How Funding Gaps Force African Startups To Become ‘Foreign Local Firms’

African youth
Picture credit: Ventureburn

August 6, 2020//-Flutterwave, Tala, Paga, Paystack, Hotels.ng, Syncommerce, Breadfast, Andela, Branch, Hourspent, Truzo, Jumia, and perhaps many more. 

What do all those names have in common besides being tech startups that operate in Africa? Answer: They are all incorporated abroad (outside the countries where they operate), and are technically foreign companies by virtue of their registration.

To some, this foments identity crisis. To others, it’s an important strategic decision that, among other things, has a bearing on the aspirations of a homegrown venture.

So, what pushes so-called African startups to domicile outside the continent or in countries where their core product/service is not available? What are the attractions that lure local tech startups into seeking ‘refuge’ abroad? The answer is tied to a number of factors that are both circumstantial and beneficial.

On one hand, some African startups seek havens in ‘startup-friendly’ countries and register there, possibly as entities under holding companies incorporated in those foreign countries.

On the other hand, circumstances dictate that a startup has to have a certain identity to be able to access certain much-needed resources.

When African startups have to ‘do the needful’

Funding for African startups has soared like never before in recent years. In 2019, venture capital (VC) investments in local tech startups crossed the billion-dollar mark for the first time, according to the 2019 African Startup Funding Report by WeeTracker.

However, an overwhelmingly huge chunk of that funding came from foreign investors, and this has generally been the case over the years.

Indeed, recent data from African Venture Capital and Private Equity Association (AVCA) suggests that 40 percent of the total number of investors that took part in VC deals in Africa between 2014 and 2019 are based in the United States of America (USA).

Funders based in African startup hubs like South Africa, Nigeria, and Egypt account for a combined 15 percent. The rest of the funding came from the United Kingdom, the Netherlands, France, China, Canada, and the United Arab Emirates.

Remember the saying that goes something like this: “He who pays the piper calls the tune”?

Well, it’s no secret that, for instance, many American incubators, institutional investors, and angel investment networks — whose funds are propped up by large pension funds and even universities — have mandates that compel them to only invest in American companies.

Even the well-known accelerator, Y Combinator (YC), which has written cheques for no less than 28 African startups to date, maintains that it only invests in U.S. corporations.

In fact, YC assists founders of companies it selects to join its programme to create a U.S. company which the accelerator will then invest in.

Due to the uncertainties that surround the regulatory environment, the restrictions on the movement of foreign exchange, and the arcane tax laws that are in place in several startup hubs in these parts, foreign investors often look to minimize risk by seeking the relative comfort of grounds that are more familiar.

So, in order to access the huge pool of capital and boundless global reach that are currently limited in availability, Africa startups with certain funding goals or global expansion plans find merit in incorporating abroad.

For African startups looking to go global, being incorporated overseas is kind of a way to swing the odds in their favour given that the subtle bias, discrimination, doubts and stereotypes held by investors put African founders at a disadvantage from the start.

Iyinoluwa Aboyeji, the co-founder of Andela, Flutterwave, and Future Africa, was recently quoted by Afrikan Heroes as saying: “I have a preference for the U.S. because it is a deeper capital market with more experienced investors.”

Previously, he had mentioned to Disrupt Africa that he had “incorporated every successful tech venture he has built in Delaware, in the U.S., which is now the go-to spot for African startups incorporating outside of Africa.

Aboyeji also stated that “America is the deepest capital pool in the world,” and that for startups looking to raise capital, “it makes sense to domicile in America to increase your chances of fundraising success.”

The earlier alluded AVCA data does mention that about one fifth (21 percent) of the total number of VC deals between 2014 and 2019 went to startup companies incorporated outside of Africa.

And of those companies, 53 percent are based in the United States. The data goes on to show that foreign-based African startups have it easier when it comes to fundraising than those based in Kenya, Egypt, Nigeria, and Ghana.

When a startup seeks out other perks

Besides the fundraising implications, there are other perks that lure African startups into incorporating abroad; perks which they obviously can’t leverage on home grounds.

For starters, while countries like Mauritius and Seychelles are hardly part of discussions around startup developments in Africa, they appear to make up for that by offering perks that seem to draw in tech startups who are increasingly incorporating in those countries.

As an example, Mauritius has attractive investment incentives and favourable tax policies which sort of makes it a preferred destination for the incorporation of startups.

Part of the country’s rules is that income generated by any company set up in Mauritius on or after 1 July 2017, which are involved in innovation-driven activities and where the Intellectual Property (IP) assets are developed in Mauritius, are exempt from tax.

Simply put, there’s no withholding tax on dividends or interest in Mauritius. Additionally, capital gains realised by a non-resident or resident shareholder on disposition of its shares/units in a Mauritius entity is tax-exempt in the country. Also, Mauritius has no foreign exchange control, unlike many African countries — meaning that funds can be moed with ease.

Further, incorporating in the earlier mentioned U.S. city of Delaware also appears to appeal to some African startups for reasons bordering on privacy protection, established court system with deep expertise on corporate law, as well as its policy of no tax on income, sales, or intangible income.

Other U.S. grounds like California, Texas, Nevada, also draw African startups with considerable incentives, as do countries like Singapore and European nations like Germany, England (London), Estonia, Finland, and Sweden.

Funder Likes & Funding Gaps Force African Startups To Be ‘Foreign Local Firms’

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