On 20 June 2017, venture capital firm Village Capital released the report “Breaking the Pattern: Getting Digital Financial Services Entrepreneurs to Scale in East Africa and India”. This was carried out with support from the Bill & Melinda Gates Foundation
The report focused on why the biggest chunk of digital financial services (DFS) startups in both regions are not receiving the investment required to scale.
For the report, Village Capital interviewed 55 entrepreneurs plus 23 investors, researchers, and other entrepreneur support organizations in India and East Africa. These weighed in on the barriers to scale for financial health innovations.
One of the key insights from the report was that Investment is highly concentrated in just a few companies. Despite a few well-known DFS companies operating at scale, like Safaricom’s M-Pesa in Kenya and India’s PayTM, most are not receiving the investment they need to scale.
For instance, in East Africa, startup investment is at an all-time high, but 72% of venture capital went to only three startups in 2015 and 2016. Most fintech startups are not getting the funding they need. Companies like M-Pesa are the exception, not the rule: in East Africa the past two years, 72% of venture capital went to only three startups.
Investors aren't investing in the East African region due to a perception of risk in the digital payments space. One of the causes is the fact that it is difficult for DFS companies to access the digital payments infrastructure - Heather
The second key insight was the Human Capital Trap and Business Model Challenges: Investors in East Africa and India consider DFS companies to be risky because of human capital challenges and structural barriers in the marketplace; but these challenges are hard to overcome without investment. As one Indian entrepreneur notes: “The traditional Silicon Valley model of building a product so viral that you don't need a sales force cannot be applied to India."
Lastly, the report found a “pattern recognition problem”. This was attributed to the the high cost of early stage due diligence in India and East Africa. Investors often fall back on patterns to find companies and make investment decisions – relying on networks and indicators like prestigious universities or accelerator programs.
If you’ve been paying attention to the Economist or the New York Times, you might think we’re in a golden age for digital financial services in India and East Africa. In fact, we’re only at the very beginning - Ross Baird, CEO of Village Capital.
We’ll need hundreds of companies to reach scale to truly improve the financial health of communities in India and East Africa, requiring us to look beyond the ‘one size fits all’ model of venture capital in markets that operate under an entirely different set of rules - he added.
When we spoke to Heather Strachan, Manager of Product & Emerging Markets Operations at Village Capital, she revealed to us that the startups that have been able to get these investment in the fintech sector are those that have partnered with other big players or follow specific patterns.
She also pointed out that the digital payment infrastructure is dominated by Telecom companies like Safaricom and MTN which makes it extremely difficult for one to succeed without them.
However, to ensure that this pattern is broken, the report provided several recommendations for all stakeholders including. These were explored at length with Heather.
One of them is that the ecosystems increase the number of local entrepreneurship organizations as well as local investment funds. These can be used to identify and grow local talent as well as build connections with some of the top foreign investors.
The other recommendation was pulling local capital together with foreign capital so that entrepreneurs can more easily access funding and raise full rounds. Lastly, the report recommends that investors should think differently about their investment structures when it comes to the East African region.
Right now, most investors come with the 'Silicon Valley one size fits all' approach which means only equity investment - Heather
Investors should look at what exactly a particular startup needs and they structure their investment around that.
Asked about the possibility of investors bringing more than just money on the table but also their expertise, she says that is incredibly important to help companies leverage additional expertise, skills, and relationships. It is important that there are also local investors supporting companies to provide some of this expertise and individual support.
However, for the period of 2015 and 2016, 80% of the investors in East Africa have been foreigners, which highlights the lack of local investors active in the region.