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Any overt focus by South African ecosystem players on creating the country’s first unicorn is a “misdirection of attention” says venture capitalist and founder of 4Di Capital Justin Stanford.
With the number of multi-million acquisition deals concluded by South African startups seemingly on the increase of late, Stanford says the country should rather focus on systematically repeatable value creation.
‘Focus on headline number of $1-billion valuation is misdirection of attention’
It follows the $445-million sale of Kapa Biosystems in 2015 and, more recently, the $123-million GetSmarter deal announced in May.
Responding to emailed questions from Ventureburn, Stanford gave his views on why the number of acquisitions are on the increase and what local startups can do to attract interested foreign buyers.
Ventureburn: There appears to be a hotting up in the number of deals and deal values in the last two or three years. Is there something driving these deals — as in the devaluation in the rand over the last two years?
Justin Stanford: I don’t think the rand has anything to do with it. This is just an early marker of the developing ecosystem, which is starting to emerge from a very nascent start.
Also, foreign acquirers are getting more interested in doing business in Africa and more willing to purchase our businesses. Previously they were more hesitant but they are starting to wake up to the value on offer, and many are wanting to gain exposure to Africa with a view to growth.
VB: Why haven’t we seen any deal that has (at least those that have been reported) topped the Thawte deal valued at over $800-million in today’s money?
JS: It takes a long time to grow a truly valuable business. Our ecosystem is still young. And for something to be worth over $1-billion it has to be addressing a huge market.
This isn’t easy to reach from Africa. Thawte was really an outlier, but they [such outliers – ed] exist. Dimension Data sold for billions of dollars and was serving a totally global market out of Johannesburg, but again another rarity, and it took 20 plus years to build. The more important question is one of systematically repeatable value creation, and I think that focusing on the headline number of $1-billion valuation is a misdirection of attention.
VB: Of the list of 10 biggest deals Ventureburn identified, nine have been in the Cape. Could one then expect the next unicorn to likely come from Cape Town or Stellenbosch? And are there any promising startups on the horizon?
JS: Yes and yes. There are companies which originate from these areas that have the potential. As an example, LifeQ, which is a global company, has its origins in Stellenbosch — if it fully succeeds it could get there. There are others too.
I’d still be more interested though in having many companies with $100-million potential than one or two with $1-billion potential. This would be more of a sign of a healthy and diverse ecosystem which is more constructive, useful and sustainable.
VB: Most of the buyouts have been by big companies in Europe, the US and Australia — when will we see more acquisitions from SA corporates themselves? Do we need more firms like Naspers to buy up local tech companies to keep the IP in SA?
JS: I think for now big-ticket acquisitions are more likely to be by foreigners, and smaller ones by locals. SA has a cost advantage globally which is attractive to foreign buyers. The same tech can often be built for 10 to 20 times less here.
Many buyers also are seeking to acquire a presence or route to market in Africa, or a strong talent pool, such as engineering teams. Foreign valuation multiples are also typically more attractive for the sellers.
SA corporates are starting to show an increasing interest in the startup ecosystem however, with quite a few putting their toes in the water recently. We want to be participating in a global ecosystem and industry though, so I think it’s a positive that we are seeing increasing foreign interest. It has also put to bed this myth that if your business is domiciled in SA that no foreigner will buy you, or that you will suffer a valuation discount as a consequence of your location.
VB: And when will we see more SA tech startups listing on the stock exchange here, as the preferred exit for now seems to be a buyout rather than listing?
JS: There is still no culture of IPOs as an exit for startups in SA. I don’t see this as likely to change in the near term.
As it currently stands the structure of our stock exchanges and the typical participants in those markets don’t really encourage this type of activity. There isn’t much interest from the buy side, and the rules and regulations are more geared for well established companies.
The JSE (Johannesburg Stock Exchange) is mostly a means for large pools of savings in professionally, conservatively managed retirement and pension funds to buy shares in established corporates.
London’s AIM is a more likely target I would suggest, but even that is likely to be a way off. For now trade sale exits are the most viable option, or there’s also always just being a profitable business.
VB: What are foreign investors looking for in tech investments here in SA?
JS: The same thing they look for anywhere. Sound team, good opportunity, large addressable market, good product-market fit.
VB: How can local entrepreneurs better prepare their startup for a buyout by a foreign investor?
JS: Other than building a successful and growing business in an exciting market that is of interest to foreign acquirers, they should make sure that all ducks are in a row in terms of corporate governance, IP ownership and rights, structures, all legal and financial, and a capital structure and cap table that is familiar and well known to the global industry, conforming to the global norms.
This is one reason why at 4Di Capital we use US-style typical venture capital term sheets and funding mechanisms, so that there is nothing unfamiliar when an outsider comes to take a look.
All of these items will need to pass a stringent due-diligence examination in the event of a possible acquisition. Many companies, when growing fast, fail to keep a handle on these and leave a lot of loose ends, which will suddenly become an issue when faced with a professional due diligence.
VB: Lastly, just about all these exits, if not all, are by white males. When will we see more women and black entrepreneurs making massive exits (say about $10-million at least)?
JS: I don’t know. There are many businesses still brewing that could become successful on this scale, some of which have female or with black entrepreneurs involved. It takes a long time to build a truly valuable business typically. At 4Di our view is that it takes at least seven to nine years.
These things take time, and we are in a very young, very nascent local ecosystem that is just at the start. We will see more exits of this value once more entrepreneurs have built businesses that are worth these valuations and are of interest to acquirers. There is no shortcut to this.