Paul Graham, the founder of the highly influential Y Combinator accelerator program penned arguably his most famous essay in September 2012. In this essay, titled Startups = Growth, Paul Graham argued that startups are built to grow fast. “Being newly founded does not in itself make a company a startup. Nor is it necessary for a startup to work on technology, take venture funding, or have some sort of “exit”. The only essential thing is growth.” he argued. This mantra of hyper-growth is something that startups worldwide have followed to the dot, raising millions of dollars to capture as big a market as possible in the shortest time available at the expense of profitability.
But in 2022 and 2023, startups are retreating en masse. In December 2022, Uganda’s ride-hailing giant Safeboda announced its exit from the Nigerian market to focus on its core market of Uganda as it pursues a path to profitability. In a conversation with TechCabal, the then co-CEO Alastair Sussock said the margins on the okada (motorcycles) business in Nigeria “were too thin”, while the Uganda unit was “moving quickly to profitability”. In an ideal startup world, Safeboda would have ridden out the thin margins in Nigeria but due to the prevailing market conditions, they called it quits.
In April this year, Copia Global, an e-commerce startup, also announced its exit. This time around, it was the Uganda unit that they were winding down, leading to a loss of 350 jobs according to Bloomberg. Copia decided to focus on its core Kenyan business. “This is the right move for Copia given the market environment,” the company’s Chief Executive Officer Tim Steel told Bloomberg. “By focusing our resources on our Kenyan business, we can assure short-term profitability and long-term success. This means pausing our international expansion plans, including suspending our Ugandan operation.”
But it isn’t just Safeboda and Copia Global that have scaled back. Nigerian digital bank Kuda, Mobile Money challenger Wave, cross-border payments app Chipper Cash, fresh produce startup Twiga Foods, and Kenyan delivery startup Sendy have all announced cost-cutting measures, including laying off employees and exiting markets. So why are startups scaling back? Isn’t growth by all means no longer needed? We can not rule out bad business practices and short foresightedness on the side of the startups, but for this explainer, we will focus on the “given market environment” something that both Safeboda and Copia Global, (and many other startups), cited as they exited the markets.
Enter Venture Capital.
For startups to be able to grow as quickly as they want, they need to raise funding. And for the majority of the time, they turn to venture capital (VC). VC firms furnish the startup with the funds to cushion the losses (that is the startups are able to spend money they don’t actually make). The VCs take equity in the startup and hope that it will capture a big enough market share and then turn profitable in the future. Essentially, what this means is that the ability of startups to grow as quickly as they want is directly tied to the availability of VC funding. And in 2022 and 2023, VC funding, especially for the later funding rounds has declined sharply.
How has VC funding declined?
To understand how VC funding has declined, we will turn to data from CB Insights, a data and intelligence startup in the USA that tracks global VC funding. In 2021, VC funding was a red-hot market. A record $681 billion globally was raised by startups as low-interest rates and a historic public bull market made the year an outlier. VCs threw caution to the winds and funded almost anything that came by as they fought to back the next big thing in what was dubbed as the “new normal” post-Covid (Do you remember those hyper-quick grocery delivery startups?). But it all came crashing down in 2022 in what the Morning Brew, a US-based daily newsletter publication, described as a “simple correction following an irrationally exuberant year”.
VC funding fell by 35% to $445bn in 2022 and the market correction has since shown no signs of abating. In Q1 2023, startups raised just $58.6bn, a 13% Q-O-Q decrease from Q4 2022, and a 61% Y-O-Y decrease from Q1 2022. Funding dropped in every region with the USA (-1%) faring better than all the other regions. Africa (-30%) and Latin America (-54%) were the most affected.
To further expand on the decline in VC Funding in Africa, we will cite The Big Deal, a database that captures publicly disclosed deals or deals openly shared by the investors or the founders themselves of African startups. The database captures deals of $ 100K+ since 2021, after capturing deals of $500K+ for 2020 and deals of $1M+ for 2019. The Big Deal and CB Insights track their data separately and sometimes, this brings disparities in the figures. For example, CB Insights put African 2023 Q1 funding at $0.7 billion, while The Big Deal reported $1.3 billion.
As per the Big Deal, African start-ups raised $1.3bn in Q1 2023, a -29% decline Y-O-Y. Without exits (In the startup world, an “exit” refers to the event where the original investors or founders of a company sell their shares, typically through an acquisition or initial public offering (IPO), resulting in a financial return on their investment), funding declined by 52%. The number of deals of at least 100k+ fell by half from 300 to just 150, which is the lowest since 2020 a year ravaged by COVID-19. Also, in the month of March 2023, only $66m was raised, the lowest monthly amount in 2.5 years.
The decline in funding can not be only attributed to the exuberant 2021 funding. So many other factors have contributed to this. The economic downturn ravaging the globe has led to a crash in public markets like the New York Stock Exchange. Global inflation has also led to central banks all over the world raising interest rates which makes investment not favourable hence VCs investing with even more caution as they wait for the conditions to improve. Also, the Russian invasion of Ukraine in February 2022 created unprecedented geopolitical tensions since the end of the Cold War.
However, this is not the first rodeo for tech startups when it comes to difficult market environments. In 2000, the dot com bubble burst with multiple startups closing shop. But the industry recovered, until the 2008 Global Economic Crisis driven by the housing market in the USA. But this didn’t devastate the tech sector as much as the 2000 dot com bubble. Startups also went through a funding bust in 2020 when Covid-19 wreaked havoc. Many startups like Airbnb and Uber saw their valuations and revenue disappear as people were forced to stay home. On the other hand, startups that propagated the COVID-19 environment like Zoom saw an uptick in their fortunes.
So how does this affect African/Ugandan startups?
Uganda, just like many other African countries has very young private markets. Venture capital, as an investment class, is almost non-existent especially when a startup needs to raise funding rounds of over $100,000. So they turn to the West. For example, Safeboda raised an undisclosed funding round in December 2022 just before it exited the Nigerian market. Its investors in this round were all based outside of Africa. The lead investor Yamaha Motor Company is from Japan, Unbound is based in London, Allianz X is in Europe while JAM Fund, headed by Tinder founder Justin Mateen is based in Los Angeles. Essentially, this means global trends trickle down to African startups. When the West sneezes, we catch the cold.
So what do investors do in an economic downturn?
In an economic downturn, investors ask their portfolio companies to cut back on unnecessary expenditures and increase runway. (Runway in startups refers to the amount of time a company has before it runs out of cash, based on its current burn rate and available funds. For example, if a company has shs 10 million in the bank, but spends shs 2 million a month on expenses without making any profits, its runaway will be five months.) This is well explained by famed Silicon Valley VC firm Sequoia, which has correctly predicted and warned startups of tough times before in both 2008 and 2020.
In a presentation titled Adapting to Endure, Sequoia asked its portfolio companies to take a “hard look at how they’re spending their money, and if necessary, cut back on research and development (R & D), marketing and projects that aren’t essential”. And it is not just Sequoia, Y Combinator sent an email to its founders with an apt message, “Regardless of your ability to fundraise, it is your responsibility to ensure your company will survive if you cannot raise money for the next 24 months.”
Essentially, investors are asking startup founders to increase runaway. To increase runaway, startups have laid off many employees. In 2022, startups globally laid off about 100,000 employees. In Uganda, Safeboda and Wave all announced layoffs. But in 2023, over 130,000 workers have already been laid off in just four months.
Another way to expand runaway is to exit supplementary markets (Nigeria in the case of Safeboda and Uganda in the case of Copia Global) to focus on their core markets (Uganda in the case of Safeboda and Kenya in the case of Copia Global) where these startups have already committed a significant amount of resources and are probably performing better than the supplementary markets. Hypergrowth is a cash-burning procedure, and it isn’t feasible in the current markets.
In any case, there are not so many VCs willing to fund cash-burning hypergrowth now. Founders who have expressed frugality will however be very attractive to VCs. The metrics needed to raise such funding are now tougher than before, and most VCs would rather double down on portfolio startups to cushion them through the downturn. (Three of the four investors in Safeboda’s recent round were already existing investors.)
An argument can be made that Copia Global had also raised $50m as recently as January 2022. Some of this funding was allocated to their Uganda expansion which was already in motion. They also planned to raise as much as $100m to continue the expansion to West Africa as well. But it is normal procedure in the funding world for the startup to receive this amount in instalments, and sometimes, tied to meeting milestones. It is logical to assume that some investors in Copia may have scaled back on meeting such commitments as the downturn gets worse. Copia may still be able to receive this funding in the future if conditions get better and that is why its CEO Tim Steel was optimistic. “We will work hard to reach the point when we can restart our PanAfrican plan,” he told Bloomberg.
What’s Next?
The economic downturn shows no signs of slowing down. In fact, as per funding data, it is getting harder to raise funding. In April, just 20 deals of at least $1m+ were recorded which is half of what was recorded in April 2022. The $130m total amount raised in April 2023 is less than both totals of April 2022 and 2021. As it gets harder to raise funding, there will be more startups exiting markets and laying off workers to maximise runway.