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How African tech ventures can become more valuable

21 February 2018   |   4:21 am
Every early-stage tech founder I have met, freezes when the issue of company valuation comes up as it is an uncharted territory for them. They know that the effort they have put into building their company...

Every early-stage tech founder I have met, freezes when the issue of company valuation comes up as it is an uncharted territory for them. They know that the effort they have put into building their company and product is worth something, but they are typically afraid of underselling or overselling themselves. This fear is not unique to African founders; it is a global phenomenon. It is why the guys at YCombinator invented a trust instrument or note that they call “Simple Agreement for Future Equity” popularly known by its acronym “SAFE”. As the name implies, it is a simple agreement promising early-stage investors equity at a valuation yet to be determined by the founders.

I have always advised local founders who are about to raise their first round to consider this “SAFE” option as it protects them and creates trust with early-stage investors. Some local Angel investors have baulked at this and still issue term sheets insisting on convertible notes which are primarily debt instruments with interest risk.

I also believe the “SAFE” is the best route to take as it is the first filter for entrepreneur-friendly investors who believe in the founders and would most likely go the distance. The agreement template is provided free online by YCombinator, and I have gladly signed “SAFE”s with some local entrepreneurs.

What is Value?
My friend Han Rabinovitz from Tel Aviv taught me a few lessons while I was at the Google Launchpad Accelerator earlier this month. He gave me a new perspective on what value is in technology startups and how it can help growth.

According to Han, “a problem is a short-term need.” Solving a problem is not necessarily creating value as the need may be ephemeral or substitute solutions available. He goes on to say that, “delivering value is about meaningfully changing something in people’s lives”.

My hypothesis (based on Han’s definition of value) is that a startup becomes valuable only when this meaningful change starts to happen with its customers. At the early stage, ideas have little value as “change” is still experimental. It is only when consistent and proven change has occurred in the lives of the customers at scale that a startup becomes valuable.
Potential is not the same as value. Potential is more of a significant probability of creating value or valuable products. Potential can be realised or unrealised due to intrinsic or extrinsic factors. One can also invest in potential before value creation. That is what I believe most early-stage investors do. They invest in the “potential” that an idea together with a team can create significant value in a market and to borrow from Han “become valuable”.

Becoming valuable is the result of the combination of a lot of factors. Timing, narrative, relevance and awareness have to be in a mix that creates maximum impact. I don’t think you can hack value. I believe you can either be very lucky or very diligent about creating it. Most diligent people who take their time to understand their market and create meaningful change are typically successful. “Being Lucky” is not a business model.

The African value conundrum
A startup can create meaningful change in the lives of people in a market but still cannot become a commercial success for the investors. It is not valuable to them if value isn’t convertible into commercial revenue or capital gains.

Capital gains investors pitch in early when a startup shows potential to increase value creation. They buy low and sell at high valuations. The ability to be able to sell their stake and exit easily without regulatory constraints or high tax liabilities is an essential factor most commercial investors consider. It is why “investor-friendly” tax havens like Mauritius and Delaware are choice locations of incorporation for tech companies.

The vibrancy of the market where the stakes of the investors are sold also play a vital role in the commercial valuation of the startup. In a vibrant market, the value of a venture is typically subjective or based on individual investor analysis and is dependent on what the highest bidder is willing to pay. It is why Silicon Valley startups with no revenue but only potential still get high valuations. They have a market with a lot of ready buyers who set the price.

The African investment market is not the same as Silicon Valley, our investors are fewer, and obstacles are more. Offshore incorporation in investor-friendly locales to get early-stage investments has become a quick and acceptable fix. I believe that in the end, the buck will still stop back at home. Regulation to help create a vibrant local investment market will not just help increase early stage valuations; it will also make global investors more comfortable with the possibility of exits.

For now, African tech startups do not yet have the luxury to wait for regulation to change or for the local market to mature. They have to find the market where it exists. African ventures who plan to become valuable, have to become globally relevant to both global customers and investors