Private Equity and Venture Capital in East-Africa and Kenya

4 Introduction to the case study

The following section presents an overview of the venture capital industry in Kenya and the last decade's development. As such, we present the emergence of venture capital in Kenya, followed by an outline of the actors and recent changes in the venture capital ecosystem.

Subsequently we present the case entities that constitute our multiple-case study.

4.1 Private Equity and Venture Capital in East-Africa and Kenya

Figure 7: VC investments into SSA 2013-2015. Adopted from Divakaran et al. (2018)

Briter Bridges (2020), an independent body that collects data on African investments, shows in their latest report that private capital investments in Africa in 2019 accumulates to $1.5 billion. More specifically on Kenya, leading African news media on entrepreneurship, Weetracker (2020) shows in their report from 2020 that Kenyan startups raised $428.91 million in 2019, placing Kenya as second to Nigeria in the amount received during the year in Africa, at a nearly 300% rise in investment volume from 2018. While almost nonexistent in the early years of private capital, low-income countries in Sub-Saharan Africa (SSA) nowadays account for a growing amount of international venture capital (VC) investments (Hain & Jurowetzki, 2018). The opportunities for African digital development has been popularized through epithets such as ‘Lions go digital’, suggesting that the huge generation of young, technology-savvy Africans could grow Africa’s economy (McKinsey Global Institute, 2013., FT, 2018).

Additionally countries such as Kenya and Nigeria have been proclaimed as the ‘new

emerging markets’, particularly through the recent improvements in IT-infrastructure,

IT-competence and the development of innovative tech-solutions, (Hain & Jurowetzki,

2018). The gross escalation is largely attributed to big-ticket deals of more than $40

million, where companies in Fintech, E-commerce, and Agritech top the charters

(WeeTracker, 2020). Overall, the increased investments in Africa has been as the result

of an increasingly positive outlook for African business environment (Roxburgh, 2010).

4.1.2 First there was M-Pesa

Over the last decade, Kenya has been rising as the top pillar for start-up growth in Eastern Africa. Platforms such as M-PESA, the mobile phone-based money transfer platform from 2007, have been described as stimulating a butterfly effect, acting as the

“the trigger and driver of a new ecosystem of mobile technological innovations” (Manske, 2015: 14). Through other success stories of ventures such M-Kopa and Twiga Foods, the country has built a global reputation as a rich start-up hub, which has come to be known as the Silicon Savannah (Financial Times, 2019). As one of our interviewees puts it:

“We've seen a huge growth in software and tech businesses and then here in East Africa, Kenya has been the hub and is primarily been driven by strong infrastructure and mobile money, right? So mobile money to Kenya so you can see it in the trends right. FinTech is something that's done really, really well in Africa. And that's because more and more people have access to mobile money” (interviewee 2 from VC 3, 2020).

Since 2010, several hubs for information sharing between innovative tech-entrepreneurs have been founded in Nairobi, Kenya, which later developed into numerous accelerators and incubator programs and gave rise to the technological ecosystem claimed to be the centre of African technological innovations (Manske, 2015).

Following these developments, some of the largest tech-Multinationals such as Google,

Microsoft, Nokia and IBM have opened branches and research centres in the capital

(ibid). The illustration below has been adopted from a Vodafone report made in 2015,

and although changes have occured since, it firmly illustrates the strong existence of

accelerators and tech-hubs in the entrepreneurial ecosystem in Nairobi. And as many

foreign VC firms set up regional offices in Nairobi, one interviewee expresses his

impression of the development of the VC landscape: “The ecosystem is quite rich and is

quite interconnected, so you can meet people easily” (interviewee from VC 2, 2020).

Figure 8: The rise of a technological ecosystem in Nairobi. Adopted from Manske (2015: 13).

Although 42 percent of the Kenyan population is officially unemployed, informal

enterprises with innovative solutions for managing everyday problems are germinating

everywhere (Manske, 2015). The combination of this constructive attitude, known as

Jua Kali (“under the hot sun”), combined with the competences of the increasing number

of local and foreign developers and technology experts that come out of Kenyan

universities, creates a potential for creative business ideas, as mobile technologies open

up new ways of solving numerous challenges (Manske, 2015). Hence, the reputation of

Kenya as a global ICT-hub, holding a strong entrepreneurial class and good supply of

human capital within the sphere has helped contribute to the hype of the Kenyan

tech-scene (Ndemo & Weiss, 2017). As one of the interviewees stated: “Foreign VCs are

getting more and more turned on to the space [...] Africa is sexy for venture capital,

because it's got the youngest population of any continent, the middle class is growing

faster than in any other continent, governments and infrastructure is changing frequently.

It's arguable that the African economy is growing, at an exponential rate. So good funds will be turned on to this [...] especially because a lot of high net worth individuals also want to start making a positive impact” (interviewee 2 from VC 3, 2020).

4.1.3 Institutional Stability

Kenya has shown stability over the past couple of years. Recently, a much-hyped handshake between the President Uhuru Kenyatta and the leader of the opposition Raila Odinga in March 2018 has given an additional boost to the hope about the political stability of the country (Wilson, 2019). The growing economic development in the country reaches a GDP per capita of USD 2,127.42 in 2019, responding to a GDP growth of 6.62% (KNBS, 2020). Accordingly, this has increased the interest for foreign investors to enter the country (Chambers, 2019). Kenya’s newly formed policies around protection of minority investors, online tax-system and strengthened access to credit by introducing online registration, modification and cancellation of security interests ranked Kenya 56th on the World Bank's Ease of doing business rankings in 2020 (The World Bank, 2020). Beyond offering relative regulatory stability, Kenya has long been known for its private sector-led economy, which has gained strong political support, both in an absolute sense, but particularly relative to the other economies of East Africa (Tyce, 2020). Additionally, The World Bank (n.d.) reports strong efficiency gains due to the online systems for tax filing and payments. Further, Kenya scores high in protecting minority investors in the ‘extent of director liability index’ by requiring shareholders to approve the election and dismissal of an external auditor (World Bank, 2020).

To promote investment in Kenya, the Government made substantial changes to Kenya’s

licensing regime in 2006, and reduced the number of licences required to do business,

while making licensing regimes simpler and more transparent. Furthermore, in 2008,

the Government reduced the number of licences required to set up a business from 300

to 11 (Africa Legal Network, 2015). Following Kenya’s Constitution Article 40(5), the

state is required to support, promote and protect intellectual property rights, whereas

enacted legislations that protect the intellectual property rights include the Trademarks Act (Chapter 506), the Copyright Act (Chapter 130), and the Industrial Property Act (2001), which relates to patents, industrial designs and utility models. Internationally, Kenya is a member of the African Regional Intellectual Property Organisation and the World Intellectual Property Organisation (ibid.). Additionally, the Competition Authority of Kenya (CAK) is mandated to promote and protect effective competition in markets and to prevent misleading market conduct throughout Kenya (Chambers, 2019). Thus, showing that the Kenyan government bodies are focusing their efforts by putting several acts in place to protect foreign investors.

Other institutions that govern and support the investment scene include the Kenya Investment Authority (KenInvest), which is a corporate body established by the state to implement the legislations from the Investment Promotion Act, 2004. As such, it decides whether a foreign investor can become certified for investments in Kenya, and in 2015, this encompassed an investment size of at least $100,000 and an evaluation of “the extent to which the investment will contribute to the Kenyan economy by increasing the number and quality of jobs in Kenya, training Kenyans in new skills or technology, encouraging economic development, allowing the transfer of technology, adding to tax revenue or affecting foreign exchange” (Africa Legal Network, 2015: 9). In that regard, one of the interviewees further notes that recent changes made by the CAK encompass an exemption to the VC transactions from competition pilots, so they don't have to get regulatory approval to do investments that are less than $100,000, and hence are able to deploy without spending more money for regulatory filings (interviewee from the industry organisation, 2020).

Kenya’s vibrant investment environment is centred around the Nairobi Securities

Exchange (NSE). As of May 2020, the NSE had 67 companies listed in the stock market,

showing little growth in terms of companies listing on the stock market through IPOs

(NSE, n.d. a). However in January 2013, the NSE launched its Growth Enterprise Market

Segment (GEMS), a new market which SMEs to raise on-going capital. The NSE included

incentives for SMEs to list such as reduced requirements for listing, reduced listing fees,

and reduced corporate taxes for listed companies (NSE, n.d. b) As of 2018, there are five

companies listed on the GEMS, which are Atlas, Home Afrika, Nairobi Business Ventures, Flame Tree, and Kurwitu, showing a relative positive growth in terms of listings (Mbogo, 2018).

In relation to the government’s efforts to attract more foreign investors to the country, a variety of legal and institutional changes have been made. Over the past years, some of the most notable regulatory changes to the VC industry include a regulation from 2015 that allows local pension funds to invest in private equity and venture capital, as such the first investment from pension plans in private equity took place in 2018 in an infrastructure project (Jacobius, 2018). As such it can be seen that the government has focused its attention in the last decade on promoting the regulatory environment and ease of doing business, particularly for private capital investors.

4.1.4 Actors in the Kenyan Venture Capital Landscape

The funds that constitute the private capital industries can be divided into distinct

groups. First, there are private equity funds. Private equity funds invest in businesses

ranging from SMEs and family-owned businesses to large pan-regional businesses that

operate in Kenya, in East Africa, or across the continent. Such investments may include

globally governed funds with dedicated regional teams for Africa and Kenya (Divakaran

et al., 2018). Other funds are regionally invested, focusing on firms within East Africa. At

present, there are no PE funds that operate solely in Kenya. Second, beyond the set of

traditional private equity funds, Development Finance Institutions (DFIs) are somewhat

also competing for the same dealflow as the PE funds. A number of these institutions

include large players such as the Commonwealth Development Corporation (CDC), the

International Finance Corporation (IFC), the Danish Investment Fund for Developing

Countries (IFU), the African Development Bank (AFDB), the Asian Development Bank

(ADB), the European Investment Bank (EIB), the Islamic Development Bank (ISDB). The

strong participation by DFIs in the market is not surprising; DFIs have often been among

the earliest investors in private equity in emerging markets worldwide and have been

crucial to providing a demonstration effect for the industry. They also provide

governance, environmental and social best practices and serve as a training ground for the human capital that is required to start and manage successful investment firms (Divakaran et al., 2018).

As foreign VC firms are increasingly finding the industry attractive, the number of VC firms that invest in Kenya is growing. Our primary and secondary research shows that there are more than 40 VC firms investing in Kenya. Some of the most active VC firms in Kenya include: Acumen, DOB Equity, AE Ventures, AHL Ventures, Novastar Ventures, and TBL Mirror Fund. The few domestic VC firms that exist are: Grey Elephant Ventures and Savannah Fund.

Moreover, some of the most prolific accelerator and incubator programs include iHub co-working space, NaiLab accelerator, GrowthAfrica accelerator, Safaricom Spark Venture accelerator, Pangea accelerator, Antler global accelerator among others. In addition, AfriLab is a pan-African organisation that helps the accelerator programs and innovation hubs through knowledge sharing and capacity building (Afrilab, n.d.).

Furthermore, aiming to build up Africa’s startup community, VC4A was established in 2007 to create a platform for gathering the knowledge, capital and network that startups need to succeed (VC4A, n.d.). On their platform, entrepreneurs can gain access to the VC4A Startup Academy, mentorship opportunities and the ability to raise capital.

Furthermore, the Baobab Network is highlighted by many interviewees as a promising new platform for gaining knowledge about what is going on in the VC landscape, as the platform publishes information on ventures, sectors and markets to its members, while also being and accelerator which provides capital to the startups in its cohorts (Baobab Network, n.d.). About the increasing amount of accelerator programs, interviewee 2 from VC 3 emphasizes that the environment is growing very rapidly. In fact, the growth might even contemplate the proximity and relatedness of the different actors in the VC landscape: “there are so many accelerations that I just hear about, and I don't know about them. In theory, they should know about us, and we should know about them.”

In addition, there is a growing number of BAs in Kenya. The African Business Angel

Network (ABAN) is a pan-African non-profit organisation that supports the deployment

of early stage capital in startups across Africa. Since the launch in 2015, the number of

BA networks has grown to over 80 across Africa. BA networks seated in Kenya include Viktoria Business Angel Network, Intellecap Impact Investment Network (I3N), and 1000 Alternatives (ABAN, n.d.).

Summary of chapter 4.1:

In this chapter 4.1, we have shown that VC inflows have increased in East Africa, and that the VC industry in Kenya has seen some rapid changes over the past two decades.

As such, the success stories of technology startups have spurred the development and

gained international attention. We have showcased the main governing institutions to

the Kenyan VC industry and highlighted the institutional stability that is increasingly

being associated with it. As such the number of supporting actors within the VC industry

has been flourishing in the last decade, including VC firms, accelerator programs and

BAs.

In document Venture capital and the finance gap in emerging markets: (Sider 61-69)