Preparing for a successful funding round during an economic downturn – Part Two

In Part Two of this series, Victor Basta, CEO, DAI Magister continues his masterclass on preparing for a successful funding round during an economic downturn and what companies can learn from trends in the African ecosystem.

It pays to save the planet. Nowhere is more money being raised in the world today than in climate tech. In Africa and the Middle East, climate tech is the only sector where total funding is increasing. There are also many more climate funds searching for deals, with ample 'dry powder’ (money available to invest); it's a critical reason that Green Light Planet (AKA Sun King) in Nairobi was able to raise their mega-round from General Atlantic's climate fund and M&G's newly created mega-fund dedicated to climate, and a reason why many of Africa’s climate-positive companies will now attract international interest.

Climate tech covers a broad spectrum, and many companies don’t even realize they qualify to be attractive to international climate funds. Companies operating in energy generation, energy flexibility, sustainable mobility, natural capital (water and wind), agriculture, and related technologies all can credibly position themselves to raise based on their climate positioning.

Climate tech funding in Africa has so far been tiny; only $0.6 billion was raised in 2021. However, this doubled to $1.2 billion in 2022, while other key sectors, such as fintech, declined. Key sectors include sustainable mobility – with Moove raising $105 million in March 2022 and raising $31 million in December 2021; the energy sector, with Shell acquiring companies like Daystar in September 2022 and Yellow Door Energy raising $400 million in October 2022, as well as the agri-tech sector, with Apollo raising $40 million in March 2022 and Twiga raising $50 million in November 2021. 

To some extent, this trend echoes the ESG trend of a few years ago; if a company could integrate a credible ESG story into their value proposition, it could raise more money, or at higher valuations, or both. We are already seeing a record number of African growth companies position themselves in the climate tech sector, with very encouraging interest happening in real-time.

As Larry Fink, Chairman and CEO of BlackRock, says: "The next 1,000 unicorns won't be a search engine or media company; they will be developing green hydrogen, green agriculture, green steel and green cement." 

Restructuring is no longer a dirty word

In 2021, any mention of a restructuring or job cuts would have tanked a company's valuation overnight. Now, very often, it raises it. The reason is that the baseline on which investors evaluate a company's potential has completely shifted toward a focus on how fast a company can become profitable, and cutting costs is the fastest way to change any bottom line. So much so that, in our experience, probably 70% of the time today, instances of restructuring are viewed positively by investors, even though many African companies remain reluctant to do this to the extent they need to.

The art of unit economics

Investors' expectations have not changed; they still look for attractive growth, a high customer lifetime value (LTV) vs customer acquisition cost (CAC), and more upsell than churn. But in addition, the focus now is on efficiency. Investors closely monitor the burn multiple, payback times or ‘magic number’ calculations. Companies must now answer credibly exactly how they will have enough cash to last 36 months, whereas previously investors only expected money to last 18-24 months.

But even within this expanded set of metrics, there is a lot of room for companies to present their numbers positively. For example, customer acquisition cost (CAC) is usually about the amount of sales and marketing expense needed to acquire a new customer. However, companies can think about whether that should refer to the previous two quarters of marketing spend, or only the previous quarter. In other words, how long does a company have to spend on marketing to win a customer. Or in terms of lifetime value, how long is the actual expected lifetime of a customer? Will they be expected to be a repeat customer or one-off? What other products will be sold successfully to that customer in future? All these considerations can change a ‘standard’ LTV/CAC ratio dramatically. It’s not about companies fiddling their metrics. It’s about companies getting full credit for the potential that already resides in their customer bases, and we find most companies significantly under-appreciate what they have already built in terms of customer base.

Another area to look at is ‘profitability.’ Often companies can already show they are profitable in certain markets or with certain offerings; it’s just that they lose money overall because of sustained investment to expand. Yet many still do not do the detailed breakdowns needed to show potential new investors what they have already achieved. Bottom-line losses are still too-often lumped together, costs allocated incorrectly, and a worse-than-reality picture is formed in the minds of potential new investors. For companies already operating fundamentally successful businesses, it is an invitation for investors to pass on an opportunity they otherwise should be interested in, something which African companies simply cannot afford to do in the current environment. The point is that there is a too-often-missed opportunity to be on the front foot and frame your numbers in a way that provides financial rigour and accuracy and steers the focus to toward your successes.

Preparing for a successful M&A exit

The African startup ecosystem is maturing at warp speed; what happened in a decade in Silicon Valley many years ago is happening in 2-3 years today on the continent. Perhaps the most pronounced feature of this is that, barely five years after the ecosystem really got going, companies are already accelerating their thinking about exits, even as exits remain largely unproven. For some, it is borne of necessity; they cannot raise the next round they hoped for unless they get much bigger, and more international, and merging is the surest way to achieve both. For others, the ecosystem has developed so quickly they already realise they cannot win in their market and choose to be acquired to deliver a solid profit to their investors and management. For others still, in a challenging environment, they begin to value real cash rather than paper profits.

Whatever the reason, in aggregate we see perhaps 1/3 of larger African growth companies now actively talking to other companies, both bigger and smaller, about some form of M&A (either buying, selling, or merging). Today we are seeing that take two broad forms. The first is active discussions around merging two private companies. Neither company feels it can qualify to raise the money it aspires to in the current market. However, the combined company is better positioned as a multi-market, multi-product aspiring leader and aims that will attract significant international funds. A second form is a successful African growth company that has become large enough, and moving quickly enough toward profitability, to already be an attractive African platform acquisition for international majors. Both types of deals will happen, repeatedly, in the coming months.

We have already seen the first instances of this, with Paystack being acquired by Stripe and DPO becoming the African platform business for Network International. In addition, boards are increasingly pushing CEOs to think about engaging with potential buyers and marketing to those buyers alongside marketing themselves to potential next-round investors. Therefore, we expect many more 'dual track' funding rounds in 2023-24 as companies explore raising money and being acquired in tandem. We are seeing the first evidence of this, with companies as diverse as Shell, Moniepoint, MFS, Fairmoney and Yassir expanding through targeted acquisitions to build up their own offerings and geographic reach.

The key to successful exits is preparation. This isn’t only internal preparation (auditing, compliance etc) but external preparation. External prep involves positioning a company in a way that strategic buyers will find attractive, engaging strategic buyers long before a company is ‘up for sale,’ building commercial relationships that prove the value of any later M&A in a buyer’s eyes, and building personal relationships at key buyers so an exit is sold not just to a buyer, but appreciated directly by key people within a buyer.

A key element of preparation is corporate marketing. Companies must get ‘known’ by larger buyers, and it is very often the case that buyers outside Africa simply do not know, or know much, about interesting targets. Particularly in a geography which many buyers perceive as ‘risky,’ it’s critical that African growth companies establish clearly with key buyers that they are ‘safe to buy,’ and can be scaled much faster with greater global resources. Again, we have several initial proof points, but the next wave of strategic exits will have to prove, across several sectors, that African companies have now matured to the stage of being more than just interesting startups, but companies that strategics can now bet significant cash on.

For every Stripe, a dozen more international buyers are 'thinking about Africa' but have yet to pull the trigger on a deal. However, in the coming 12-24 months, we expect many to act and returns to begin flowing back to the ecosystem that has carefully nurtured these companies over the last few years. In terms of sectors, the most active we expect will be fintech, and the battles between banks and telcos will only fuel valuations and interest in many fintech’s of scale on the continent.

As companies across fintech, tech-enabled commerce and renewable energy reach scale and maturity, and while the funding environment remains challenging, we expect another ten or more strategic acquisitions will take place across Africa in 2023 alone, making this a record M&A year in the growth sector.

It’s a strong sign that the ecosystem is maturing from just funding to actual returns.