A Guide To Angel Investing During COVID-19: Eight Tips for Investors in East Africa
Editor’s note: This article is part of NextBillion’s series “Enterprise in the Time of Coronavirus,” which explores how the business and development sectors are responding to the pandemic. For news updates and analysis, virtual events, and links to useful resources related to the COVID-19 crisis, check out our coronavirus resource page.
The world has experienced many different crises and pandemics over the years, which have disrupted national, regional and even global economies – sometimes gravely. Although the disruption due to COVID-19 is not novel, its magnitude may be greater than any crisis we’ve faced in many years. Whether it was the economic recession in the United States and Europe in 2008, or the microfinance crisis in India in 2010, the effects major crises have on the economy of a country and region are profound, and they can vary greatly depending on the regional context.
For instance in East Africa, the COVID-19 crisis is having particularly far-reaching consequences due in part to the prevalence of small and medium-sized enterprises (SMEs). To take just one example, 98% of the businesses in Kenya are SMEs – and other economies in the region are also heavily dependent on the SME sector. These businesses are especially vulnerable to the current crisis due to factors such as the disruption in supply chains, which has increased the cost of doing business for companies with already tight margins, and the loss of income due to pay cuts or job lay-offs, which has reduced the purchasing power of these enterprises’ customers. For this reason, many resources have been rightly focused on helping these entrepreneurs survive the pandemic.
But though it’s true that entrepreneurs will need financing to ensure that their businesses survive the economic downturn, it’s also important to look at the other side of the coin – the funders that are supporting them. Most institutional funds are currently focusing on their well-performing portfolios by providing monetary support to ensure these enterprises’ survival, so they may not be deploying capital to new investee companies unless the deal was negotiated to term-sheet level prior to COVID-19. The burden thus lies with angel investors to support these companies in order to ensure their short-term survival – and subsequently, to ensure a healthy pipeline for the institutional investment funds after the crisis has passed.
However, angel investing in East Africa is still nascent, with high net worth individuals opting to invest in asset classes like real estate and money markets, among others. Further, some of these wealthy investors are unaware of the opportunities that early-stage companies present. Therefore, the region’s angel investors will need to exercise some level of aggressiveness and adopt a high-risk tolerance in seeking out new investment opportunities.
If you’re an angel investor focused on East Africa, how can you ensure that you not only select companies that are likely to succeed, but also that you will get some level of returns from your capital? Below we’ll discuss some practical considerations that can guide your investment thesis.
Diversify Your Portfolio
You can consider diversifying your investments based on the sectors you invest in, the financial instruments you use, your geographical focus and the stages of the companies you select. The aim of diversification is to reduce the risk of your investment, while ensuring that financial returns are maximized. In the process, it’s good to optimize your diversification efforts by mixing different strategies.
Bet on the Jockey, Not on the Horse
Consider selecting potential investee companies that have a team and leader who is not only visionary, but is also agile enough to pivot and adapt to quickly-changing situations. This type of leadership will carry the business through the COVID-19 crisis by ensuring that it is responsive to current market needs, which will ensure that your investment survives.
Be Selective with Your Money
During these times of crisis, be very selective about where and how you invest your capital. You may want to consider how potential investee companies performed pre-crisis, and whether they already had the potential to scale. Equally importantly, consider companies that have lower burn rates and that do not spend their available cash fast. This will ensure that the capital you invest carries the company for a longer period. It might also be prudent to consider the type of currency that you will use when supplying capital to the potential investee company, as this has the potential to greatly affect your potential returns.
Don’t be a Shark
Though this crisis presents an opportunity (and a temptation) to undervalue companies, as sharp declines in available capital may make them more likely to accept less favorable terms, be careful not to be a predatory shark. This might seem to provide an advantage to investors, but it also has the potential to significantly affect the motivation of a company’s management team, potentially reducing performance (and returns) in the longer term.
Invest with Other Angels
Co-investment during these times will give you some level of comfort in the investment you make. Look for other like-minded investors who are willing to take the risk and invest together, because if managed properly, co-investing has more potential to generate returns than investing in a deal single-handedly. That is, when more than one investor comes together to invest in the deal, there is higher likelihood of the enterprise succeeding due to the different perspectives and networks that each investor brings. Co-investing can therefore be viewed as a de-risking mechanism.
Get Creative with Due Diligence
Since physical movement remains restricted in many markets, seek out innovative ways to build and enhance trust with the entrepreneurs you’re supporting. This can include using technology-driven solutions, such as conducting a virtual field visit tour over Zoom, and/or working with local on-the-ground partners, who may include accelerators and incubators or local consultants. Such partners will be responsible for assessing the market perception of the product/service, getting insights from customers/users of the product, and even speaking to other on-the-ground financiers who have previously evaluated the deal to understand its attractiveness. These measures will ensure that you’ve established some confidence in the investee company (and vice-versa) before you make the investment.
Plan to Provide More than Just Money
During this time of crisis, companies require more than just the money. Plan to also provide strategic support, knowledge and access to networks to your portfolio companies, to ensure that they have the tools and contacts they need to survive the pandemic. This approach is worth the time and money it will require, because without it, your capital may be used inefficiently, and you could lose your investment entirely.
Have Realistic Expectations on Exits
Have an open and honest conversation with potential investees about your return and exit expectations. This is important because, during this crisis period, investment-holding periods may be longer than anticipated, which ties up capital and delays returns for all investors. You may therefore need to work harder and explore other avenues for exits, such as strategic buy-outs, in which a potential acquiring company will acquire the shares from the angel investor, based on the assumption that the acquiring company and the investee company may have synergies in the value chain, thereby increasing the acquiring company’s market share.
Intellecap has compiled more guidance around some of these practical steps here. We hope it will help angel investors navigate the many challenges – and find beneficial opportunities – during these unprecedented times.
Photo courtesy of Edward Howell.