Angel Investing Through Syndicates & Special Purpose Vehicles (SPVs)

Investing

Global VC funding has been cooling off in 2022, following an aggressive rally in the past two years. However, Africa has largely been an outlier in this trend by evading the slowdown; until the month of July. The month of July experienced a 20% drop from the amount raised in the same month in 2021; while all other months from January to June 2022 reported higher numbers compared to the previous year.

Even with the dip, 54 startups across Africa received funding total to USD 246 million in July 2022. Cumulatively, this brings the total amount of VC funding raised in the continent since January to USD 3.4 billion; equivalent to 70% of the USD 4.9 billion raised in 2021 full year, according to the Brite Bridges 2021 report. With 5 months to go in 2022; we expect VC funding in Africa to hit the USD 6 billion mark by year end; which will be lower compared to the USD 7 – USD 8 billion projection for 2022 in January.

Going against the slowing VC funding tide, innovation and entrepreneurship in Africa is getting more vibrant. New tech and tech-enabled startups are being churned out in large numbers from local startup ecosystems. Innovation hubs running incubation and acceleration programmes across the continent are increasing in numbers, and they are doing their part in supporting local startups to develop scalable business models. However, with VCs slowing down on new funds deployment, these startups will end up struggling to raise the needed capital to scale their ventures.

To fill this enlarging funding gap, angel investors across Africa need to rise to the occasion and do the needful – that is, fund local startups to help them survive long enough, until VC funding comes back in full swing. Startups with sustainable and scalable business models which are already operational should not be left to die due to lack of funding to keep them alive in the medium term. Pre-seed funding is very critical in determining their long-term success; and hence local angel investors should jump in and provide the needed fuel.

Angel investments are a risky asset class though; hence prudence must be exercised before getting one’s feet wet in the space. Investing alone in start-ups for new and even established angel investors magnifies the risk of having all your investment being lost in one deal. To mitigate this highly likely downside in angel investing, the concept of portfolio diversification comes into play. Portfolio diversification is used by mainstream VC funds to ensure they balance out their winners and losers. In a typical portfolio of 10 startups; a VC fund will hit a home run with only 1 startup, 2 -3 of them will be walking deads and about 6 – 7 will be write-offs.

The above grim industry averages are most likely to be worse for angel investors who are not professional investors, and are not involved in active portfolio management on a day to day basis. In order to take advantage of an early entry into the cap table of promising startups; while avoiding too much risk exposure, angel investors are increasingly investing in syndicates.

A syndicate is a group of angel investors who come together to pool enough funds to invest in one startup. Syndicates reduce the risk exposure for angel investors by accommodating their small capital injections into the startup (typically at least USD 1,000 per angel); and hence the angel investor does not have to risk all their funds allocated to alternative investments in one startup. This, however, does not achieve the diversification goal. To further reduce their risk exposure, angel investors need to invest in a portfolio of startups by joining different syndicates that are created to fund other startups. This way, the angel investor is able to diversify their portfolio, such that a loss in one startup does not drown their full investment funds.

On the other hand, managing random syndicates can be a hectic process for angel investors who are often having other professions and occupations that take much of their time. To have better structures and smoothen the investment process, angel investors should join their local business angel networks where they can co-invest with their peers. Under the angel network model, individual angel investors join a network within a region where they want to invest and they all co-invest in the startups that meet their investment criteria.

The angel networks often have professional investors among them who can help in the due diligence needed before investing. In addition, there will always be a sector expert within the network who can provide support in technical due diligence, in order to help the rest of the angels in making informed investment decisions. Through the syndication model, angel networks create special purpose vehicles (SPV) that pool the funds from the angels and then invest as one entity into the startup. This helps to avoid crowding the startup cap table; and on the other hand it helps to separate the risks involved in each startup from the overall portfolio.

Author: Jeremy Riro

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