From Here Ventures - Annual Investors Letter, 2022
Sharing our Annual Investors letter from January this year.
TL;DR: main take-away from this letter, we are localizing our approach to venture investing in Africa to align with ground truth and see a viable path to a 3-4x return.
While it may not feel like it, the demise of tech is premature and overstated.
AI is finally here, and promises to be the most transformative technology in recorded human history if we can harness it right. How will AI play out in Africa?
That is anybody's guess, but given the continent's structural and institutional gaps the opportunities for impact are significant.
To more immediate matters, in my first Annual Investors Letter I would like to share our fund activities, concerns, opportunities and paint a picture of the way forward.
Agenda
General Market Insights
Fund Activity
Detail & Data
Portfolio
Concerns
Problem: Talent Gap
Solution: Startup Talent Network
Localizing our Strategy
Fund Size
Evolution in VC
Why Localize?
Unicorn or bust?
Power Law or nothing?
Baseball VC
Projected Returns
Portfolio Construction
Proof points and Comparables
Conclusion
A) General Market Insights
Funding slow down maps to ground level reality in this market where until the recent entry of VC an efficient path to sustainability has always been the #1 goal and a sign of scrappy, capable, clear minded entrepreneurs
The quality of founding teams is improving with more second time founders and experienced operators taking the plunge
Asian capital increasingly active in Nairobi (Japanese corporate venture, Chinese, Singaporean and Japanese backed funds)
Local capital increasingly interested in venture which bodes well for the future of the ecosystem
Talent continues to be a challenge accelerated by global competitive forces aggressively tapping Africa for its human capital
Disjointed, immature capital markets present opportunities for innovation and capitalizing on whitespace
To be effective VC needs to map to local realities and avoid copy & paste models
B) Fund Activity
We made our first investment in June of 2022 and currently have a portfolio of 5 investments with a goal of 7 by the end of Q1. This amounts to a pace of approximately an investment every 6 weeks or 8 annually. Measured, yet steady.
Fund Detail
Capital - 2.4M
Called - 1.2M
Invested - 800K
Portfolio - 5
Average check - 160K
Stage - Pre seed(3), Seed (2)
Instrument - SAFE
As you might expect, all investments have been done through standard SAFEs at Pre-seed and Seed stage and therefore IRR and other fund level performance data is premature.
However, individual company performance data is available in summarized fashion below.
Portfolio Data & Details
Below are individual company leading indicators and some performance related data.
Lipa Later: leading BNPL player in Sub Saharan Africa.
400% YoY growth between 2021 - 2022
Primary market profitable
Regional expansion to Uganda, Tanzania, & Nigeria underway
Rology: Cairo based HealthTech company bringing tele-radiology to Middle East and Africa
Regional expansion to Kenya, UAE and Saudi Arabia underway
Elevate HR: HR software platform startup with fintech strategy
Customers - 10
Q1 sales pipeline - 20 (prospects)
12 month sales pipeline - 180
Strategic advantage: proprietary community of 650+ HR professionals growing 5% MoM powerful asset for brand equity and accelerating sales pipeline
Shukran: Fintech cultivating a tipping culture as a gateway to expanded financial services to an underbanked market segment.
450 users growing 10% MoM
Onboarded 10 restaurants with TAM of 500+ in Nairobi alone
Pursuing PMF with strong stakeholder interest and engagement
Kinetic Education: Edtech startup providing an immersive entrepreneurship training platform to high schools.
Customers - 1 (flagship customer is well recognized private school with regional footprint across Kenya and South Africa)
Q1 sales pipeline - $10,000
Beachhead market - 65 high end private schools in Kenya
Good timing:
Government policy in Kenya shifted towards practical learning programs designed for skills acquisition
Education buyer (parents) increasingly demanding practical learning and critical thinking skills from education programs
Capital Call: Next capital call is planned for March 1st 2023
C) Concerns
Talent Gap
The Principal-Agent problem is quite pronounced. Side hustle culture is entrenched in the local psyche accelerated by work from home during the pandemic.
Employees optimize for immediate payoff above all other considerations such as equity, gaining experience, or career growth. Gen Z’s expectations of overnight success is proving problematic for continuity.
Most reliable mechanism for attracting and retaining talent is paying top tier market rates which puts local startups at a disadvantage as competition is now global in scope with Big Tech and better capitalized startups from abroad mining Africa for talent.
ESOP is not yet broadly appreciated as a valuable component of an overall compensation package.
On the positive side, Nairobi’s vibrant tech hub is growing fast and the population of startup-exposed professionals making commitments to the sector is increasing.
Solution: Startup Talent Network
Recognizing the crucial need for talent we saw a need to build a community for startup professionals. Today, Startup Talent Network is a Slack based community with 218 members growing 10% MoM and already proving useful to our recruiting efforts.
D) Localizing our Strategy
Fund Size
TD;DR: we are adjusting our investment approach from a valuations driven model to a liquidity via company profits model and reducing our fund size to $5M
With the changing market conditions fundamentals are back in vogue which aligns very well with my view of what entrepreneurship should like especially in Africa.
When we started on this journey the target fund size was $15M and so far we have raised $2.4M with additional commitments getting us to $2.9M this quarter.
Market conditions have impacted our fundraising velocity while at the same time significantly slowing the pace on the investing side. Prices are much more realistic which means opportunity can no longer be gamed, but must be earned.
As a result, I no longer believe we need to raise a $15M fund to be effective and we are adjusting our fund size to $5M and extending our final close to December 31sth 2023.
This adjustment maps well to the roll up your sleeves venture building approach I believe in. A smaller fund allows us to concentrate our efforts around a tighter portfolio where we can support founders with the capabilities we have built such as recruiting, go-to-market, and fundraising.
Evolution in VC
After many years of dogma the venture industry is embracing new ideas for doing what it does which is long overdue.
In 2021 Sequoia announced an historic shift that enables them to play across the capital stack from Seed to post IPO, holding long term positions in their publicly listed portfolio companies.
Angellist have popularized rolling funds, opening the industry to fund managers and investors who would never have otherwise had access.
In an eye opening episode of the popular 20VC industry podcast Martin Casado, former founder and partner at Andreessen Horowitz had this to say:
“Venture investing is now a mature asset class like real estate with more predictability and less randomness of outcome and VC needs to grow up to this reality”
Why Localize?
Africa is nothing if not complex and unforgiving. Capturing value here requires a grounding in how things work here. The most effective players are those capable of evolving their ideas to fit local context.
Venture is no exception and the funds that will be successful in Africa will need to map their approaches to fit local context and in a world where value and fundamentals are more highly scrutinized, digging deep to ensure those are present is necessary.
Unicorn or bust?
Traditional VC requires certain preconditions to work; large, homogeneous, regulatorily harmonized markets capable of supporting high velocity scaling along with mature private-to-public capital markets for funding that growth. Current market corrections notwithstanding, these are the preconditions necessary for birthing Unicorns.
The reality is most of the world does not look like this.
Global markets are composed of balkanized, country bound markets where scale means crossing borders into different regulatory regimes, cultures, and ecosystems, which invariably tempers growth and will often be at odds with the expectations of go-go high velocity, scale-at-all costs venture capital.
Does this mean that venture capital is not viable in these markets? Not in the least.
Not every investment has to be a Unicorn to post returns. With the right approaches there are significant opportunities to be had and I believe there exists an opportunity for funds in emerging market funds to outperform their mature market peers.
Power Law or nothing?
Traditional VC subscribes to the Power law dynamic where a tiny minority of investments are relied upon for a fund's returns. A winner take all mindset is the basis for this strategy.
Around the world, tech businesses can do quite well by winning an individual country market but not be anywhere near the $10M MRR Unicorn level numbers.
Traditional VC would pass on such opportunities because they do not pass the industry's Rorschach test question; Could this investment return the fund?
Investing in an early stage SaaS business offering a product in a specific country market with a 12 month path to profitability requires a different mindset and strategy than Power Law thinking.
In Africa, revenues and not valuations are the one truly reliable yardstick for assessing value. Monetization here is hard because people do not part with money as easily as they might in markets with higher levels of disposable income.
Baseball VC
We see an exciting, under-recognized opportunity in tech entrepreneurship for incorporating company revenues as an alternative path to liquidity.
Companies with a 12-18 month profitability time horizon with strong margins that allow for a path to liquidating our position from profits is the sweet spot.
To make this work we employ the Shared Earnings Agreement which is analogous to a convertible note with some adjustments.
This approach changes the qualifying criteria for deals, terms, and most crucially the risk and return profile of each individual investment and by extension the fund itself.
We recognize this will not work for all types of startups. There will be those who need to invest in building their assets with a longer term horizon before cash flows and profits can kick in. We will continue to invest in the most promising of these via the standard instruments like SAFEs and priced equity rounds.
The ratio between these two types of investments will be in the 65/35 range.
I call this approach Baseball VC because portfolio construction and deal structuring are analogous to how a baseball manager would think about winning the World Series; optimizing for base hits and singles while keeping an eye out for occasional home runs.
I believe this is how any grounded, hard working fund manager should approach venture investing in Africa.
Projected Returns
With this approach we see a viable path to a 3-4x return over the 10 year fund life with the keyword being recycling.
We expect a 2.5x return from 60% of the portfolio in the initial 5 year investment period affording us the luxury of recycling those earnings into a new batch for a second 5 year cycle with the same 2.5x/60% return profile ultimately positioning the fund in the 4-5x return window. Pairing this down to 3-4x as the realistic target.
I realize this sounds outlandish, but what makes it possible are the huge structural gaps in Africa that impose significant market inefficiencies offering opportunities that in the developed world have already been competed-out or regularized.
Even as we liquidate positions we shall seek to retain a small stake of approximately 1-2% on cap tables for any possible upside.
Portfolio Construction
With a $5M fund we can invest $200k across 20 deals with the following structure:
65% Shared Earnings - 13
35% SAFE /Priced Equity - 7
Of course we analyze every situation on its individual merits before making a decision on investment strategy. We fully anticipate there will be cases where we chose to exercise pro rata to double down on emerging winners.
Proof Points and Comparables
Over the past two decades the top performing capital deployers in tech have been Vista Equity Partners and Constellation Software, both who employ differentiated approaches to tech investing with some overlapping themes.
Mark Leonard, Founder and President of Constellation Software started off as a VC pivoting to an acquire and grow strategy early because he could not see the venture model working in his home country of Canada in the 1990s.
Mark has grown an initial investment of $25M in a venture capital fund to a $1.73B in annual revenue, decentralized conglomerate and can be credibly accredited with unearthing VMS (Vertical Market Software) as an attractive investment class in tech.
I see similar dynamics and opportunities between Mark’s Toronto/Canada of the 1990s and the Nairobi/Africa of the 2020s from a tech opportunity perspective.
My number 1 priority is returning investor’s capital and this is what I think about and work towards everyday.
My 2nd priority is enabling entrepreneurs to build businesses that bridge gaps to unlock growth and development on this continent creating a virtuous cycle of innovation, entrepreneurship and economic growth ergo, Changing the African narrative.
I believe the imported traditional venture capital model restricts our ability to execute against these shared priorities leaving a significant untapped opportunity on the table.
E) Conclusion
Durable Opportunity
Despite looming concerns of a global recession, Africa remains a compelling opportunity for the traditional reasons including demographics, long tech runway and the huge structural & institutional gaps presenting white space to build into.
We know the prevailing economic conditions will come to pass and growth will resume. We know that tech will continue to lead the way in driving productivity and growth. We know that Africa possesses the largest opportunity delta than any other region in the world.
All things remaining equal, capital, energy, and know-how invested on this continent over the next few decades will yield some of the strongest financial, impact, and satisfaction returns.
Africa is the final frontier for global development and for those whose spirits yearn for adventure and impact, there is not a more compelling place to invest capital, time, passion and energy.
Africa = Growth!
Mark Karake, General Partner