Liability of foreignness

The fact that the majority of the VC investments are made in foreign founded businesses is repeatedly described as an issue for the VCs. Many of the interviewees highlight that the fact that most ventures are foreign founded is a topic of a heated societal debate. The interviewee from VC 4 states, “people were worried if, as they are coming, are they coming in to kill the local entrepreneurs? Or are they coming in to promote local entrepreneurs?

And, what are some of the synergies that we exploit from the process?” As various

interviewees are highlighting this on-going debate, we find it to be a symbol of the

scepticism that still surrounds the VC scene. Although another interviewee highlights that there is generally being made more effort today in finding locally born ventures, many of our interviewees state that they do not have any particular strategy or interest in finding ventures with local founders. In that regard, the interviewee from the accelerator program highlights that, in order to find locally born ventures, VC firms must come up with different strategies for screening and deal sourcing, specifically in relation to the lack of the knowledge of the local market, “It's not a cut and paste. Just because other things, other investor tools, and the way of doing things work in Europe or in Silicon Valley doesn't mean it will work in Kenya, or in Africa. We have very different market segments, and different nuances and you have to adapt and put in consideration those markets and nuances that come with this market.” As such, the lack of knowledge on the local markets in the foreign networks, gives rise to certain liability of foreignness, particularly for the foreign founded ventures where the lack of market specific knowledge is constraining the traction and scale-up of the VC firms investments.

It is argued that foreign entrepreneurs lack knowledge about the local markets and consequently try to sell some products or services or apply business models which do not match with the local context. The interviewee from VC 5 states, “It's a challenge in one way or the other because sometimes when these foreigners come in, they try to come up with solutions which are Western, but the problems are here. Sometimes many of these fail, because they lack that local nuance”. This shows that foreign founders, who constitute the majority of the founders receiving venture capital, are facing challenges related to liability of foreignness.

In particular, it was shown that many of the solutions that the ventures are providing,

are not fit for the local setting. The interviewee from VC1 stresses that foreign founded

ventures often face issues specifically relating to the preferences of the local consumers,

hindering the growth and success of their ventures. He states in relation to one of their

portfolio companies that “One thing they came to realise is that there's a certain standard

of quality that's expected from the middle class in the country.“ As such, the lack of

understanding of the preferred quality amongst consumers hindered the initial success

of the venture.

The interviewee from VC 4 additionally emphasizes the need for knowledge of the local setting, referring specifically to supply chains and business partners amongst the founders who the VC firms invest in. He states, “You have to relate well with the value chain whether you're sourcing products from the farmers, you have to be able to relate well.” Further emphasizing exposure to the local market and building trust amongst various business partners as important elements to navigate the local context. The interviewee from VC 1 additionally notes that some of the ventures they have invested in, have been facing this particular challenge. Telling the story of one American entrepreneur whose business they had invested in, “He didn't have a good understanding of the local context, the local farmers, the local framework, the policies around land, policies around farming. He had good business acumen, but the lack of understanding the local market made the business drastically underperform within the first few years until we brought on board professionals who had good understanding of the local market.”

Showing that the lack of understanding extends merely market knowledge and includes how to navigate the regulatory environment, ultimately creating a liability of foreignness, forcing the VC firm to bring in external managerial support with local knowledge.

Additionally, the interviewee from the startup mentions that the level of local understanding will also affect the scale-up process of the ventures, which VC firms invest in, particularly during the recruitment process. He states, “that means that there's no structures in place, there are no processes in place regarding how things should be carried out. That means that you get people who are not empowered.” Thus, he explains that staffing is another liability to foreignness facing the investee venture, in particular as many foreign-led ventures receive investments to staff a lot while scaling up rapidly.

The lack of understanding of training and local recruitment obstacles is thus particularly constraining the success of the ventures. Furthermore, the level of digital and technological development in Kenya was noted as an area where VCs suffered from a wrongful perception of the local context. The interviewee from VC 2 mentions that

“We've seen some examples, even in our portfolio, where we made some wrong decisions,

assuming that taking a digital approach would work and the market would adapt. It's not

that easy. [...] We did lack local knowledge as investors about the fully digital approach

and what you think the market is able to integrate when in reality it's not.” Hence, the challenges regarding local knowledge are not only pertaining to entrepreneurs but also to VC firms, who face barriers relating to the liability of foreignness in relation to understanding the level of digitalisation in the market.

The knowledge of the Kenyan market is additionally perceived as a major barrier to the investors in terms of building a well-informed criteria framework for their investments. The interviewee from the accelerator specifically highlights differences related to the level of information and understanding of the local business landscape.

She mentions that this becomes particularly problematic when investors lack local presence and understanding of the market dynamics, stating that “This happens if you're dealing with diaspora investors, because they are not in this market. They may have the business know-how and they may understand the principles of building a business, but they can't contextualize the dynamic of this market.“ The interviewee from VC 1 additionally stresses the importance of building local knowledge to support the creation of relevant investment criteria, stating that “It is crucial to be able to build research on the different problems that the continent is facing and then you look at those businesses in that context”.

Therefore, it can be said that the foreign-led networks creates benefits for the foreign founded firms who can more easily get access to investments through these networks.

However, as many of these ventures face challenges relating to their lack of understanding of the local context, the VCs face barriers relating to monitoring and supporting their ventures. Additionally the VC firms seem to struggle gaining information on the local markets and regulations as an effect of being heavily centralized around foreigners who lack this particular knowledge.

Summary of chapter 5.2:

In relation to the liability of outsidership it can be said that most VCs constitute the

epicentre of the networks and do not seem to be facing direct barriers related to the

liability of outsidership. These networks are to a large extent constructed around

foreign funded VCs and foreign founded-ventures and it can thus be said that the

liability of outsidership seems to pertain with locally founded ventures who struggle

gaining access to venture capital. An effect of this is that most ventures who receive

venture capital are led by foreigners who lack knowledge of the local setting. Such

liability of foreignness particularly relates to understanding the local consumers,

business partners and regulatory framework, ultimately hindering the growth of the

ventures, constraining the success of the VC firms' investments. Additionally, the VC

firms, particularly the ones with limited local presence, face challenges related to

gaining information on the local markets and ventures.