Tech start ups have it all – except high profits

Startups, in the eyes of investors, are akin to galaxies waiting to be explored, each with its own constellation of attributes. 
Investors adore Uganda’s rising tech stars, pumping a whopping Shs263.7 billion into thirty-two deals tracked by the East Africa Private and Venture Capital Association (EAVCA) in 2022, with a median deal size of Shs8.23 billion.

When additional investments are taken into account, the total value of these investments for the year came to about Shs420 billion, reflecting an increase in interest in the Ugandan tech startup ecosystem.

EAVCA data shows that investors are increasingly interested in technology, media, and telecommunications (TMT), which attracted the most deals in 2022 with Shs207.2 billion in investment. 

“With an aggregate deployment of Shs187.75 billion in new investments, the FinTech segment was dominant - mirroring the wave of global venture capital-backed FinTech investments that swept across Africa in 2022,” EAVCA notes in its 2023 startups review.

The startups are focusing on technologies that provide underserved communities with microloans and savings solutions, while high-risk investments offer an outsized opportunity for returns given the significant number of people who lack access to formal banking services, high rates of mobile phone subscriptions, and rising Internet penetration rates.

FinTechs that provide working capital microloans or asset financing to small businesses turned out to be the big winners of the year, with Asaak and NUMIDA standing out.

The company that stood out the most, Asaak, “a mobile-based microfinance platform offering two-wheeler asset financing,” attracted Shs112.2 billion in follow-on investment in a round led by Resolute Ventures and another Shs74.8 billion in debt from Cauris Management.

In addition, NUMIDA, a FinTech company that uses “proprietary credit models and tech-enabled underwriting processes to provide unsecured working capital loans to semi-formal” businesses, was notable for being accepted into the prestigious Silicon Valley-based Y-Combinator accelerator’s 2022 cohort, which is credited for having shaped the trajectory of major tech brands like Airbnb and Dropbox.

When NUMIDA joined the programme, it received Shs1.87 billion from Y-Combinator in addition to Shs46 billion in funding from a round led by US-based Serena Ventures. This indicates that international venture capital firms are becoming more interested in supporting high-quality, scalable start-ups in Africa.

These businesses are drawing a significant amount of investment from investors with a global focus (58pc) as well as investors with an African or Pan-African focus (21pc), an East African focus (19pc), and only 2 percent from Ugandan investors thanks to their trendy products and legions of customers.

There is, however, a problem with the startups: their business models.
In May 2022, Makerere University conducted a case study that revealed 45.9 percent of newly founded businesses fail.

They frequently offer steep discounts on their services, which range from office rental to ride-hailing, in an effort to boost revenue growth.
The rationale behind this is equivalent to making a quick land grab in the hopes of discovering gold.

Some startups, however, do not have the economies of scale and entry barriers that they advertise. At the same time, more stringent regulations limit their ability to move quickly and break things.
Fintechs, which receive the majority of funding in Uganda, are revolutionising how people manage their finances, pay for goods and services, invest, and save money and their operations spurred during the Covid-19 pandemic.

While bank branches saw a decline in foot traffic and the use of cash declined, more people used mobile banking apps, made contactless payments, and bought cryptocurrency.

Challenges
BNM Advocates notes that even though the innovative and disruptive nature of technology-led financial services has led to a rapid pace of change in financial services markets, it has presented a challenge to policymakers and regulators around the world to keep up.

“More specifically, there is little knowledge of, and data on, the number of Fintech companies operating in Uganda. There is little data available on which sectors the Fintech companies operate in, their business models, and the products that they offer,” it notes in its analysis of the difficulties fintech start-ups face in Uganda.

Additionally, one of the key benefits of Fintechs are how they rely on the latest technologies and early adoption of new solutions. 

Companies need to use technologies like machine learning, cloud services, and blockchain to reduce the costs of daily operations, risk management, and compliance in order to stay competitive. 

“A Fintech start-up needs to invest wisely into its app for customers — a smooth working interface and beautiful design play a significant role in user retention,” said BNM Advocates.

“The development of native apps for iOS and Android requires significant resources: in fact, one will be paying two separate development teams for building two separate apps. For many start-ups, a better choice might be to build an app with a cross-platform framework,” it added.

The review notes that fintech investors are interested in a company’s software, technology, and underlying intellectual property. 
A start-up will face numerous challenges such as developing a product, hiring qualified employees, raising capital, and other issues.

Intellectual property may seem inconvenient, expensive, or in conflict with the objectives of simply getting a product to market before a competitor. 

“However, intellectual property is often the most valuable asset of a Fintech start-up. Protecting intellectual property can be essential to obtaining venture capital funding or preventing competitors from unfairly competing with you,” BNM Advocates notes.

Unit economics
Rapid scaling and growth are frequently regarded as the essential ingredients for success in the fast-paced world of startups.

However, concentrating only on growth can occasionally obscure unit economics, a factor that is just as significant.

Fundamentally, unit economics is concerned with the per-unit direct revenues and costs connected to a specific business model.

In other words, it provides a clear indication of whether a startup’s business model is sound and aids in calculating the profitability of selling one unit of a good or service. 

“If a company is losing money on each sale, growth will only exacerbate the problem, leading to financial instability and potential collapse,” notes Pankaj Sharma, the executive vice president of Global Remittance Business Management at Remitly Global Inc in an analysis about the importance of unit economics in growth of startups.

Customer activity, over time, is a critical factor in determining a company’s future profitability and scale in growth startups. 

When this customer activity dimension is added to product/service-unit level economics, it reveals the revenue and costs associated with a specific cohort of customers over a specific time frame.

“This approach allows companies to analyse the financial performance of different customer segments and assess the impact of various acquisition strategies, retention efforts, and product enhancements on their unit economics,” says Mr Pankaj.