How early-stage venture capital can unlock socio-economic progress

South Africa, as Africa’s third largest and most diversified economy on the African continent, holds immense potential for economic and social development. With its abundant natural resources, youthful population, resilient infrastructure, and deep capital markets, South Africa can regain its position as a dynamic force on the African stage.

However, to harness this potential fully, critical challenges like power shortages and unemployment must be addressed.

A thriving start-up ecosystem can, as advocated by the South African Startup Act position statement of 2021, “unleash the growth and innovation embedded in our entrepreneurs and youth” and accelerate socio-economic development, competitiveness and the transformation of economies.

The Start-up Act lobby group also focuses on the most pressing issues that younger generations care about, given the relative youth of founders. High on its priority list are issues around energy transition and climate change, along with the varied consequences of this.

This is why we have seen, for example, between 2021 and 2023, climate-tech start-up funding increasing by anywhere between 25% and 37%, depending on the sources (The Big Deal and Partech, respectively).

Early-stage funding is critical for a thriving innovation ecosystem

Historically, start-up founders relied on angel investors in their close friend and family circles. This was revolutionised in 2012 by US President Barack Obama’s Jumpstart Our Business Start-up Act (Jobs Act).

What do we mean by early-stage funding? Early-stage funding includes pre-seed (first funding a start-up gets at the outset), seed (first official institutional funding, raised in exchange for equity, and usually used to launch in the open market), and pre-series A (thin funding stage between seed-stage and series A, to help start-ups gain more traction in the market and prove the product is ready for growth and thus ready for series A funding) stages.

This funding is critical for nascent innovations to get off the ground, gain some traction, and help start-ups be geared for successful fundraising to scale up.

But early-stage investment also comes with mentoring, a network of contacts, and access to specialised industry knowledge, all critical components to success.

In a country characterised by historical inequalities based on race and gender, equitable access to early-stage funding is crucial for building an inclusive entrepreneurial ecosystem.

Venture Capital (VC) funding

The years 2020 and 2021 were very encouraging in terms of VC funding: On the one hand, early-stage investment in Africa peaked in September 2020 at the height of the Covid-19 pandemic given an unprecedented demand for tech-enabled solutions such as food and grocery delivery, edtech and healthtech.

Closer to home and following the trend, 2021 saw funding in the South African ecosystem reach the top of its apex – bringing the country to second in terms of total funding to start-ups in 2022. But it was short-lived: In 2022, South African start-up funding fell to fourth behind Nigeria, Kenya and Egypt, with early-stage funding particularly hard hit.

Listen/read:
Start-ups fail primarily due to a lack of mentorship and funding
Absa acquires minority stake in agri-tech startup
Funding for African startups set to reach record highs

Reluctance toward early-stage funding is not surprising: South African investors are known to be traditionally risk-averse. It is also true that, in the recent past, South Africa has become a higher-risk investment destination – the recent greylisting of South Africa by the Financial Action Task Force (FATF), the continued unpredictability and the unreliability of power or logistics services, make for an additionally risky environment.

The wisest investors therefore diversify across other geographies (such as East Africa) and currencies that yield lower overall portfolio risks; however, this means that South Africa becomes a critical component of a risk-diversified portfolio, rather than a singular investment destination.

Read: SA still an attractive emerging market for investors

And while early-stage investment is risky, experts advocate its benefits – not only do they offer the greatest opportunity for returns (according to Zachariah George, managing partner at Launch Africa Ventures, from three to 10 times the original investment), they are also critical for a viable pipeline of start-ups throughout the investment value chain.

A changing environment – fertile ground for start-ups in SA

A number of promising changes are brewing in South Africa, aimed at de-risking the local environment and supporting systemic growth in innovation.

Promising progress has been made in advocating for a Startup Act in South Africa. As the South Africa Startup Movement puts it, “a Startup Act is essentially a component of policy or legislation that aims to make it easier for startups to establish, grow and scale”.

The recently launched progress report for 2022/23 reported: Over 2022, traction was gained with the public sector, with the introduction of the Sona (state of the nation address) announcement on start-up Visa and red tape reduction by President Cyril Ramaphosa, among others. Successes hailing from Tunisia and Kenya show promise, and South Africa can greatly benefit from such a regulatory framework.

Read: Record funding drive by African start-ups masks challenges ahead

The establishment of the Innovation Fund by the Department of Science and Innovation in 2021, although recent, has already shown early successes. It supports tech innovation and commercialisation in high-risk technology development initiatives to balance the risk aversity of commercial investors.

Awareness about early-stage funding importance is growing, and funds such as the University Technology Fund, ANZA Capital, Grindstone Ventures and Savant, among others, are aiming to address this gap.

A call to action

Despite these promising early successes, we are far from having the critical mass needed for a visible impact. More resources, expertise and activity are required. South Africa and other African nations can continue gaining traction if, as a collective, the early-stage founders, investors, policymakers and development organisations focus on a combination of efforts.

This includes private sector Series B funds getting involved in start-up financing earlier in the pipeline with emerging fund managers. It also entails the public sector maintaining its efforts to build successful public-private partnerships and a more enabling regulatory environment, such as better tax incentives to encourage early-stage and angel investment and improve existing regulatory barriers with the various considerations outlined in the South Africa Startup Act.

As the 2023 South African Innovation Summit approaches, capital availability takes center stage. Influential LPs and VCs will convene to discuss the future of venture capital and investment opportunities, reflecting South Africa’s ongoing journey to unlock socio-economic development.

Listen to Small Business Conversations podcast host Akhona Matshoba speaking to Fezile Dhlamini, CEO of SA startup Green Scooter: 

You can also listen to this podcast on iono.fm here.