Performing due diligence on startups in Africa: analyzing investment opportunities

Investing in African SMEs - Due Diligence
What does it take to build a fruitful partnership between an early-stage entrepreneur and an equity investor in Africa? VC4Africa members and investors Hugues Vincent-Genod and David Munnich from Investisseurs & Partenaires (I&P) share some lessons on due diligence from the handbook Investing in Africa’s Small and Growing Businesses.

Building a partnership between an investor and an entrepreneur can be a complex process: the entrepreneur and the investor have to agree not only on a growth strategy, but on the terms of the investment, the exit plan, the governance… It is all the more complicated when the dealsize is small (i.e. below USD 500,000) and the entrepreneur is often the only one involved in the discussion with the investor.

Based on the lessons learned by some of the first African investors focused on Small and Growing Businesses (including I&P, Business Partners, XSML, Injaro Investments), I&P is sharing a handbook that shows what entrepreneurs can expect from such partnerships, how investors function and what they demand. The handbook lists key learnings from 6 investors who have together raised and invested several hundreds of millions of dollars in Africa, and 10 entrepreneurs who have partnered with them.

One of the key topics is the due diligence, which is presented through case studies like the experience of Gabriel Fopa and his company ITG Store.

ITG Store

When I&P invested in ITG Store in 2012, a strong effort was put into structuring the accounting system, reorganizing the financials and giving growth a chance to be sustainable over time. It was not at all easy, but it worked out well thanks to the strong trust built between the entrepreneur and the investor. Since then ITG Store has realized a massive increase of its turnover; it has tripled its staff in 2 years and can now prepare future expansions with confidence.

ITG Store was founded in 2006 in Douala, Cameroon. It provides integration and outsourcing services in information technology. Since his own experience of approaching an equity investor was not an easy road, ITG Store founder Gabriel Fopa explains: “At the beginning, the entrepreneur and the investor are speaking two different languages, and their two different dictionaries have to be harmonized. On one side, the entrepreneur is passionate and enthusiastic, and is convinced that everyone understands what he does, why he does it and why it has such rich potential. On the other side, the investor has his own constants: he asks questions about the market, the competitors, their strengths and weaknesses, etc. The entrepreneur never analyses these aspects in detail because what’s more important to him is how to capitalize on his own strengths. The investor makes him realize that enthusiasm and technical skills are not enough, but rather the beginnings of what’s necessary.”

Not all encounters between entrepreneurs and investors end up being a good match. Bridging this gap between the two, as described by Gabriel, is what makes the difference. This is how the investment becomes possible and successful. The due diligence is the (often long) process whereby investors and entrepreneurs build the basis of their partnerships: mutual understanding and trust.

Gabriel says: “I was initially quite uncomfortable with the due diligence conducted in my company, with the interviews of my customers and my prospects. I felt stripped naked in the marketplace and I almost put a stop to the mission. However, I soon understood that this was a useful exercise: it highlighted the real perceptions of my customers, the depth of the market and the strengths and weaknesses of ITG. In particular I understood that while the company had real technical and technological capabilities for handling projects, it did not have the financial strength to grow.”

Gabriel finally says: “Alone I was fast, but together we can go very far. The added value of the equity investor comes from being a partner-developer for the business: not only investing money, but also providing support, helping patch cracks and grow.”

Due diligence

As in the example of ITG Store, the key points of a due diligence process, carefully looked at by an investor, are often the following:

  • – The entrepreneur: his experience, his vision and skills,
  • – The company’s track record and progress on the investment project: how mature is the project?
  • – The market analysis and competitive advantages of the company, particularly vis-à-vis imports or informal competition,
  • – The human and technical resources needed to implement the project,
  • – The business model,
  • – The expected impact, and management of environmental and social risks.

The specificity of a due diligence for SGB investors is that analyzing the investment opportunity is just one side of the coin; the other is making the business investment-ready, as VC4Africa often shows. While performing due diligence, the investor helps the company mature and reduce the risk of its investment project to better absorb financing. The investor takes an advisory role in a context where SGBs struggle to find affordable quality support to become investment-ready.

While working alongside entrepreneurs during the due diligence, investors also show that they can bring value to the business and convince the entrepreneur to welcome them as new shareholders and board members.

During the due diligence, investors and entrepreneurs agree on a “term sheet” presenting the essential information on the investment: financial structuring, financial projections, rules of governance, exit mechanism and business valuation.

The ambition of the handbook is to stimulate the development of early-stage equity investment in Africa, by showing how some investors have already achieved strong impact and financial performances with that method. It also presents some conditions under which success can be built, and suggests a roadmap for first-time fund managers in Africa. I&P’s objective is to sponsor 10 new fund managers dedicated to this challenge in 10 African countries.

Photo credit: Béchir Malum, I&P Handbook Investing in Africa’s Small and Growing Businesses

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