Deconstructing the Local Angel Investment Cycle in Kenya (Part 1)
Imagine you’re meeting your relatives for the annual holiday dinner and you notice your nephew is missing. His mother explains that he’s busy building his own startup so he no longer has time for anything.
Not even family dinners.
Noting his apparent tenacity and how he’s trying to do something with his life rather than idle away on the sidewalks complaining about the lack of economic opportunities, you offer to back him up financially if he splits ownership with you.
Six months later, you ask him how business is going, and he tells you he’s nearly nailed his product but he needs more money.
Three months later, you re-inquire about his progress, and he tells you he has perfected his product but client acquisition has been a bit difficult in this market and he needs more money to keep the lights on.
In the next annual family dinner, he attends.
Only he drives up to the house in a Mercedes Benz.
You wonder how that is possible considering all the money troubles he’s been complaining about.
Unfortunately, that’s how angel investing appears in emerging economies like Kenya.
In investment terms, an angel investor is an affluent individual who provides capital for a business startup, usually in exchange for convertible debt or ownership equity. In African markets, arrangements with angel investors tend to exist informally, are usually undocumented, and are catalyzed by pre-existing connections (familial or otherwise).
The only problem is sour outcomes of such investments tend to translate to family feuds and cautionary tales that reinforce the old-school thinking that the only secure investments are those going into real estate or government securities.
That’s why a need exists for institutions like Viktoria Ventures (VV) that formalize angel investing. Viktoria Ventures is a Kenyan company that helps early-stage companies obtain seed funding from local angel investors. It does that by managing a network of local angel investors and guiding them through the investment life cycle so they could screen deals, do due diligence and overall, structure a deal formally where both parties win.
That’s definitely much better than waking up one day to discover that your nephew has been siphoning your hard-earned money to upgrade his car.
Investment Life Cycle
The investment life cycle as explained by Jason Musyoka from Viktoria Ventures are detailed in the following sections.
The initial stage of the investment life cycle is screening. As an investor, you need to be really picky about the deals you select. As mentioned in the previous post, as an investor you need to see more than a back-of-a-napkin idea. You need the startup to have a validated idea with paying customers. This is not to say that a back-of-a-napkin idea will not work if funded, the realities of the market are such that there are way too many ideas compared to available investment money.
It also means that you’ll need to be more analytical while attending pitches, rather than being blown away by catch phrases such as,
“This will help us make the world a better place!”
“This is absolutely going to 100x very fast and we want you to be part of it!”
“We are the Facebook plus Uber multiplied by Reddit of our industry!”
“We have no competition!”
“We’re closing next week and want you to be part of this revolution!”
As an investor, you have to be equipped with the realistic expectation that the failure rate among the startup ecosystem is very high. While data from the African market is not readily available, the closest one given by a Nigerian bank Stanbic IBTC claimed that over 80 % of Nigerian startups fail within their first five years.
After filtering out opportunities in multiple stages that look closely at the founding team, business idea, traction, and business model, due diligence needs to be made. Due diligence is an audit made to confirm all facts given by the startup are correct.
The main categories you need to look at as an investor during this stage are:
- Market diligence, which covers your independent review of the claims that the entrepreneur made regarding the industry they’re operating in. It’s necessary to verify the market size, competitive players in the market, and industry trends.
- Business diligence, which looks into specific claims that the startup makes about its own operations. These include looking at their books to review revenues and expenses, seeing what their customers think of their product/services, and doing background checks on the founders.
- Legal diligence, which focuses on the company’s structure, documentation, and history, to ensure everything is as claimed. This involves wading through a humongous pile of paperwork with a fine-toothed comb, including but not limited to, corporate records, employee benefit plans, properties and assets owned, financing documents, etc.
Deal structuring necessitates a negotiation process where both parties win and the investment arrangement is formalized. Ultimately, the goal is to be in what is known in game economics as a positive sum game, where both sides gain more by cooperating than by acting on their own.
While the entrepreneur gets an influx of money, as an angel investor you can also bring in a set of much-needed expertise into the startup. You can also make demands for better governance within the organization rather than watch it being run like a kindergarten playground.
Major red flags when it comes to investor-entrepreneur conversations are as follows:
- Feeling like integrity is lacking and there isn’t 100 % honesty.
- Receiving push back on the subject of reporting, board meetings, or access to company information.
In the next post, we’ll shed light on post-investment activities such as value addition and exiting.
Last but not least, even if you do every step of the investment life cycle correctly, that does not mean your investment will pan out as it’s important to note that angel investing is still risky business.
Co-written with Amina Islam