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Why your favourite African startups are incorporating abroad

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Venture funding in Nigeria’s tech industry has been growing over the years. Yet most investments have come from funds domiciled abroad. Although VCs are increasingly launching funds aimed at investing in Nigeria and other African startups, only few of them keep their funds in Africa. And this has implications on how startups secure funding and how they make business decisions like where to incorporate.

Tosin Oni, a Principal at Nigerian VC firm, EchoVC, explains to TechCabal that there are two reasons why VCs domicile funds outside Nigeria and many African countries.

First, the uncertain regulatory environment in Nigeria is a major headache for investors. “Many investors are worried about any clampdowns by governments in emerging markets where they operate,” Oni said.

Nigeria has maintained tight rules on financial activity designed to prop up the Naira. Dollars could come into the country’s financial system easily, but getting it out is a quagmire. “If you bring dollars into an African country, it is difficult to get it out, so the liquidity is not as good,” said Bdioui Ilyes, the Chief Finance Officer and Partnerships at the African Development Bank (AfDB). It’s not the ideal situation VCs investing in multiple countries across Africa would fancy.

“So domiciling funds in an offshore country helps to forestall the risk or possibility if that,” Oni added.

A second explanation is that offshore countries are natural habitats for investors. Countries like Seychelles and Mauritius, although African, have the climate and the favourable laws that allow global investors to operate effectively. “This becomes the preference for would-be limited partners who would rather do business in a climate and whose laws they are familiar with,” Oni explained.

“It further provides comfort to investors who prefer to invest in climates they understand and can predict.”

In a 2017 article on TechCabal, Olubunmi Abayomi-Olakunle explains that “many foreign investors are unfamiliar with the dynamics of local tax and regulatory frameworks.”

“They reflexively fall back on a familiar offshore parent structure, even though these structures may sometimes be bad for the long term interests of the operating company.”

But really, does it matter? Should the location of a VC fund have any impact on startups? Yes, it matters big time.

VCs consider a number of things when investing, including taxes and regulatory oversight during exits. But because Nigerian and many African legal and financial systems are too “dynamic” and uncertain, VCs choose to invest in startups incorporated abroad. Think US, UK, Europe or at a Mauritius incorporated startup.

Some others are comfortable with investing in local startups and may go on to set timelines for these companies to reincorporate in foreign jurisdictions to enable them to attract more funding from investors. Explaining a typical startup dilemma, Ilyes shares that: “If you are a company in Ghana [or any African country] with a scalable solution and you are targeting angel investors, some of the investors will tell you that they are not going to put my money in a corporation that is domiciled in Ghana.”

“So open up a company in London that owns 100% in the Ghanaian company and then I invest through the London company or HQ or vehicle’”

So it’s no surprise to find out that some of your favourite Nigerian and African startups are actually foreign by incorporation. Andela, Paga, Flutterwave, Paystack, Branch, Tala, SureRemit (Seychelles), among many others; and Jumia isn’t an exception. These startups have incorporated in San Francisco, Delaware, Mauritius, or other non-African jurisdiction that has business-friendly investment laws.

But a new trend has been on the rise regarding funding activity. A growing number of Africa-focused funds are emerging, with many of them led by African managers. Meanwhile, other funds are expanding their local operations on the African continent, either by opening new offices on the continent or investing more in Africa-focused startups. Whether this will flip the script and get more funds domiciled locally is a bit of a stretch.

However, Oni is betting that this trend will continue. And if it does it could make them reconsider where they domicile funds. “One thing we know that rings true is that LPs typically require fund managers to be domiciled in the regions they wish to invest in,” he said. 

For the meantime, capital hungry startups will continue to incorporate until the continent becomes business-friendly.

The post Why your favourite African startups are incorporating abroad appeared first on TechCabal.

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