Like everywhere, access to capital has tightened for African growth companies, and valuations are back to 2019-2020 levels.

Not disastrous by any means, but it means virtually every successful founder will face a challenging next funding round. Nearly all of Africa’s most successful companies last raised 12-24 months’ worth of money at valuations based on sheer growth and the perception of future scale. Now that valuations have re-set, those reference startups face a next funding round focused on their current size and profitability, dimensions they haven’t had to worry about till very recently. This means rounds today are taking longer and require compromises on valuation and other terms. It also means that mergers & acquisitions (M&A) have started to feature much more prominently in funding round discussions, as boards explore serious alternatives to now more-expensive private capital. In fact, around half of DAI Magister's African large round advisory work (currently across 11 significant projects) involves some element of M&A, versus precisely zero one year ago.

For many of the best companies the reason is straightforward: when it’s no longer easy to raise money at 2-3x their last round valuation, boards begin to think about their range of options. And founders who are today being told by larger funds that they need to show clear evidence of becoming market leaders start to consider if they might be able to do that faster, and with more certainty, by combining with another complementary growth business, which would make that combined company a larger, more attractive investment opportunity for the top-tier funds they all want to attract.

 What does Disney have to do with companies in Africa?

The point about Disney is that no company is immune to this change in sentiment. Disney invested heavily in streaming and has largely succeeded. In fact, they surpassed Netflix in the number of subscribers in October 2022 (235m vs 223m), making them the number one streaming platform in the world. 2021's market would have rewarded Disney's remarkable, sustained growth handsomely. However, 2023's market focused instead on how much that growth has cost; steep streaming losses cost Disney 40% of its market value, and eventually also its CEO. This is proof for every growth company CEO that it’s not his or her circumstances, but a change in market sentiment that has affected even the most blue-chip of blue chips.

Widening the lens to a key tech sector, Software as a Service (SaaS), shows the systemic effect of this shift just as starkly. The recent downturn has cut valuations for unprofitable publicly traded SaaS companies by 50%. Yet for profitable SaaS companies, valuations reduced only 30% from arguably unsustainable highs. The sector message is as clear as shareholders’ message to the Disney Board: in today’s market, growth alone will not lead to high valuations.

The discretionary discount: companies selling discretionary products have been hit hardest

Global trends reflect directly on all growth companies, everywhere. Nowhere is this clearer than discretionary Business-to-Consumer (B2C) businesses. The ‘reference’ global players in B2C such as Peloton and DoorDash have seen massive valuation cuts in this downturn. Consumers who must tighten their belts cut these expenses first, and hardest, and so discretionary B2C businesses have seen their addressable market shrink, dramatically and quickly. It's the same in every downturn, especially one fuelled by higher inflation: the first thing to fall is non-essential spending; entertainment, travel, furnishings, etc.

Here, interestingly, Africa provides a lot of insulation. 80% of consumer spend in Africa is on essential products and services, half of that number is on food or food-related items, costs consumers can’t simply cancel overnight. Therefore, the vast majority of Africa’s B2C businesses serve those essential needs, distributing food, drink, essential medicines, and essential transport. Because there is far less to cut back on, as a result most African B2C companies have not seen a huge, near-overnight cut in their available market. It’s also the case that many Africans facing worsening economic times resort to second and even third side-hustles, and so we are seeing a rise in social commerce driven micro-SME sales as people sell, for example, hand-made crafts through social media as well as working a day job. Economic downturns aren’t easy for anyone anywhere, but Africans by and large have been forced to become more used to hard times than populations elsewhere, and this resilience now suddenly has more value.

What this also means is that African companies selling essential goods (non-discretionary products) become relatively more valuable than much better-known global players. It’s not that any growth company is immune from lower valuations. But companies that show evidence of being able to provide essential goods and services, as well as low-cost discretionary products, will now start to become particularly attractive for capital.  

Balance sheet lenders adopt the brace position: positioning themselves as insulated from Buy Now Pay Later (BNPL)

Most African growth companies essentially sell money, in a wide variety of forms: consumer financing, business/trade financing, embedded finance, through mobile peer to peer, via POS devices, via leasing etc. They also do this by selling everything from mobile phones to solar home systems to productive motorbikes on multi-year financing plans. In fact, the majority of non-fin-techs in Africa have some fin-tech element built into the core of their business. So, what happens to valuations of balance sheet lenders outside Africa has a direct bearing on many how African growth companies are perceived and valued. 

At the height of the market, the reference balance sheet lending businesses globally were Buy Now Pay Later (BNPL) companies. Many attracted huge valuations, led by Sweden’s Klarna. But now Klarna has recently become the most visible example of a change in sentiment toward this entire sector, slashing its most recent round valuation by 40%, and pivoting to become profitable. Much of the damage to the BNPL sector came from players lending too quickly to consumers they didn’t really know. In the rush for growth, BNPL companies took on much more risk than they could calculate, and that has led to major write-offs as hard-hit consumers have more recently failed to repay their loans.

Though far away from Sweden, the pivot of companies like Klarna becomes highly relevant for African lenders, especially those preparing for their next funding round. It is now essential for them to position themselves as insulated from the BNPL trends that have cratered valuations for developed-market players. Providing a service that banks cannot offer, and lending where banks are too inefficient, remains a very profitable business across emerging markets, and none more so than in Africa. But African balance sheet lenders must be very careful to explain how they are NOT BNPL companies, that they have a strong handle on the credit risk they are taking, and profitably fill gaps that banks are unable or unwilling to fill. The fundamentals are there for many of the best African lenders, but scrutiny and scepticism from international investors has never been higher for these models.

Neo-bank U-turns

Powered by nearly unlimited funding and the success of companies as disparate as Monzo in the UK, N26 in Germany, and Nubank in Brazil, digital 'neo-banks' focused on growth at any cost. Often referred to as ‘challenger banks,’ neo banks are essentially online or mobile-only banks that offer more customer-friendly banking, with fast product development and tailored offerings for their target consumers. This led to an explosion in neo bank funding, with Revolut being valued in its last round at over $30 billion, and Nubank being valued at $20 billion today.

Today, neo banks face a squeeze from several directions. Incumbent banks are fighting back, adopting technology at a faster rate, and setting up their own neo bank offshoots. Customer acquisition costs (CAC) have risen so quickly because many neo banks are chasing the same younger, urban, professional demographic, and it’s increasingly challenging for many to become profitable. As a result, only two out of 25 of the largest neo-banks today are profitable, and out of 400 neo-banks worldwide, 95% are still losing money, and many only earn $30 or less per customer per year. There are, however, a few bright spots. Starling is moving to consistent profitability, and Monzo has a major push to become profitable, but it's fair to say that raising money as a 'neo-bank' these days, anywhere in the world, has become much harder to do.

In Africa, neo banks have sprung up in every major market, but they are simply not the same as the neo banks elsewhere. African neo banks simply don’t have the same number of young, urban, professional customers to target, and as a result they veer to focus on lending, on business customers, or financing payments and receivables. Many adopted the term ‘neo bank’ when valuations generally were rising in the sector. Now those same African companies need to veer back to describing the (perhaps more boring, but ultimately more valuable) base of business they actually do, and for many shedding the label ‘neo bank’ will lead to a higher valuation, not a lower one, in their next round.

You can read Part Two of this masterclass here.