potential of funding fintech should not be left unexplored, neither should the limitations of such focus at the possible expense of other sectors be discounted. As much as possible, funding for startups should align with a country’s priorities as outlined in their National Development Plans.

In advancing the path towards graduation, particularly in the face of systemic youth unemployment and climate change challenges, entrepreneurship’s role as a conduit for innovation and sustainable development cannot be underestimated. While many ecosystems have advanced in the last decade, it is essential to take stock of existing challenges to direct?sustained public and private investment towards what works.

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Jaye Louise Sergeant is a Programme Management Assistant and Federica Irene Falomi is an Economic Affairs Officer at the UN Technology Bank.