Ideas that matter: Venture capital in Africa needs to change
Africa has the world's riskiest startups but the most risk-detached funders
Oscar Wilde said that “an idea that is not dangerous is unworthy of being called an idea at all.” And across Africa, dangerous ideas might be exactly what we need.
This newsletter edition highlights one such dangerous idea about how venture capital in Africa operates.
It's 'dangerous' because it challenges established contours of the continent’s VC landscape that are often taken for granted.
The Big Idea: VC in Africa must become risk-aligned
“Africa has the most risk-detached funder ecosystem in the world investing in the riskiest startups in the world. This must change.”
That opinion from Stephen Deng, Co-founder & General Partner at DFS Lab, sparked an extraordinary discussion on LinkedIn between investors, founders, and ecosystem builders across the continent and beyond on venture capital in Africa.
(The post amplified this tweet Deng wrote in response to a recent tech summit in Nairobi.)
Key perspectives
1. DFIs distort incentives and slow ecosystem maturity
Deng argues that a lack of return-driven incentives in African VC means “funds are getting re-upped by default.”
“We’re seeing non-competitive DPI overall as an ecosystem for many vintages deep into their harvesting periods. AUMs are still rapidly growing on outdated marks. The portfolio construction math doesn't make sense many times given where markets are moving.”
He clarified that his critique isn’t about DFIs themselves, which he agrees are “critical members of this ecosystem,” but rather about “how we structure incentives in those institutions and beyond.”
“In my opinion, there’s only one way that global capital flows increase to African VC — and that is if the upside justifies the risk... The only way that capital flows into this geography is if upside discovery is de-risked instead of just downside protection.
The assumption that private capital will flow into VC if we just protect their investments is faulty. This is a game of power-law driven exceptions and the winners have to really win. Building a world of slightly softer losses doesn't move the needle — hence my point on ‘brutality.’”
Hope Ditlhakanyane supported this need for ‘brutality,’ noting:
“Many startups are comfortable in ‘the middle,’ neither growing nor dying fast enough. We’re also not more rigorous (or honest?) about which business models are best suited to VC model and required returns versus which aren’t.”
Florent Nduwayezu provided a striking data point:
“In developed markets, VC-backed startups fail fast; about 50% shut down in the first few years. In Africa, it’s different. In Kenya; where most VC money goes; only 24% of startups fail early.
Instead of failing, many startups just survive without real growth. DFIs fund most VC firms, but their focus isn’t on big returns. Less focus on financial sustainability, more attention to impact-driven metrics, an overemphasis on visibility and ecosystem engagement, less sense of urgency.”
Shingai Samudzi shared this experience:
“I’ve had one African VC pull out in the 11th hour of diligence because, while I have two parents born in Zimbabwe and 3 of the 5 members of my team are also African nationals, I have a US passport.
They loved the economics, the team, the business model. But their LPs required all founders to be ‘African’ by their own arbitrary definition. The investment criteria is sometimes more about [something else] rather than funding the absolute best venture scale companies.”
2. DFIs provide essential capital that wouldn't exist otherwise
David van Dijk asked a practical question:
“What if the commercial investors don't step in? ... Without the DFIs, there wouldn’t be much left.”
He added:
“I fully agree that the model is abnormal and far from ideal. There is a difference between a government’s approach to risk and return versus a fund manager’s, who is mandated to make high-risk investments. And I agree this will have side-effects.
If your LP never talks about returns, then yes, [returns] will probably go down the priority list. So, I fully agree with Stephen… [But] until we start attracting commercial investors and unlocking local capital, we make do with the capital available… Don't throw the baby out with the bathwater.”
3. The real challenge is in the operating environment, not (just) capital sources
Emna Jabri highlighted a more fundamental challenge:
“The elephant in the room is not DFIs that sometimes prop-up weaker businesses. The bigger challenge is that doing business in most African countries is just harder than in VC funds’ usual preferred markets…
That’s why international VCs often avoid African markets — not because they don’t see the opportunity, but because these factors, when plugged into their risk-return analysis, make many African businesses look unattractive.”
She added:
“Western investors expect African markets to attract capital and provide VC attractive returns without the same mechanisms that make their own markets investable. DFIs currently fill this role, not to eliminate risk for VCs, but to create the conditions where investable businesses can emerge.”
Cheryl Wang points to another underlying challenge:
“The root cause is the undeveloped financial markets. How else will VCs see their returns if they don’t have a viable exit? It explains why the African ecosystem remains reliant on DFI money.”
4. Local capital activation is key
Iyinoluwa Aboyeji emphasized the role of local capital:
“The reality is that local angels built and funded the African tech ecosystem, especially in Nigeria, and then global funds amplified already existing success. It wasn't DFIs…
If you think about the funder ecosystem as DFIs and the tiny proportion of VCs they back then sure [this is a problem] but in reality the true funder market is largely comprised of local and diaspora angels who are the most risk-aligned and consistent, but are unfortunately typically crowded out by global funds and DFIs who distort the market for extraneous reasons…
Our focus as an ecosystem should actually be on how we can mobilize local capital by giving angels downside protection. There are many ways to do this but we need governments to actually do their jobs and put on their thinking caps. Sadly its much easier for ecosystem players who don’t want to compete in the market to just guilt governments into giving them money in the name of funding startups rather than to do the hard work to create a proper market for angel investing.”
He added:
“Many big professional LPs … won’t bother with Africa because the entire GDP isn’t even the value of one FAANG… Instead of wasting our time with all that, it might be much wiser to deepen access to local capital.”
5. Venture capital as an asset class is brutal by design
Tayo Akinyemi asked:
“What specific problems does the ‘brutality’ of risk-aligned VC solve? Is it what enables healthcare, energy, food, education and financial services to get delivered cheaply and equitably? Is it what spurs founders to these outcomes profitably? Is it the return expectations of funds invested in African opportunities and their LPs? Do all three get sorted if VC is more brutal?”
To which Stephen Deng responded:
“[There’s an] inability to discuss [this] with honesty because the incentives don't encourage it. These social outcomes matter, but VC doesn't have to be the only tool, and when it is, the pre-conditions of success need to be there.
Simply: venture capital is not an asset class that can justify itself by the cost of risk which is what ZIRP showed us. It must justify itself by the upside on risk. Hence how brutal it will be in our context.”
Spicy takes
“Everyone seems to be copying the VC model without questioning if it’s truly relevant for all the kind of business models and industries that we need in the next 25 years to support our demographic boom. We won’t be solving our problems and creating a path to prosperity only by investing in some fintech and climate-tech male founders in Nigeria and Kenya.”
“DFIs give their money to bankers to invest in startups. They don’t know how to help the startups or have an intuitive feel for products. There is a complete lack of real risk taken that is similar to how Silicon Valley and Silicon Hills were built in the USA. Their ‘desriskiing’ is paperwork only.”
“The most (only?) successful African VCs that I can think of have no DFI backing (4DX, CRE, Oui Capital, LoftyInc — until fund 4).”
“Kenya can be venture viable but the mzungus are crowding [local founders] out with DFI money.”
“DFIs and large foundations rarely do anything bold. They can’t disburse because they need another 100k USD week-long strategy event in a fancy hotel whiteboarding ‘youth employment.’”
“VC funding in Africa is a warm but worthless blanket we keep consoling ourselves with—while being left behind technologically, time and time again… There’s a place for it, but it needs to be balanced with other investor profiles that actually push the ecosystem forward.”
Last word
“Oversimplification is the enemy,” as Andile Masuku noted.
And indeed, Africa’s venture capital ecosystem needs more nuance than a single post can provide.
The discussion here reveals that misaligned incentives are one of several interrelated challenges facing the continent’s VC landscape, including:
Capital sources: DFIs provide essential funding but with incentive structures that may not always drive optimal outcomes
Local capital activation: The disconnect between African capital and startup investing represents both a challenge and opportunity
Market realities: The fundamental realities of operating in many African markets should not only be reflected in founders’ business & operating models but in investor thesis and portfolio construction approaches as well.
No single intervention can transform the ecosystem, but more honest, public conversations about incentives, risks, and returns — like the one Stephen Deng initiated — are essential first steps.
What's your experience?
Investors: What’s your gut reaction to this big idea?
Everyone: Are the continent’s startup ecosystems better served by reforming DFI incentives, activating local capital, building more exit pathways, or something else entirely? Where would you focus efforts?
Leave a comment with your thoughts, or join the conversation on our LinkedIn page.
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Awesome read, would have been nice to get perspectives from more founders especially active ones. My 2c , DFIs and similar institutions i.e those that exist because they have a social mandate are a key component for venture development in Africa. We also need to interrogate the “outsized returns” expectation that is typical of VC , is that what Africa needs to develop?