Rows of white faces stare out from the social media meme showing tech start-up executives circulating among young Kenyans, who are angry that foreign entrepreneurs attract more capital than they do.

A young Kenyan entrepreneur, almost in tears, told us she needs a white face to front her start-up if she is going to raise capital. Village Capital found that 90% of the capital invested in East Africa in 2015-2016 went to a very small group of expatriate-founded businesses.

This is Africa in 2019. What is going on?

Image: Village Capital

The impact investment field is now valued at $502 billion per year, according to the Global Impact Investing Network, and is a growing source of finance for businesses of all kinds in Africa.

However, there are many issues on the ground that means that capital is not necessarily reaching the most impactful business models and that the promised returns may not be realised. There appears to be a gap in understanding between foreign impact investors and local entrepreneurs that needs to be bridged if capital is to be allocated to locally-founded businesses with long-term growth potential.

So what is going on? The vast majority of impact investment firms operating in Africa source funds from outside Africa and most make investment decisions outside Africa too. Recent evidence suggests that the biases and behaviour of foreign impact investors may not lead them to investing in the local entrepreneurs with the best chance of long-term financial success and social impact.

A growing backlash

There is a growing backlash against impact investors among local entrepreneurs in Africa, who are becoming increasingly frustrated at the bias investors have shown in favour of expatriate-founded business.

Often expatriates bring northern business models to the south, but may fail because the founders lack understanding of the practical and political realities on the ground.

Furthermore, the vast majority of these foreign start-ups are focused on a narrow sub-sector of industries, with ICT as the main feature of what are perceived by investors to be exciting and innovative business models.

While the application of ICT across a wide range of sectors in Africa, particularly financial services, can have a big social impact, this investor bias excludes other, more conventional sectors of the economy, viewed by local entrepreneurs as having more relevance and significant long-term growth potential and social impact.

The impact of these biases is that expatriate-founded businesses attract most of the capital and, as a result, grow faster than businesses started by local entrepreneurs who lack capital. This self-fulfilling cycle gets accentuated by new entrant investors following the crowd and adding capital to a handful of “successful” businesses.

Why investor behaviour matters

Discussions with entrepreneurs in the Ashoka network in East Africa, and a survey of members of the Schwab Foundation for Social Entrepreneurship, have highlighted several areas of concern in the way that impact investors behave towards entrepreneurs and the terms they offer.

Experience suggests there is a need for much greater knowledge of local markets and a need for greater transparency in their interactions with entrepreneurs, if capital is to be allocated efficiently and effectively. Some areas of concern are highlighted below.

Impact investors often do not have any funds to invest but do not tell entrepreneurs they don’t have any money

Investors are frequently fundraising, but most do not tell the entrepreneur that they do not have funds available and will have to raise capital before they can actually invest. Many of these investors are seeking a pipeline of projects to aide their fundraising and use business ideas from contacts with entrepreneurs, often without their permission.

Entrepreneurs can waste a lot of time engaging with investors, believing that they are able to invest, when they do not have any funds. The time entrepreneurs waste on what may turn out to be a wild goose chase, can damage the business itself and leave entrepreneurs exhausted and frustrated.

Most impact investors seek commercial returns and few, if any, make an explicit trade-off between commercial and social returns

Impact investors offer entrepreneurs access to capital they would otherwise not be able to source locally. Impact investors may accept greater risk than more conventional investors by offering unsecured loans and early stage equity investments, often without a clear exit. However, most still seek commercial returns on the capital they invest. This is often not clear to local entrepreneurs, who understand the daily trade-offs they make in building a business addressing market failures that delivers measurable social impact.

Innovation attracts funds regardless of local relevance

To attract early stage investment, the local entrepreneur’s business must now be perceived to be highly innovative, typically involving the use of ICT, often combined with a northern business model. Conventional ‘bricks and mortar’ businesses are looked down on and are hard to sell.

Most investors do not have a clear investment process

The process of moving from first engagement to disbursement of funds can be lengthy and time-consuming for busy entrepreneurs struggling to manage a young, growing, business. Entrepreneurs have to spend time informing the foreign investor about the market and their business which can significantly distract from running the business itself. This can be very damaging to the business during the process of fundraising and can even reduce the value of business itself.

An example of excellent behaviour was an investor who reviewed a business plan, together with detailed financial projections, took it to their investment committee who decided not to invest, all within 6 weeks. The key here was that the locally-based investment professional had worked for years in that sector and understood the value of the business and was keen to invest; but his colleagues outside Africa did not.

Investors lack staff who have hands-on business experience

Entrepreneurs often receive advice about how to run their business from staff of impact investors who have never run a business themselves and who may have little knowledge of the local market. Entrepreneurs frequently complain that they have been asked to change their business model (route to market, product range etc) against their own business judgement, or invest in new staff as a condition of investment, but with no guarantee of securing the investment. Many have made these changes only to be let down at the point of investment when the investor pulls out.

Most influential actors tend to be expatriates who have no prior experience in entrepreneurship leading to market distortion and poor decision-making

The most influential actors in the Nairobi entrepreneurial ecosystem are incubators, accelerators and impact funds. According to research conducted by Endeavor and the Bill & Melinda Gates Foundation, these organizations are mainly led by individuals who have no prior entrepreneurial leadership experience and often tend to be expatriates who have very limited understanding of the local market context.

Additionally, these organizations are funded primarily by grants from donors, governments and corporations. This has been cited as a major influencing factor as to why businesses struggle to scale, as these groups are sending the wrong signals to the entrepreneurs they support and can create grant dependency.

Local entrepreneurs are often poorly-equipped to engage with foreign investors on their terms. The majority are raising investment for the first time and are inexperienced, naïve and unprepared, resulting in a mismatch between northern impact investor expectations and the local entrepreneur’s hopes and capabilities.

Foreign investors typically expect sophisticated financial models and detailed business plans which, in their eyes, reflect the calibre of the entrepreneur and by proxy the business itself.

Local entrepreneurs will have different, frequently qualitative, skills, market insights and valuable social capital and political networks, crucial to business growth and long-term sustainability. However, this unique local knowledge and social capital are valued less highly than quantitative skills in the due diligence process. There are examples of expatriate-owned businesses running into serious political difficulties because of a lack of political awareness, insights and networks.

How to improve investor decision-making

It is clear to the authors that there is a large gap between foreign investors and local entrepreneurs and that capital is not invested in an efficient manner that supports the growth of early stage African businesses. There is a critical need to involve experienced local business people in the investment decision-making process. While local business people may not want to work for investment funds they could join in-country advisory or, ideally, investment committees that make decisions.

There is a small but growing pool of local angel investors whose insights and capital could be leveraged by foreign investors to find and support local entrepreneurs.

Donors/investor consortia need to invest in locally-managed entrepreneur support networks to help find and support new businesses.

There is a need for more effective linking of local business people with young entrepreneurs supporting them by becoming mentors, or non-executive directors.

There is a need to promote standards of good practice for engagement of impact investors with entrepreneurs and vice versa. Good practice would include honesty in communication, setting out a clear investment process and decision-making points. This could be a written voluntary code of good practice developed by key networks.