Startup Financing Rising Amongst Economic Challenges

Startups are heralded for their numerous economic benefits. However, starting a business in Ethiopia—whether small, medium, or big—has always been a nightmare for entrepreneurs and investors. This has been well-evidenced throughout the years in ease of doing business rankings. One sticky point in getting a business off the ground has been the lack of financing. Startups are a driving force in the business community, responsible for the creation of new jobs, development of innovative products and services, and expansion of overall productive economic opportunities. There are now few pieces of evidence which support the view that the current administration has a decent understanding of the role of startups. Through the governmental push and other endeavors, the culture of financing startups is slowly rising. Still, the country could further benefit from better capacitated venture capital and angel investors, writes EBR’s Bamlak Fekadu.

Ethiopia’s transformation into a digital economy is driven by a policy that takes inspiration from China and hopes to transform the nation into a leading manufacturing and trading hub in Africa. Towards this ambitious plan, the incumbent Prosperity Party (PP) introduced the Homegrown Economic Reform agenda followed by the Ten-year Perspective Plan based on six priority reform areas which included diversified growth and job creation and financial sector development. The agenda establishes strategic pillars emphasizing private-sector-led economic growth that is consistent with productivity and competitiveness, as well as long-term financing.

A governmental briefing document called Plan of Action for Job Creation (PAJC) aims for 14 million jobs by 2025 and 20 million by 2030 by fostering an enabling business adminstrative environment. Further, the Digital 2025 strategy and the Startup Business Proclamation 2020 can be mentioned as significant moves in this regard. A primary consideration in drafting PAJC has been an important paradigm shift from state-led to private-sector-led growth.

According to a survey conducted by the Ethiopian Statistics Service (ESS) in 2017/18, approximately 155,000 small-scale manufacturing enterprises were operating nationwide, generating 2.1 million jobs and adding ETB49 billion to the nation’s gross domestic product.

As such, the startup ecosystem in Ethiopia seems to be undergoing a change of its own with a number of startup companies founded each year. Yet, despite their profound economic significance and colossal untapped potential, they continue to face a variety of hurdles when it comes to up-scaling. Since financial services remain out of reach for businesses in the lower echelons of the economy, connecting to Ethiopia’s thriving economy has never been simple for the majority of the country’s youth.

The search for manufacturing facilities, the creation of a workable business plan, and the carrying out of transparent feasibility studies are additional challenges for startups. Bureaucratic hassles for newly emerging business models are worse than the regular because civil servants have no past trends to look at in issuing such licenses and regulating the businesses. Even though there are a few government- and NGO-supported startup generation and incubation programs in the country, proper servicing by the public sector remains an issue when it comes to providing opportunities to those who truly need them. Still, the biggest hurdle is not administrative, but rather financial.

The country’s economy presents many opportunities for startups and entrepreneurs ready to make a change, especially through digital means. However, the current situation is perpetuating the problem of having capital as a sole collateralized commodity when looking to take up finance to grow.

Founded last year, Code Ethiopia is among startups striving to gain concept funding or capital venture as well as a working space and technical support. The organization works on developing Enterprise Resource Planning (ERP) software for small and medium-sized firms.

“We are developing the ERP software that enables firms to manage their finances, human resources, assets, and sales remotely and onsite,” Selam Goshu, Founder of Code Ethiopia, told EBR.

For Selam, even though access to finance is very difficult for several reasons, she sees the culture of capital ventures emerging from various institutions. However, the number of startup potential ventures still far outweighs supports given.

Selam thinks this is in part due to a scarcity of accessible support programs and a lack of diversity in incubation methods. There is simply not enough capacity and breadth of knowledge within the existing incubator network to adequately nurture many of the potentially successful early-stage disruptive ideas.

The Homegrown Economic Reform agenda lists “limited access to finance for entrepreneurs and startups” as one of the six roadblocks to information and communication technology (ICT) penetration and one of the four main macroeconomic imbalances threatening the economy.

Further, the Digital 2025 Strategy places special emphasis on the importance of nurturing the small but promising existing ecosystem of digitally enabled startups—an approach that has culminated in the currently proposed Startup Act.

The Ethiopian Startup Proclamation Act was first published in 2020 but is yet to be ratified after a decade of efforts to establish a legal framework for the startup ecosystem. It aims to establish a National Startup Council and an Entrepreneurship Fund to be chaired by the Ministry of Innovation and Technology (MInT). The ministry will handle due diligence works for startups partaking in the fund without collateral.

The proclamation introduces various incentives for various players in the startup ecosystem. Accordingly, it introduces a startup scholarship and support for intellectual property rights registration. It will draw monies for its activities from the under-establishment Entrepreneurship Fund. Administrative assistance, including legal support during registration, accounting, human resources management, and other supports, are also included.

The draft entitles startups and innovative businesses to tax breaks, an extended tax reporting period act, and the ability to act as an authorized economic operator for import and export. Subsequently, it provides direction for the government to devise a mechanism to subcontract startups when foreign firms bid on public projects in Ethiopia and incentivize those contractors who subcontract startups. Furthermore, it will allow startups and innovative businesses to open forex accounts and international cards to finance online services needed for their business.

According to an expert at MInT, the government is trying to make doing business easier for startups. “The new startup act, which is currently awaiting parliamentary approval, will usher in a new era for startups and the digital economy strategy,” says the expert. “It includes increased ability for the Ethiopian diaspora to do business and opens up the space for venture capitalists to benefit Ethiopia-resident start-ups.”

He hopes the Entrepreneurship Fund with the goal of assisting and funding startups will narrow the gap. It could also be a revelation for local investors to engage in concept funding. As of March 2022, the fund had conducted investor due-diligence while closing the first round of fundraising.

Concept funding is a form of financing provided by investors for startup businesses that are believed to have long-term return potential. However, in Ethiopia, there is no formalized venture capital or concept funding protocols.

The whole startup ecosystem is of the utmost importance for Ethiopia since obtaining work is extremely tough. With unemployment at 23.1Pct as of 2020/21 FY and the median worker aged around 19.5 years, the workforce is expected to grow by approximately two million each year for the next decade. Access to finance will grow as a challenge for startups as well as micro, small, and medium enterprises (MSMEs).

Through all these challenges, it is evident that positive change is underway in the Ethiopian startup ecosystem’s legal and physical infrastructure.

A piece of interesting news came out a few months back when the Development Bank of Ethiopia (DBE), which was known for rolling out massive multi-million-dollar loans for giant projects, announced it will commence financing startups.

The startup ecosystem appears to be receiving more attention than before, as is also evidenced by entrepreneurship competitions and grants like the Startupper of the year Challenge by TotalEnergies, Dashen Bank’s Kefeta, and others.

Another prominent positive direction is Enat Bank’s initiative to provide 5Pct of its profit as subsidized and uncollateralized credit to women-owned startups based on personal guarantees and the feasibility of the business plan.

One of the nation’s leading consulting firms, Precise Consult’s position paper recommends the adoption of venture capital (VC) and angel investments in boosting startups and their ecosystems. VC is a form of financing provided by investors for startup businesses believed to have long-term return potentials. In Ethiopia, there are no formalized venture capital protocols. Precise urges the government to encourage the development of venture capitalists and angel investors so as to support early-stage companies.

Nowadays, the culture of venture capital and angel investment has started to show signs of growth. As of the 2020 investment report by GIZ, Global Business Network, and Make-IT Africa, there were 22 venture capital groups active in Ethiopia, of which only five were domestic. Research by Cepheus Capital revealed that close to 570 businesses offer a wide range ecosystem services in the digital finance, e-commerce, and transport sectors in the Ethiopian digital economy landscape.

The research indicates that the startup ecosystem is growing by more than ten-fold when compared to GIZ’s report of 2020, which involves incubators, accelerators, and angel investors alongside seven co-working spaces like Yene Space, Blue Space, and five associations.

Consequently, some venture capitalists have emerged with the initiative to fund and nurture exceptional business ideas among the youth that are innovative, scalable, and have transformational potential, including Bluemoon, Startup Factory, Addis Ababa Angels Network,  iceaddis, among others—offering funding and co-working spaces.

Some successful startups and specific founders are already integrated into the local economy with the investment of venture capitalists like Eshi Express. Eshi Express is an on-demand delivery and digital logistics startup founded in 2017 with investment from Ethiopia’s pioneering Addis Ababa Angels Network.

Another significant challenge to start a novel or innovative business are working spaces, over the past few years several co-working spaces have come and gone. Co-working has emerged as popular working concept in the capital where several workers from different companies can share office spaces and the trend of using common infrastructure is growing due to cost saving and convenience.

Iceaddis, was opened in 2011 as the first innovation hub, and incubator in Ethiopia, and has been active in building services, organizing events, and facilitating investments that look to develop startups. They have supported more than 160 entrepreneurs, incubated 45 startups, accelerated 31 startups, launched more than 75 products, and hosted events in excess of 300 over the past decade.

With the need for working space securing some relief, MInT is working with the Commercial Bank of Ethiopia to identify mechanisms to disburse loans to projects that have gone through MinT’s due diligence. This will allow tech entrepreneurs to access starting funds.

According to a member of the Legal Directorate of the Ministry of Labor and Skills, some necessary legal progresses are on the way towards introducing a directive that adopts the culture of funding startups. “Further legislative discussions are on queue with stakeholders like the National Bank of Ethiopia and Ministry of Revenue,” he said.

An entrepreneurship instructor urges the government to push the case forward because of its significance in reducing unemployment and realizing sustainable growth.

“The next generation of innovators is being discouraged from pursuing their ideas due to a shortage of finance and accessibility to attain their objectives,” he told EBR, adding that due to these prevailing conditions “the wider economy is being deprived of the potential benefits of a number of promising new ventures.”

In 2020, Ethiopian startups raised USD2.25 million in announced investment, up from USD0.65 million in 2019. The figure excludes grants, prize money, and non-equity assistance, according to the Baobab Network, a technology accelerator built for Africa. For comparison, financial technology firms raised more than USD8 million in 2021. On the other hand, disrupt Africa’s African Tech Startups Funding Report 2020 puts Kenya on top with USD191.4 million, followed by Nigeria and Egypt with USD150 and 142 million. Geographic issues are also evident in the startup ecosystem. Addis Ababa is the only Ethiopian city among the top 500 and in the global top 1,000 startup-friendly cities, according to the report.

The digital strategy 2025 suggests public-private engagement to mitigate the lack of direct access to finance. The strategy states that private sector investors, including angel, venture capital, and private equity players, should be leveraged to provide seed and growth funding while facilitating technical and business expertise towards fund disbursement. Properly directing the Entrepreneurship Fund according to the Startup Act to provide early-stage capital to start-ups can unlock tech entrepreneurship. Furthermore, it suggests that intellectual property be recognized as an asset for valuing a company so that business owners can use it as collateral when seeking investments. EBR

10th Year • Sep 2022 • No. 110

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