“To prosper, Africa needs a massive, concerted, ambitious effort to transform our economies,” Akinwumi Adesina, President of the African Development Bank Group, said. “We need growth that benefits everyone. The High 5 priorities will get us there more quickly.”

The High 5s and the Bank’s recent progress are highlighted in the Annual Development Effectiveness Review 2016 — the latest edition of the Bank’s key monitoring and tracking tool — which was released Monday, June 27, 2016.

This year, the Bank has revamped the review to give greater attention to Africa’s fundamental challenges and how the Bank is addressing them.

The Bank is also reorganising itself to become more agile and responsive to the continent’s needs. A new business model has been adopted and three new vice presidencies established: on power, energy and green growth; on agriculture, human and social development; and on the private sector, infrastructure and industrialisation.

To increase its efficiency and carry out its work more quickly, the Bank is moving closer to its clients by establishing five regional integration and business delivery offices.

All these changes will help achieve the structural transformation outlined in the Bank’s Ten Year Strategy. The High 5 priorities are an integral part of that effort:

Light up and power Africa — About 635 million Africans still live without electricity and demand for energy is rising rapidly. Through the New Deal on Energy for Africa, the AfDB is working to unify efforts to achieve universal access to energy. Its new Energy Strategy aims to increase energy production and access, and improve affordability, reliability and energy efficiency.

Feed Africa — More than 70% of Africans depend for their livelihoods on agriculture. If its full potential were unlocked, agriculture could vastly improve the lives of millions. The Bank is framing its agricultural operations within a business-oriented approach, based on a deeper understanding of the obstacles, potential and investment opportunities.

Industrialise Africa — A persistent lack of industrialisation is holding back Africa’s economies. Over the next 10 years, the Bank will invest US $3.5 billion per year through direct financing and leveraging to implement six flagship industrialisation programmes in areas where the AfDB can best leverage its experience, capabilities and finances.

Integrate Africa — Through its Regional Integration Policy and Strategy, the Bank is focusing its integration efforts not just on movement of goods and services but also on mobility of people and investment.

Improve the quality of life for the people of Africa — Africa’s economic growth has not been rapid or inclusive enough to create enough jobs and improve quality of life. The Bank is committed to building up the availability of technical skills so that African economies can realise their full potential in high-technology sectors. Acknowledging the urgent need to address climate change, the Bank will nearly triple its annual climate financing to reach $5 billion a year by 2020.

By AfDB

It also supports the creation of a larger variety of products and services, improves the management of risks, makes payments easier and helps lenders better monitor their clients. In addition, it provides instruments, such as insurance packages, and information that help households and firms to cope with negative events, ensuring more stable consumption and investment.

Given the weakening growth outlook for the region, examining all potential sources or lubricants for growth is now of particular interest. So, in our latest Regional Economic Outlook for Sub-Saharan Africa we examine the extent to which developed, well-functioning and accessible financial institutions and markets could boost growth and what policy options would best help achieve this potential.

Good progress but significant challenges remain

To fully appreciate the potential for further financial development, take a look at the encouraging progress sub-Saharan African countries have made over the last decades.

First, the region has led the world in innovative financial services based on mobile telephones, especially in East Africa. The fast spread of systems such as M-Pesa, M-Shwari, and M-Kesho in Kenya has helped reduce transaction costs and facilitate personal transactions even in the absence of traditional financial infrastructure. Microfinance has also grown rapidly, providing services to customers at the lower end of the income distribution, and large parts of the population now have access to financial services more generally (Chart 1).

But financial inclusion, the degree to which all segments of the population can benefit from financial services, still lags well behind that of other developing regions of the world. For instance, as cellphone ownership continues to grow among the poor, the less well educated, and women, there is a large potential to fully exploit mobile payments to compensate for the shortcomings of traditional methods in providing financial services to the most underserved.

Second, the financial sector has deepened—the region’s median ratio of private sector credit to GDP has doubled from its 1995 level. However, with the exception of the region’s middle-income countries, financial market depth and institutional development are also still much lower than in other regions.

Third, we now find Pan-African banks—locally-owned banks that operate in several countries—in the vast majority of sub-Saharan African countries. Their expansion has filled gaps in services left by European and U.S. banks, promoted greater economic integration, and made the sector more competitive. But as often is the case with new and rapidly growing financial developments, Pan-African banks also bring a number of challenges, in particular the need to strengthen supervisory oversight on a consolidated and cross border basis and improve the internal controls and transparency within those institutions.

A large untapped growth potential

But how much more financial development could sub-Saharan African countries realistically achieve? Examining a combined index of the various dimensions of financial development shows there’s a substantial gap between the level of financial development at which many sub-Saharan African countries are currently operating, and what they could reach when compared to other regions with similar structural characteristics.

So, the potential for further financial development is substantial, and the impact of filling the gap is about 1½ percentage points additional annual growth for the median sub-Saharan African country, with variations across country groups (Chart 2).

In addition, we show that higher financial development can reduce the volatility of growth, especially if financial development is initially relatively low, as is the case for most countries in the region (Chart 3). Here, more financial development relaxes credit constraints and provides instruments to withstand adverse shocks. However, as the sector deepens, its contribution to reducing volatility declines because financial depth also increases the propagation and amplification of shocks.

Safeguard macro-stability and strengthen institutions stability

So, what should policymakers do to help sub-Saharan African economies reap this potential?

Our analysis shows that the region’s financial development has been largely driven by better macroeconomic fundamentals over the last decades, but hindered by weak institutions. So, providing strong legal and institutional frameworks and corporate governance in particular, are critical for creating an environment in which the financial sector can develop and thrive.

But countries also need to be vigilant about risks to the financial system and their spillovers to the economy. As regulations in many countries are not fully in line with global best practices, and their implementation remains weak, improving the regulatory framework and strengthening supervisory capacity as well as enforcement powers are essential. Among many other reforms, the harmonization of regulations and supervisory procedures to avoid regulatory arbitrage and establishing an appropriate mechanism for resolving nonviable financial institutions are high priorities.

Finally, financial supervisors should monitor carefully the risk related to mobile money transactions as they become increasingly popular in the low-income segment of the population—ensuring households’ funds are safe while allowing them to enjoy making transactions more easily, saving for worse times or taking up a loan to start a business.

By Anne-Marie Gulde-Wolf 

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SoFi

The financial market has been going though many changes thanks to the growth of the digital economy and availability of app-based mobile devices. Mobile payments are one obvious area in which the financial industry is evolving. Square is a clear leader in the U.S., Canada, Japan and Australia, while companies, such as Ezetap in India, are cornering the market in developing nations.

Another emerging sector turning traditional banking on its head is online financing. San Francisco-based SoFi (which stands for Social Finance) is set to disrupt the banking sector through its unique approach to lending and wealth management. What launched in 2011 as a financial services company to refinance student loans has expanded to mortgages, mortgage refinancing, personal loans and wealth management. The company touts its proprietary technology, customer service and products, while marketing itself as a “non-bank.” Instead of going to a local bank branch to obtain a loan, SoFi allows members to apply online or over a mobile device—making it particularly appealing to Millennials.

What Sets SoFi Apart? There are other companies that offer online financing and wealth management, but SoFi’s management team and their ability to partner with major financial institutions give them strength and credibility. Japan-based SoftBank Group was so impressed with SoFi that they provided $1 billion in funding to help the company charge lower rates on student, personal and home loans, as well as help fund plans to expand into wealth management and deposits.

23andMe

I recently went to my doctor for a yearly physical. As part of the process, I underwent several blood tests and had a heart stress test. What if, in addition to these tests, my doctor could also analyze my DNA to better understand my genetic mix and its relationship with my health? He might be able to predict and help prevent certain hereditary diseases. That is the potential behind 23andMe.

For the last ten years, the company has been developing a suite of genetics tests to provide customers information on health, ancestry and traits. The company claims more than 1 million customers and says it has built one of the world’s largest databases of individual genetic information. Though not currently cleared to use genetic information to predict the likelihood of a disease, the potential is there and investors have taken note. The potential revenue of an FDA-approved test for diseases is so significant, the company could be well on its way to an IPO.

What Sets 23andMe Apart? The company’s success is tied to the persistency of founder and CEO, Anne Wojcicki, who spent a decade in healthcare investing, primarily in biotechnology companies, before co-founding 23andMe. She understands the market and has been able to navigate some major hurdles, including gaining FDA approval for the company’s direct-to-consumer genetic testing business. Though the company had to regroup a bit, 23andMe relaunched in early 2015 with guns blazing—and hasn’t looked back since.

Udacity 

Online education is making it easier for many people to learn new things or brush up on skills to help advance their careers. While many e-learning platforms, such as Courseraand Khan Academy, offer courses across a wide variety of topics, Udacity is focused on technology. Its mission is to “bring accessible, affordable, engaging and highly effective higher education to the world.”

Udacity was created almost by accident. Co-founder, Chairman and President, Sebastian Thrun, and Peter Norvig (currently the Director of Research at Google Inc.) offered an “Introduction to Artificial Intelligence” course online to anyone, for free. Some 160,000 students from more than 190 countries enrolled. Not long afterward Udacity was born.

Today the company focuses on teaching skills that industry employers need and delivering credentials endorsed by these employers—at a fraction of the cost of most traditional schools. One of those employers is Google. The company recently announced a partnership with Udacity to offer a Google Android Basics Nanodegree designed for people with no programming experience.

What Sets Udacity Apart? The Co-founder, Chairman and President, Sebastian Thrun, recognized the opportunity to monetize courses teaching the skills employers are looking for—and he seized it. He brought in the right team to make it work, including CEO Vish Makhijani who has years of executive leadership experience working with companies including Zynga and Yahoo. The market has taken notice. Udacity has received funding from major investors, including Bertelsmann, Charles River Venturesand Andreessen Horowitz. It is currently valued at $1.1 billion and is set to become a leading provider of educations services.

Oscar 

If you are confused about your health insurance policy and bills, you aren’t alone. The insurance market in U.S. is not working well, especially when compared to most other developed nations. We pay huge premiums and still have expensive medical bills—and that’s just for the insured.

Enter Oscar Health Insurance. The company was created in 2012 partially because co-founder Josh Kushner was frustrated over trying to make sense of a health insurance bill. He and fellow co-founders, Mario Schosser and Kevin Nazemi, wanted to use technology to improve how customers find health care. According to its website, Oscar is “reinventing how to manage care, process medical claims, control healthcare costs and provide transparency. With all the complexity hidden behind an easy experience for our members.”

What Sets Oscar Apart? Oscar is changing a broken industry by offering a common sense solution to health insurance. It uses sophisticated technology to make it easy for customers to find information and be able to make decisions. Though currently only offering plans in parts of New York, New Jersey, California and Texas, the company is growing rapidly. It currently has more than 145,000 customers and is valued at $2.7 billion. Investors include Khosla Ventures, General Catalyst Partners and Goldman Sachs.

WeWork

Great ideas don’t have to be all about technology, but they should be about the market and customer needs. If you can identify and solve a market challenge, you can win.Adam Neumann and Miguel McKelvey did just that when they founded WeWork back in 2010. Both were independently employed and were working out of a partially vacant office building. They convinced the landlord to let them rent out the empty parts as shared workspace—and WeWork was born.

Today the New York City-based company fills the need among entrepreneurs for a work space that won’t cost an arm and a leg. It currently serves close to 50,000 people in cities across the U.S. and around the globe. Part of the appeal of WeWork is that it doesn’t just provide an empty desk. Membership includes access to a number of perks, from free coffee and craft beer on tap to Wi-Fi, printing and even meeting rooms with ping pong tables. Just the type of hip appeal that many of today’s entrepreneurs and independently employed persons are looking for.

What Sets WeWork Apart? The company recognized that technology is not always the path to success – marketing is. It’s not just enough to offer office space for rent—it has to appeal to the mindset of the self-employed generation. Though this startup is not tech-based and has a pure and simple business plan, it’s attracted the attention of Benchmark, Goldman Sachs, Fidelity and T. Rowe Price, who have funneled $1.4 billion into the company—putting it at a valuation of $10.2 billion.

These five companies have all approached business a little differently and, in so doing, have made their way into the “billion dollar club.” One size does not fit all when it comes to building a company, but studying the approach of these success cases is a good way to find inspiration for your own business plan. Strong partnerships, a good leadership team, persistency, common sense solutions and a solid marketing plan can make the difference between an average company and one that takes the market by storm.

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Africa’s power sector needs far exceed most countries’ already stretched public finances, making it crucial for governments to attract greater levels of private investment to scale up generation capacity. To reach the scale required, governments must provide a sound investment climate and enabling environment, the report finds.

 “Independent Power Projects in Sub-Saharan Africa – Lessons from Five Key Countries” draws on case studies carried out in Kenya, Nigeria, South Africa, Tanzania and Uganda – countries that have the most experience with IPPs in the region.

“Independent power projects now constitute the primary vehicle for private investment in the African power sector,” said Makhtar Diop, the World Bank’s Vice President for Africa. “The objective of this report is to identify key lessons that can help African countries attract more and better private investment.”

Currently, there are 126 IPPs in 18 Sub-Saharan countries, accounting for an installed capacity of 11 GW and $25.6 billion in investments. But to benefit more countries the report recommends these IPPs should be much larger and spread across the region.

Enabling factors for attracting more and better IPPs include:

1. More competitive procurement efforts from countries in Sub-Saharan Africa, which includes encouraging long-term contracts through a competitive bidding process. This can help secure reduced prices and help avert other issues, such as the possibility of a problematic contract. If direct negotiations are conducted, they should be done transparently.
2. Clear and conducive energy sector policies, structures and regulatory environment.
3. Systematic and dynamic power sector planning, including the ability to accurately project future electricity demand, determine best supply or demand management options and anticipate how long it will take to procure, finance, and build the required electricity generation capacity.
4. Financial viability of the public utilities is vital as they remain the principal off-takers of power produced by IPPs. Given the high-risk environment of most countries in Sub-Saharan Africa, it will be important to provide proper mitigation through financial guarantees and security measures to attract new investors.

The report also finds that renewable energy IPPs are becoming more promising and can be viable if procured competitively.

The report concludes that all sources of investment need to be encouraged and for IPPs to flourish, countries in Sub-Saharan Africa need dynamic, least-cost planning linked to the timely, competitive procurement of new power generation capacity. This must be accompanied by effective regulations that encourage distribution utilities that purchase power to improve their performance and prospects for financial sustainability, thereby widening access to electricity.

By the World Bank

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The experience inspired Nyankamawu to create Volta, a company that builds solar power projects for health clinics, schools and farms across Ghana.

Volta’s customers pay for 25% of the capital costs upfront, and the rest via monthly payments over two years. None of Nyankamawu’s customers have ever missed a payment, Nyankamawu said.

“Our model works best when it’s a substitute for people who are already using diesel generators,” he added. “They’re saving up to 45% on their costs by switching to solar.”

I met Nyankamawu at the Clean Energy Ministerial in San Francisco earlier this month, an annual gathering of energy leaders from 23 countries and the European Union. The meeting marked the first time the ministers met since more than 170 countries signed the Paris climate agreement to limit the global temperature rise to under 2C, a goal that won’t be met without strong domestic policies that give the businesses incentives to invest in a low-carbon future.

I often hear criticisms that businesses, which account for most of the manmade emissions that are causing global warming, aren’t doing their part to keep the rising temperatures in check. Surveys and anecdotal evidence show that many corporate leaders don’t see their role in this global effort.

But that’s not what I have seen. A growing number of companies are turning to renewable energy to reduce their carbon footprint. I am impressed with entrepreneurs like Nyankamawu and other business leaders who work on making renewable energy affordable and accessible. And they represent progress. Putting money in renewable energy, whether through power purchase agreements with big solar and wind farms in the US, or tiny household-sized solar projects in Africa, was a rarity even just five years ago.

Many Fortune 500 companies recognize a direct connection between climate change and their financial wellbeing. Earlier this month, a half-dozen major companies, including TD Bank and Interface, joined RE100, a coalition of businesses that are switching to 100% renewable electricity. The shift has been especially strong in the US, where large corporate buyers contracted a record 3.2 gigawatts of renewable energy last year, nearly 20% of the 16.4 gigawatts of renewables added to the US electric grid overall. That means tens of thousands of workers rely on solar and wind power to do their jobs, and that number will only go up.

One of the most impressive efforts I heard at the San Francisco meeting came from Lisa Jackson, who leads Apple’s environmental and social initiatives. Jackson talked about the company’s effort to use solar and wind energy to run its own global operations and the factories in China that make its iPhones and iPads, including a plan to bring online 2,000 megawatts of green energy there. The company would work with its suppliers there to build those projects.

Some of the most compelling stories came from Africa. Home to the world’sfastest growing population, the continent is a key front in the Paris climate agreement’s quest. In Tanzania, Off-Grid Electric allows homes and small businesses to install solar systems and pay for them via mobile phone payments. Off-Grid says it’s currently installing more than 10,000 solar units every month in Tanzania and Rwanda, and recently raised $70m from San Francisco-based DBL Partners and other investors to help hire more staff and expand operations.

More businesses will switch to renewable energy if they are able to finance it. We saw a record $329bn in global clean energy investment last year, but that falls short of the estimated $1tn that will be needed every year through 2050 to help achieve the 2C goal. A major emission producing country such as India, which aims to install 175 gigawatts of wind and solar power by 2022, will need anestimated $200bn to reach that milestone. The country attracted $10.9bn in clean energy investments last year, according to Bloomberg New Energy Finance.

There is one group of investors who could help fill that gap, but they have yet to value renewable energy investments: institutional investors. They manage public pension, insurance and other funds that are worth trillions of dollars. These investors are dipping their toes in clean energy in US and Europe but remain on the sidelines in emerging markets, which they consider particularly risky.

Michael Liebreich, founder of Bloomberg New Energy Finance, likened the challenge of fighting climate change to climbing Mount Everest: “We’ve just reached base camp.”

No doubt, getting to the top of the mountain will require huge participation from the business community globally.

The window of time to summit is now – and they’ll need to move quickly.

By Peyton Fleming

The ICT sector has proven to be a strong driver of Gross Domestic Product (GDP) growth in nations across the world. From developing countries to developed nations – the ICT sector has played a part in the success of each of these nation’s economies, the advancement of its people’s skill-sets, capabilities and positioning the nations as a place for global firms to move efficiently conduct business.

Over the past decade – ICT has been a major economic driver to boost the social and economic landscape of the African continent. The ICT sector is better positioned to leverage businesses and the continent to some impressive growth of economies. The ICT sector witnessed double digit growth and if this trend continues upwardly – ICT expenditure in Africa could exceed $150 billion by 2016. The ICT expenditure would continue to include computer hardware and software, computer services (computer and network systems integration, data processing services) and communications services (voice and data communications services) and wired and wireless communication equipment. African countries have made positive progress on access to ICT services – however there is still work to be done in terms of ICT readiness. According to the International Telecommunications Union (ITU) Development Index – it indicated that the African region has made slower progress when compared to other regions in the past two years – with roughly half the improvement on an aggregate basis. Access to ICT still remains a huge challenge for most African countries.

ICT have become ubiquitous – as it now plays an important role in transforming people’s lives globally. In Africa – ICT is set to transform many lives on the social and economic level. Africa has witnessed success of ICT initiatives from mobile banking in East Africa to smart apps that are now being used across the entire continent – apps designed to fulfill different purposes and solving diverse issues. Africa has seen tremendous growth in the last decade and a half – ICT growth has been primarily fueled by mobile cellular communications; mobile penetration; affordability and access to mobile telephony; internet access uptake (one in six people are online in Africa); submarine cable have enhanced international connectivity – the continent now has more than 10 terabytes of submarine connectivity around Northern Africa since 2014; 7 terabytes around Eastern Africa and 4 terabytes around Western Africa. These developments in infrastructure and solutions in Africa – signify and represent a renewed confidence and optimism in Africa’s digital future.

A great amount of work still needs to be done though – as of 2014/2015 more than 80% people in Sub-Saharan Africa (SSA) were still offline – deprived access to the incredible knowledge wealth and riches that the internet can bring into their lives and also the ones who have access – it is still vastly expensive with mobile broadband costing 40-60% of average income in SSA.

The digital revolution has brought many private benefits and a look at a day in the life of the internet reveals some interests trends:

• 7 billion Emails sent
• 8 billion YouTube videos watched
• 2 billion Google searches conducted
• 3 billion Gigabyte (GB) of web traffic
• 803 million Tweets
• 186 million Instagram photos
• 152 million Skype calls
• 36 million Amazon purchases

This digital revolutions also has some benefits that economies can  reap from these trends – digital technologies are transforming more businesses (advent of e-commerce); digital technologies are transforming people’s lives – through digital payments/mobile money accounts/mobile remittances (number of mobile accounts worldwide stood at 300 million as of 2014/2015); digital technologies are transforming governments – with the implementation of digital identities in some parts of the world and also digital technologies promoting development on various scales – expanding the information base, lowering information costs and creating information goods.

We might be privy to these trends; however, a significant digital divide still remains as:

• 6 billion people still without Broadband
• 4 billion people still without Internet
• 2 billion people still without Mobile Phones
• 4 billion people still without A Digital Signal

The ICT sector is among the most profitable and successful – has revolutionized the way the world communicates. Through a combination of forward looking government policies and regulatory reforms; international standards; industry innovation and investment in infrastructure and new services – billions of people have been brought in to the information society in a remarkably short period of time.

ICT entrepreneurs, small to medium enterprises (SMEs) and start-ups have a specific role in ensuring economic growth in a more sustainable and inclusive manner – as they continue to be involved in the development and innovative ICT – enabled solutions with a unique potential to make a long lasting impact in national, regional and global economies and also as an important source of new jobs. The fundamental role of ICT innovators and SMEs is also reflected in the outcomes of the World Summit in the Information Society (WSIS) which was supported by the World Telecommunications and Information Society Day (WTISD 2016) which was celebrated on the 17th May 2016 – with a theme aligned to ITU’s work in unlocking the potential of ICT’s for young innovators, entrepreneurs, innovative SMEs, start-ups and technology hubs as key drivers of innovative and practical solutions for catalyzing progress in achieving international development goals – with a focus on SMEs from developing countries.

There is progress in Africa in the advancement of ICT in transforming the economy of the continent. Bringing Rwanda under the spotlight here – as the Global Information Technology Report (GITR) 2015 – ranked Rwanda first globally for government success in ICT promotion to drive social and economic transformation and according to the World Economic Forum (WEF) Report – Rwanda scored 6.2 points out of 7. Overall Rwanda was ranked No 83 out of 143 countries – positioning Rwanda as the first country in the region and the 5th in Africa. Upon the release of the GITR 2015 report – Rwanda’s Minister of Youth and ICT stated that “Rwanda continues to be one of the fastest growing African countries in ICT and there are several avenues for growth for the ICT sector – from e-commerce and e-services; mobile technologies; applications development and automation to becoming a regional centre for the training of top quality ICT professionals and research”. A robust ICT industry creates wealth, jobs and entrepreneurs.

New developments in Rwanda’s ICT scene include KLab, a youth innovation hub; Think, a technology hub in Kigali; Rwanda Media Hub; The Office and YouthConnekt. Also, the new Kigali Innovation City attracted the first Carnegie Mellon University campus in Africa.

Whereas South Africa is ranked No 5 in ICT infrastructure in Africa – after Seychelles, Libya, Mauritius and Algeria, Rwanda’s high performance was boosted by its One-Laptop-Per-Child policy which saw a distribution of more than 200,000 laptops to grade schoolers.

Various ICT initiatives have also leveraged the transformative opportunities presented by this sector in Africa. The initiatives borne by the ICT sector in developing Africa’s digital economy include:

• Connect Africa Initiative: a global partnership mobilizing the human, financial and technical resource needed to bridge major gaps in ICT infrastructure across the continent which saw a pledge of more than $55 billion.
• International Fibre Connectivity: a number of submarine cable backbone projects proposed in recent years with coverage of 70, 000 km coastal line and estimated cost of $6.4 billion (East African Submarine Cable System; SEACOM; The East Africa Marine System TEAMS)
• East African Broadband Network (EABN): implementing an integrated East African Broadband ICT Infrastructure Network – providing cross border connectivity between 5 East Africa Community partner states (Burundi, Kenya, Rwanda, Tanzania, Uganda)
• South Africa Region Backbone – SATA Backhaul: aimed at improving cross border links that would interconnect the SADC member states through optical fibre networks and link them to submarine cable system including the Eastern African Submarine cable System (EASSY).

In conclusion,  ICT’s has the potential to transform businesses and governments in Africa – driving entrepreneurship, innovation and economic growth. ICT has and plays a pivotal role in enhancing African regional trade and integration as well as the need to build a competitive ICT industry to promote job creation, innovation and the export potential of Africa companies. The future looks certainly bright as Africa seizes the opportunities and employ the transformative power of ICT’s to accelerate its development. ICT driven Africa is a continent where its people prosper – where communities connect and flourish – where businesses thrive – where government enable strong and sustainable development. Africa’s ICT is certainly poised for stupendous growth.

By Dipolelo Moime, CEO, Legato Consultancy Ltd.

Follow him on twitter: @DipoleloMoime 

The venture capital industry creates value that far outweighs the dollars allocated to it. But ten year returns to investors haven’t reflected that fact.

Innovation presents opportunities to solve customer problems more effectively and efficiently. But creating solutions that don’t yet exist involves a high degree of uncertainty. Usually, you need to spend a considerable amount of time and money before you know your efforts are going to pan out. That’s where risk capital comes into play; private investors invest money with the hopes of earning outsized returns to account for the level of risk they’re taking

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Source: PricewaterhouseCoopers/National Venture Capital Association

Venture Capital is one of the most important sources of risk capital around. Limited Partners (LPs) commit money to venture capital funds managed by General Partners (GPs). In aggregate, US GPs put roughly $25 billion to work every year. That might sound like a lot of money, but it’s less than 0.2% of US GDP.

Yet that 0.2% has been key in creating companies that account for 21% of the US GDP, and over 11% of private sector jobs (read the report). A tiny fraction of GDP invested by venture firms every year has been instrumental in creating more than one-fifth of the value in our economy.

Of course, venture financing isn’t the only funding source most of these successful companies have used to get where they are. After getting their venture dollars, many have taken in money from banks, mezzanine funds, and public offerings. But for most of these companies, it was venture financing that made them big; by the time they qualify for later-stage funding events, their valuations are often huge.

Clearly, venture capital investing results in tremendous asset value creation, particularly when compared to the dollar inputs.

But where is the payback for investors?

The problem is that LPs are capturing very little of the value created. Over the past ten years, the average venture LP would have generated better returns investing in an index fund such as the S&P 500. Ten year returnsfor early stage venture were 3.9% as of 2013, while returns for the S&P 500 for the same period were 8%. And that’s before adjusting for risk, which makes venture returns appear even more lackluster.

I have heard two common objections to this line of reasoning, and they go something like this (followed by my rebuttals):

“If you look at the past 25 years, the numbers look much better for venture. This has just been a bad 10 years.”

Ten years is a pretty long time. And we’re talking about how venture tracks against a broad market index; it’s not like we’re expecting absolute returns to be awesome. Going back 25 years lumps in the dot-com boom, and I’m not convinced there’s any real likelihood we’re going to see another valuation and liquidity explosion like that again. Rather, I see evidence of fundamental structural changes in the venture industry that are causing these poor returns.

“It’s all about the top performing firms; you need to focus on the incredible returns they make.”

If we’re talking about what a typical LP should expect, averages are what matter. Perhaps if you’re an existing investor in one of the old-school top-tier venture firms, this argument is meaningful for you. Frankly, it’s probably the opposite for most LPs; they don’t have a snowball’s chance in hell of getting into one of those top funds. Even then, you might want to think twice; it’s not clear historical performance for those funds is a good predictor of future outcomes.

The Kauffman Foundation (a non-profit dedicated to education and entrepreneurship) wrote a scathing report in 2012 entitled, “We have met the enemy… and he is us.” The foundation is a large and experienced venture investor, with (at the time) $249 million of their total $1.83 billion investments allocated to 100 different venture firms. Here are a few choice things they had to say:

• 62 of 100 firms failed to exceed returns available from the public markets, after accounting for fees and carry
• 69 out of 100 did not achieve sufficient returns to justify investment
• venture fund GPs have little actual money at risk in their own funds: an average of 1%
• the “2 and 20” model means that GPs are assured of high levels of personal income, regardless of the performance of their investments
• venture funds were taking on average far more than 10 years to return liquidity (when they did)

In summary, they said: “Returns data is very clear: it doesn’t make sense to invest in anything but a tiny group of ten or twenty top-performing VC funds.”

Market forces impacting venture

A combination of structural factors, historical trends, and market dynamics are creating tremendous pressure on the venture capital industry.

The “2 and 20” structure

The vast majority of venture firms work on some (minor) variation of the 2 and 20 structure whereby the fund managers get 2% per year of the committed funds for salaries and operating expenses (“management fee”), as well as 20% of the net value created (“carry”). Since most funds last ten years, that means 20% of investment dollars (2% times 10 years) never even reach the portfolio companies. Sometimes the annual percentage amount drops after the active investing period. Still, net of higher annual percentages (2.5% is fairly common) and long investing periods, the reality is that somewhere around 20% of investor dollars are taken off the top.

There is nothing intrinsically wrong, or even irrational, about the 2 and 20 model; it’s fairly common in other segments of the finance industry such as hedge funds and traditional private equity (although read here and here to see how those industries may be changing). There’s also nothing wrong with investors making multi-million dollar salaries. But in the face of such poor venture returns, it is hard to justify the current economic structure.

Ironically, it’s the 2 and 20 structure that is in part responsible for a chain of events that have contributed to the decline in venture returns over the years. As time goes on, it seems that the fundamental economics of the venture model are putting the entire industry at risk.

A rising tide

The dot-com era was an extraordinary period of value creation, and many savvy venture capitalists made the most of it. As the IPO market exploded, so did the returns for the venture funds who were smart enough to be in the right deals at the right time.

During the five-year period between 1996 and 2000, the US markets saw 1,227 venture backed IPOs. And the VCs were cleaning up, with a median ownership stake of 40%. Perhaps more importantly, IPO returns averaged a stunning 88% during 1999 and 2000 (read the study).

Opening the floodgates

With venture funds practically minting money, the financing floodgates opened. Billions of dollars poured into venture capital funds, and many new funds formed. By the peak of the bubble in the year 2000, there were1,022 active US venture capital firms.

And it wasn’t just the number of firms that ballooned; the average size also grew rapidly. And the size of the firms grew much faster than the number of GPs. According to data from the NCVA, average capital per principal rose from about $3 million in 1980 to roughly $30 million by the late 2000s–roughly 10x growth.

Why did dollars managed per partner grow so much? It’s almost certainly due to the incentives associated with the 2 and 20 structure. The more dollars per partner, the more management fee, and potentially, the more carry. Increasing the size of a fund pro rata with the number of partners wouldn’t be in their interests. And if the LPs were willing to invest more money on those terms, it’s only natural that the GPs were happy to oblige.

The requirement for massive exits

Deborah Gage wrote in her 2012 Wall Street Journal article that the common rule of thumb for venture outcomes is 30-40% completely fail, another 30-40% return the original investment, and 10-20% produce substantial returns. However, her article then points out that research into over 2,000 venture backed companies by Shikhar Ghosh suggest numbers that are somewhat more stark:

• 30-40% return nothing to investors
• 75% don’t return investor capital
• 95% don’t achieve a specific growth rate or break even date

That suggests that it’s closer to 1 deal in 20 that returns a meaningful amount of money, and another 3 in 20 that return capital.

Let’s do a little bit of venture math

What sort of return would the one big winner require to make the fund? First, the fund and it’s goals:

• $125 million fund that makes 20 investments
• Typical 2 and 20 structure, with 2% average over 10 year fund lifespan
• Due to follow-on investments in the good deals that, each accounts for 10% of fund, rather than the expected 5%
• The fund needs to return at least 2x overall to investors to ensure they can raise another fund
• With 20% carry, they need to return 2.5x, or $312.5 million to hit their goal

Investment dollars, and expected outcomes:

• They’re investing $100 million net of 20% management fee
• 3 so-so deals return an average of 2x each
• 8 deals return an average of 1x each
• 8 deals are a total wipeout

Here’s how the math works out:

• The goal is 2.5 times $125 million, or $312.5 million
• $40 million into 8 deals generates $0
• $40 million into 8 deals generates $40 million
• $20 million into 3 deals generates $40 million

Without the big winner, they’ve returned $80 million out of a target of $312.5 million, which is $232 million short.

So, what return does their “fund-making” investment need to achieve? With $10 million invested in the big winner, they need a $232 million (23x) return to make their target minimum. More likely, they’re actually targeting a 3x overall fund return, which would imply that they need more than a 43x return in that one deal to make their numbers.

Wow. And to put that in perspective, those returns imply much higher enterprise valuations. Assuming the VCs own a third of the company at the time of liquidity (and ignoring a presumed 1x liquidation preference), we’re talking about an enterprise valuation of $696 million for that one company to achieve the overall 2x return on their fund.

That’s the sort of math that forces most venture capitalists to seek massive exits to make their fund economics make sense.

A weak IPO market

During the massive growth of the venture industry in the 1990s, funds relied in large part on the booming IPO market to achieve these extraordinary liquidity multiples. The returns for some funds of that era are truly astonishing. But the turn of the century brought a whole new economic reality to the venture market. The IPO market dried up extremely quickly, and has only slowly begun to recover over the past few years.

Even with recent improvements, however, the IPO market is nothing like what it was during the boom times, and likely never will be again. The number of issuances is down, and the economics for the investors are far different than they were previously. No more 40% stakes in the companies at IPO, or reasonable expectations for 88% returns from the IPO.

Rather suddenly, venture capitalists had all but lost their most important liquidity generation tool.

Venture’s new reality

The result is larger funds, higher valuations, and later stage investments, which in turn require even bigger liquidity multiples. Without a highly active IPO market, that’s a significant challenge.

More capital per partner means bigger investments

When a fund grows at a rate three times faster than partner growth, it’s not as if each partner can source three time as many quality deals, and perform diligence three times as efficiently. An obvious solution is to put more money to work in each deal, rather than simply increasing the overall number of deals.

That probably explains the trend towards larger deal sizes, and in particular more “loading up” on existing investments in the form of follow-on financings. Peter Delevett’s article in the San Jose Mercury Newsquotes entrepreneur Tony Jamous, who says, “There’s so much money right now in the market that it’s my challenge to actually keep it a small round.”

Revenue generating is the new seed stage

Just because GPs are investing more dollars in each deal doesn’t necessarily mean that they’re acquiring more of the company. Venture investing is not about making control investments; it’s about backing a team. Given the prospect of follow-on rounds, it simply doesn’t make sense to take too much of a company in early venture rounds; otherwise, you’re setting yourself up for a recapitalization when the entrepreneurs find themselves squeezed into a small corner of the cap table.

The obvious way to put more money into a company, while maintaining a suitable portion of the cap table, is to invest in companies that are worth more. That, in turn, implies investing in companies that have reduced risk by making more progress.

That’s why so many venture firms are investing later stage, where risk is lower, and valuations are justifiably higher. Later stage investments are also easier to diligence because there’s more of a track record. Ernst and Young’s Turning the Corner report from 2013 said it pretty succinctly: “VC funds are adjusting their investing strategies, preferring to invest in companies that are generating revenue and focusing less on product development, pre-revenue businesses.”

And Paul Graham, founder of Y Combinator, is clearly seeing it in the market, too, referring to “…what used to be the series A stage before series As turned into de facto series B rounds.”

Venture investors are investing later in the risk curve, meaning they have mostly vacated what used to be seed stage, and seed stage investments now are more similar to what Series A investments used to be. That in turn pushes Series B and later rounds further along the risk continuum.

Bigger investments often mean higher valuations

As traditional venture capitalists move away from true seed stage investing, they’re beginning to clump at the later stages, with more investment dollars targeting a relatively stable supply of viable startup investments. That stable supply and increased demand tend to push valuations higher.

That’s further exacerbated by the generally high levels of LP investments over the past decade. Despite relatively poor returns, Limited Partners continue to pour money into the industry, albeit with what appears to be an increasing emphasis on a smaller set of funds with the best track records. The excess capital active in the later stages of the venture market have resulted in a war for tech companies with demonstrable traction, resulting in even further valuation inflation.

The venture valuation bubble

For a number of years, I’ve struggled to reconcile the evidence of frothy venture valuations with the inability of amazing entrepreneurs to acquire funding. I suspect the best explanation is that both are true; seed stage investments are irrationally hard to achieve, while mid-stage deals are overly competitive.

Revisiting Paul Graham’s June 2013 essay on Startup Investing Trends (referenced earlier):

“Right now, VCs often knowingly invest too much money at the series A stage. They do it because they feel they need to get a big chunk of each series A company to compensate for the opportunity cost of the board seat it consumes. Which means when there is a lot of competition for a deal, the number that moves is the valuation (and thus amount invested) rather than the percentage of the company being sold. Which means, especially in the case of more promising startups, that series A investors often make companies take more money than they want.”

There is tremendous pressure in the venture industry to invest more money, at higher valuations, in more mature companies.

Higher investment valuations require higher exit valuations

We have already discussed the economic imperative for venture firms to seek massive exits. What happens when those already lofty multiples are rebased on a significantly higher initial investment valuation? It simply means that the size of the liquidity events required to achieve success are all that much larger.

The entrepreneurs are feeling it, too. Peter Delevett’s article in the San Jose Mercury News goes on to quote venture investor Craig Hanson: “In other words, too much money now makes it harder for the VC firms and entrepreneurs to strike it rich later.”

Swinging for the fences

IPOs are typically the best way for venture funds to achieve massive liquidity, but they remain elusive targets. Even when the IPO markets are working, there is a finite supply of companies that are suited to an IPO. Bruce Booth wrote a 2012 piece about venture capital, saying “… it’s not the lower frequency of winners in general, but the lower frequency of outsized winners, that has dampened returns in the asset class.”

This is creating a dilemma for venture capitalists. Their strongest economic imperative is to maximize the capital under management per partner. Success for most is more about raising and layering funds than generating income through carry. That’s not to say that they don’t hope for massive payouts from carry, but the changes in the market have made it increasingly difficult to achieve that.

Here’s a colorful way to think of it: the home run king is under pressure to beat a field of top-notch batters. But this season, they moved the fence out 100 yards farther than before. A miss is as good as a mile; the only thing he can do is swing with all of his heart.

For many venture funds, their singular goal is to invest in those very few mega deals that deliver crushing returns. Anything less simply won’t move the needle.

The future of venture capital

While venture capital is certainly here to stay, it’s clearly an industry in flux. Investors and fund managers are beginning to adapt. Meanwhile, exciting new models are beginning to emerge.

Venture capital is here to stay

Venture capital is by no means going away. It’s an important, multi-billion dollar industry, filled with talented, intelligent, and often charismatic people. Many of them are experienced entrepreneurs accustomed to dealing with change and uncertainty. The likelihood is that they’ll figure out a way to thrive, and that in turn implies that they will be able to continue to make money for their investors.

There are also some trends that will likely change some of the industry dynamics for the better. Those include:

• While the past 10 years have been bitter for many venture capitalists, there is recent evidence of an upward trend.
• The overhang in LP capital commitments is mostly worked out, and there is some evidence capital inflows are moderating to a more sustainable pace.
• The NVCA estimates there were 462 active US venture firms, down from 1,022 in the bubble of 2000; that is likely a reduction to quality, and a more appropriate overall market size.
• There is evidence that the IPO markets are reviving, improving potential liquidity opportunities.
• The underlying value created by many venture investments is real in a way that probably wasn’t true to the same extent during the dot-com era.
• There is evidence that LPs are focusing more on track records of the actual investing partners, which is probably a more efficient rubric for selection.
• There is some evidence that GPs are willing and interested to engage in a dialog about how to evolve the economics and structure of their funds.

But it is an industry in flux

I think Wade Brooks sums it up nicely in his TechCrunch article when he says, “early stage venture investing does not occur in an efficient market.” Returns to investors over the past ten years have been inadequate, and the Limited Partners are beginning to change their behavior. And the fundamental economics will not be tenable for many funds; I expect continued fallout, and further winnowing of funds.

New models emerging

Perhaps most importantly, there are new investment models emerging. These may be hybrid models where venture capitalists add value in new ways, such as Andreessen Horowitz. Or, in the case of 500 Startups, revolutions in the ways that professional investors select and invest in companies. In some cases, it may be fundamentally different approaches to investing, such as crowdfunding. Meanwhile, we can’t forget Angel investing, which offers the chance to capture enormous value, albeit with certain caveats.

And, of course, there’s the new approach that we’re taking here at Founder Equity, which we believe offers the chance to create more value, more quickly, and with reduced risk. We look forward to sharing more with you as we continue our journey.

By Joe Dwyer

The LSE made Syndicate Room Ltd. a member of the exchange on Monday, allowing the startup’s customers to invest in IPOs and private share placements.

The move, the first of its kind in the U.K, aims to democratize the process of investing in companies coming to market in a response to criticism from smaller investors that they are often frozen out of these deals in which shares are often sold at a discount.

Depending on the IPO, Syndicate Room could allow investors to put sums of a few hundred dollars into listings via its website.

Other exchanges are already in on the act. In Australia On-Market Bookbuilds flags upcoming IPOs to members who can participate. Last year J.P. Morgan Chase & Co. and Motif Investing Inc., an online brokerage, joined a program to allow individuals to invest as little as $250 in IPOs.

The battle to open up the U.K. IPO market could prove long. Currently only a few initial public offerings include a tranche reserved for retail investors. Previous efforts to draw in a wider community of investors during the dot-com boom floundered as smaller investors lost money on sinking stock prices.

The U.K.’s Conservative government is trying to rekindle former Prime Minister Margaret Thatcher’s vision of a shareholder democracy. Thousands of retail investors bought shares when the government privatized various U.K. public companies in the 1980s.

That enthusiasm for IPOs hasn’t lasted. Some 12 million people in the U.K. population are estimated to own shares, but more than three quarters of those didn’t take part in initial offerings of stock last year, according to Syndicate Room. The U.K. government hoped to sell shares this year in Lloyds Banking Group PLC, one of the U.K. lenders bailed out in the financial crisis, but it has postponed the plan given volatile markets.

Some British executives and academics have called for better use of new technology to widen access to IPOs.

The traditional IPO process is “preindustrial,” Paul Myners, the former financial services secretary to the U.K. Treasury said last April.

There hadn’t been much technological innovation in IPOs because “entrenched interests” were resisting change to a business model that suited them, Mr. Myners said. “Too many people’s rice bowls are at risk,” he said.

By Max Colchester and Simon Clark of WSJ

1) Leverage technical assistance (TA) facilities to build the pre-investment pipeline:

More pre-investment support is required in order to to develop a strong pipeline of investable opportunities for businesses; TA funders like USAID and DFID are recognising the importance of getting companies to the point where they can successfully raise capital.

The report says: “Targeted, tailored support requires an upfront commitment of resources but has proven effective in preparing potential targets for investment and in building high-quality deal flow. This process can also dramatically reduce diligence timelines if the investor is able, before investment, to increase familiarity with and visibility into a business.”

2) Develop sector specialisation:

Impact investors can also drive growth, impact and solid returns by narrowing down their focus on sector-specific portfolios. This has enabled some to use their existing knowledge to target some less well-known opportunities earlier and also to reduce diligence timelines.

The report expands: “Sectors such as agriculture, energy, and financial services present large opportunities where different companies often face similar challenges; learnings can be shared across portfolio companies.”

3) Expand investment instruments:

There is a rich variety of early-stage businesses in the Southern African ecosystem – structured investments (for example: milestone-based conversion and profit-sharing debt) can fulfil a significant need for financing that more conventional equity and debt deals cannot.

The report says: “Such creative structures can help entrepreneurs meet their ongoing cash-flow requirements while delivering long-term returns in line with investor expectations.”

4) Establish local presence:

Locally-situated impact investors across Southern Africa have reported gaining a markedly significant advantage in their ability to source investment opportunities, in an environment that typically lacks investable businesses.

“Currently, only a handful of impact investors have staff in the region outside of South Africa, and limited impact capital is available there. Locally-based impact investors will be able to identify opportunities more easily and will incur fewer costs than investors operating with a fly-in, fly-out model that may require multiple trips in order to perform due diligence and manage the portfolio.”

By Nye Longman

Crowdfunding: a big deal

“Global crowdfunding was more than 30 billion euros last year,” Lasse Makela, CEO of the Invesdor crowd-funding platform, told euronews’ Serge Rombi.

“It’s growing by more than 100 percent per year. And it’s going to be larger than venture capital financing this year.”

Crowdfunding puts sparkle in drinks company

In the autonomous Aland islands in the Baltic Sea, a family-run SME produces 100 percent natural lemonade, using only local products.

In 2014, Tony Asumaa – founder of Amalias Limonadfabrik – realised that he needed to expand production and he immediately opted for crowdfunding.

“We chose crowdfunding because it was cheap, efficient, fast and, above all, non-bureaucratic – to get new capital into the company,” he said.

Through Lasse’s platform, Tony won more than 86-thousand euros in equity crowdfunding.

In other words, those who invested in his company are now shareholders.

“We have 163 new shareholders. As our ambassadors, they promote our products, they sell them. Some restaurant owners sell products throughout the country,” said Tony.

Thanks to the fundraising, Tony Asumaa will soon automate part of his drinks production.

He wants to drive up sales from 90-thousand to 200-thousand euros.

For Tony, it’s given his SME new impetus, but it’s a way of boosting the regional economy too.

“The most important thing for us is to use local, raw materials, fruits and berries,” explained Tony.

“We export 40 percent using local transport services and we’ve created new jobs for young people here, on Aland.”

How do you seal crowdfunding success?

Lasse Makela said Tony’s success is down to a “good idea.”

“He had a good team behind him, and then there was some growth potential for the business. But also willingness and resources to do a good marketing,” Lasse added.

Serge Rombi, euronews: “Lasse, there are 600 crowd-funding platforms in Europe. Yours is the largest in the Nordic countries. How do you choose the right platform?”

Lasse Makela: “Well. It’s really about the experience. Choose the company who has a lot of transactions in the past. But also, it’s about the licences. Choose the company who has the proper licences. And this can be checked by the local authorities of that country.”

And if you want to learn more about the different forms of crowdfunding – both the benefits and risks – there’s a European practical guide online and free.