Will Tech VC Funding in Africa Rebound on Interest Rate Cuts?

VC firms and startups can look to imminent interest rate cuts to revive dealmaking but monetary policy easing alone may not bring back the industry’s ZIRP-fueled glory days.

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The African venture capital landscape has experienced a significant downturn in the last two years, starkly contrasting the robust growth seen earlier in the decade. Per African Private Capital Association (AVCA) data, venture capital inflows to Africa in 2023 totaled $4.5 billion across 603 deals, representing a decline of $2 billion compared to the previous year. 

That downturn has continued into 2024, with research firm Africa: The Big Deal reporting that African startups raised only $780 million in the first half of the year – a 31% drop from the second half of 2023 and a 57% decline from the first half of 2023.

The current depressed climate in African venture capital is characterized by a dramatic reduction in both deal volume and value. The number of active investors in the African ecosystem fell by 33% in 2023, with a particularly notable retreat of North American investors, who accounted for 50% of the overall decline in investor numbers. European and Asia-Pacific investors also pulled back, contributing 18% and 9% to the decrease, respectively.

This pullback has hit growth-stage funding particularly hard. The big foreign investors who left were mainly funding later stages, leaving not much money for companies looking to expand—some have either closed, been bought out, or are struggling to survive through layoffs and other cost-cutting measures. 

The current state of African venture capital can be traced back to the era of zero interest rate policy (ZIRP) that prevailed in many advanced economies following the 2008 global financial crisis. During this period, central banks, particularly the U.S. Federal Reserve (Fed), maintained interest rates near zero to stimulate economic growth. This environment of cheap money had a profound impact on VC funding globally, including in Africa.

Low interest rates made traditional investment vehicles less attractive, pushing investors to seek higher returns in riskier asset classes like venture capital. This influx of capital into the VC space led to increased competition for deals, driving up valuations and encouraging a growth-at-all-costs mentality among startups. African tech ecosystems benefited from this trend, with record levels of funding flowing into the continent’s startups.

However, the tide began to turn in 2022 as inflationary pressures built up globally. Central banks, led by the Fed, began aggressively raising interest rates to combat inflation. This shift in monetary policy had immediate repercussions for the venture capital industry. Higher interest rates made safer investments more attractive, leading to a flight of capital from riskier assets. For African startups, this meant a sudden drought in funding as international investors, particularly those from North America, retreated from the market.

The impact of rising interest rates on African VC deals was multifaceted. First, it led to a reassessment of valuations, with investors becoming more conservative in their growth projections and more focused on near-term profitability. This shift particularly affected later-stage companies that had previously benefited from high valuations based on aggressive growth projections.

Second, the higher cost of capital made it more challenging for VC firms to raise new funds, leading to a slowdown in investment activity. This was particularly evident in the decline of foreign investors participating in African deals, as noted in the AVCA report.

Third, the macroeconomic uncertainty caused by rising interest rates and inflation led many investors to adopt a wait-and-see approach, further dampening deal activity. This was especially true for cross-border investments, which had been a significant driver of growth in African VC in previous years.

However, recent economic data has sparked hope for a potential reversal of this trend. In July 2024, the United States witnessed an unexpected decline in inflation rates, with consumer prices rising by only 2.9% year-over-year in June, the lowest in over three years. This cooling of inflation has fueled speculation about potential interest rate cuts by the Federal Reserve.

The prospect of interest rate cuts could have significant implications for the African VC landscape. Lower interest rates in developed markets could once again make higher-risk investments in emerging markets more attractive to international investors. This could potentially lead to a revival of foreign capital flows into African startups, helping to reverse the recent downturn.

Moreover, lower interest rates could make it easier for VC firms to raise new funds, potentially increasing the pool of capital available for investment in African startups. This could be particularly beneficial for late-stage companies, which have been disproportionately affected by the recent funding crunch.

While interest rate cuts could provide a much-needed boost to African VC, however, they alone may not be sufficient to return the industry to its previous heights—2022 levels. Several other factors will play crucial roles in determining the trajectory of African VC in the coming years.

The African VC ecosystem needs to demonstrate resilience and adaptability in the face of changing market conditions. The recent downturn has forced many startups to focus on profitability and sustainable growth rather than pure user acquisition. This shift towards more sustainable business models could make African startups more attractive to investors in the long run, even in a higher interest rate environment.

The development of local capital markets and investor bases will also be crucial for the long-term health of the African VC ecosystem. While foreign capital has been a significant driver of growth, the recent retreat of international investors highlights the need for a more diverse and stable funding base. Encouragingly, despite the overall downturn, some Africa-focused private funds have continued to close successfully, including Adenia Partners ($470m), Partech Partners ($300m), and TLcom Capital ($154m), among others, demonstrating continued investor interest in the region.

Improvements in the regulatory environment and infrastructure across African markets will be essential to attract and retain investor interest. This includes everything from more startup-friendly policies to improvements in digital infrastructure and payment systems. And the emergence of new sectors and technologies could help reignite investor interest. The AVCA report notes that climate-related ventures raised a cumulative total of nearly $790 million in 2023, indicating growing interest in this sector. Currently, they represent almost half of all venture capital activity in the continent.

Then the success stories emerging from the African tech ecosystem will play a crucial role in attracting and retaining investor interest. As more African startups achieve significant exits or demonstrate sustainable profitability, it could help build confidence in the overall ecosystem.

While the potential for interest rate cuts offers a glimmer of hope for the African VC landscape, a true rebound will depend on a combination of factors. The industry will need to navigate the changing macroeconomic environment, demonstrate resilience and adaptability, and continue to nurture promising startups across various sectors. 

If these elements align, we could indeed see a revival of VC dealmaking in Africa, potentially returning the industry to its former vibrancy. However, this recovery is likely to be gradual and may look different from the growth seen in previous years, with a greater emphasis on sustainable business models and a more diverse investor base.