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The Importance of Seed Funds in Emerging Economies Words by Jito Kayumba, Partner, Kukula Capital Zambia, since its establishment as a Republic in 1964, has been a beacon of peace and stability in Sub-Saharan Africa. This is an attribute that Zambians jealously guard in spite of numerous challenges, including being landlocked, geographically placed in the middle of numerous bordering countries who have been embroiled in civil and political strife. A peaceful and stable environment makes for an ideal setting for investment and economic development. Unfortunately, poverty levels, unemployment and infrastructure deficits remain high. This, however, is where the opportunity lies. Zambia has been almost entirely dependent on the extractive industry, with copper and other metals being the country’s largest revenue earner. The narrative is shifting as Zambia has evolved significantly into a liberalised economy with an aggressive economic diversification agenda being promulgated by the government and has been well received by the private sector. In this regard, small and mid-sized enterprises (SMEs) are increasingly seeking financial injection to scale up as well as integrate their respective value chains. There is also a burgeoning startup entrepreneurship scene that is evidenced by the enormous attendance at various entrepreneurship fora such as the Nyamuka Zambia conference, the Bongo hive launch accelerator events and other startup workshops. Banks and venture capital firms, such as Kukula Capital, receive a deluge of applications on a daily basis from start-up businesses seeking funding. The entrepreneurship spirit is undoubtedly palpable and there is certainly, need to create investment provisions for start-ups and early stage SMEs with low capitalisation requirements. Historically, Zambia has not been an environment where non-publicly listed asset classes have been acknowledged as viable vehicles to place funds for a reasonable yield. The risk aversion of capital market players has restricted their placements to publicly listed equities, bonds, real estate and money market instruments. This essentially meant that there was no capital available for start-ups without a financial track
record and collateral of value. This is understandable when one ventures into the psyche of an investor. Equity investors have two important expectations. The first is not to lose any money. The second is to earn a reasonable return on the risk. This means that they first assess the downside risk before assessing the upside. The methodologies of this appraisal includes an analysis of historical, audited financial reports, a check on good governance, market evaluation, validation of concept and the scalability of the value proposition, among other elements. The unfortunate reality is that start-ups are naturally unable to provide the requirements for appraisal. The other impediment to investment in start-ups is the statistical fact that over 80% of start-ups fail. In the last two decades, Zambia has seen a number of private equity investments take place, with notable ones such as Phatisa’s investment in Golden Lay, Oakfield’s Yalelo investment and Amatheon’s agricultural investments, among numerous others. What these deals have in common is that they exceeded $10m, the companies were not start-ups and the private equity firms are domiciled outside Zambia. With such activity, it gives way to an openness to look at SME investment below $10m as well as a reconfiguration of investment guidelines to include greenfield projects with heavy risk-mitigation provisions. Kukula Capital, having had over seven years of experience, investing in Zambia’s SME space, has noted the immense possibilities of start-up/seed investing. There have been cases where seed investments have resulted in extraordinary returns. The risk certainly corresponds with the reward. These cases had a number of elements that reduced the risk significantly. The first was that the seed investment fund took majority stake – control of the business. This involved meticulous market analysis, the establishment of a strong management team to execute and the installation of sound corporate governance from day one. The second was plugging into a sector where there were supply chain deficits and opportunities for import substitution. In these cases, there was sector validation and proof of market viability that further mitigated risk.