September 10, 2024
Earlier this year (March 2024), news headlines across Tanzania buzzed with the announcement of the next big initiative aimed at rescuing the nation’s struggling startup ecosystem: the National Venture Capital Fund (NVCF). Intrigued but sceptical, I delved into an article from The Citizen to understand the rationale behind this initiative. The article highlighted Tanzania’s challenges in attracting funding, attributing them to inadequate tracking of private capital allocation, poor regulations, and a need for a better investment climate. While I agree that Tanzania’s investment environment needs significant improvement—a topic I frequently write and talk about —the proposal for an NVCF strikes me as misguided and potentially harmful to the very startups it aims to support.
Misdiagnosing the Problem
The introduction of an NVCF seems to address a problem with the wrong solution. Yes, Tanzania lags in attracting venture capital, but the underlying causes are complex and deeply rooted. These include an underdeveloped financial ecosystem, weak infrastructure, regulatory uncertainty, and a general lack of investor confidence in the country’s ability to support high-growth startups. Proposing a government-backed venture capital fund as a solution oversimplifies these issues, missing the mark on what the startup ecosystem truly needs.
The Role of SMEs: The Backbone of Tanzania’s Economy
Contrary to the government’s focus on big companies and multinational corporations, it’s crucial to recognize that the backbone of any economy, including Tanzania’s, is small and medium-sized enterprises (SMEs). The Tanzania Chamber of Commerce Industry and Agriculture reported that a staggering 95% of companies in Tanzania are SMEs. This is a significant number, emphasizing the importance of nurturing these smaller businesses rather than channelling efforts primarily towards larger corporations.
Despite the critical role of SMEs, many commercial banks receive grants, letters of credit, and other financial instruments from development partners intended to support these enterprises. However, we rarely hear of SMEs benefiting from these programs. This disconnect highlights the pressing need for more accessible funding mechanisms. We should be encouraging diverse funding sources, including angel investments and venture capital, to support startups in need of growth capital. Yet, the discussion surrounding venture capital and private equity in Tanzania often overlooks a crucial point: there are few high-quality startups to invest in.
The Absence of Existing Venture Capital and Private Equity Funds
One glaring omission in the NVCF proposal is the lack of any existing venture capital (VC) or private equity (PE) funds in Tanzania. Instead of establishing a national fund, the focus should be on creating a regulatory environment that attracts and nurtures private VCs and PEs. Currently, Tanzania’s startup ecosystem does not benefit from the presence of these crucial financial intermediaries, which play a pivotal role in providing not just capital, but also expertise, mentorship, and valuable networks.
Regulatory Hurdles: The Companies Act
A fundamental barrier to attracting VCs and PEs is Tanzania’s Companies Act, which fails to accommodate the types of legal vehicles necessary for a thriving venture capital ecosystem. Countries like South Africa, Mauritius, and Kenya have developed legal frameworks that facilitate the establishment and operation of VC and PE funds, making them more attractive destinations for investors. Tanzania, however, remains behind, with outdated regulations that deter potential investors. Without addressing these legal shortcomings, simply injecting government funds into the market will not solve the underlying issues.
Taxation Challenges and Legislative Bottlenecks
Taxation is another significant hurdle. The recent amendment to Section 52 of the Income Tax Act, which addresses changes in ownership, was a minor victory after years of lobbying. This change, viewed by many as common business sense, underscores the extensive effort required to make even basic regulatory adjustments. It highlights a broader issue: the Tanzanian market is not yet ready for sophisticated investment vehicles like venture capital and private equity. Effective lobbying and ongoing dialogue with regulators are essential to create a conducive environment for these types of investments.
Government Involvement: A Double-Edged Sword
Government intervention in venture capital is a double-edged sword. While there are success stories, such as Israel’s Yozma Program, many government-led initiatives have led to inefficiencies, misallocation of resources, and even corruption. In Tanzania, where bureaucratic inefficiency and corruption are already pressing issues, the risks associated with a government-backed fund are magnified. Venture capital is a specialized field requiring deep expertise in evaluating startups, understanding market dynamics, and managing risk—skills that government officials in Tanzania may lack.
Moreover, government-backed funds often come with political strings attached, mandating investments in certain sectors or regions regardless of market realities. This can lead to resources being funnelled into politically favoured but economically unviable ventures, stifling innovation and creating inefficiencies that hinder the growth of a healthy startup ecosystem.
Crowding Out Private Investment
One of the most significant dangers of establishing an NVCF is the potential to crowd out private investment. By stepping into the venture capital space, the government could inadvertently discourage private investors who might otherwise be willing to take on the inherent risks associated with funding startups in Tanzania. Private investors are typically more discerning and motivated by the potential for high returns. They bring not only capital but also valuable expertise, mentorship, and networks that are crucial for the success of startups.
If the government provides capital through the NVCF, private investors may perceive the market as distorted or deem the risks too high, leading them to invest elsewhere. This could result in a scenario where the only available capital comes from the government, which, as previously discussed, is unlikely to be as effective or efficient as private venture funds.
The Real Barriers to Growth
The core issues hindering the growth of startups in Tanzania extend beyond the mere lack of capital. These include:
- The Tanzanian regulatory environment is often unpredictable, with policies that can change abruptly and without warning. This creates a high-risk environment for investors, who may hesitate to commit capital without a clear understanding of the rules governing their investments.
- Startups in Tanzania face significant challenges related to basic infrastructure, such as reliable electricity, internet access, and transportation. These issues escalate the cost of doing business and make it harder for startups to scale effectively.
- While Tanzania boasts a wealth of entrepreneurial spirit, there is a noticeable scarcity of skilled talent, which cuts across all fields in Tanzania not to mention technical fields like software development, data science, and engineering. Enterprises that are growing and at a fast pace need a diverse set of skills and a big work force to hire and fire quickly. This talent gap hampers the ability of startups to build the competent teams necessary for growth, but the employment laws in Tanzania are not conducive for start ups as they mandate bureaucratic procedures that require resources and time, the 2 things that start ups do not have much of.
- For startups to thrive, they need access to markets beyond Tanzania’s borders. However, restrictive trade policies, logistical hurdles, and a lack of regional integration make it difficult for Tanzanian startups to scale regionally or globally.
- Many startups in Tanzania suffer from weak corporate governance, lack of proper legal documentation, and inadequate financial controls. These shortcomings make it challenging for investors to assess the viability of these businesses, further deterring potential investments.
- A short-term mindset among many entrepreneurs in Tanzania is another barrier to attracting venture capital. Startups with a narrow focus on immediate gains rather than long-term growth and scalability are less appealing to investors looking for sustainable business models.
Exit Challenges and Market Liquidity
Another significant issue deterring venture capital funds is the uncertainty related to exit strategies. The Dar es Salaam Stock Exchange (DSE), for instance, is small and illiquid, making it difficult for investors to realize returns on their investments through public offerings. In the venture capital world, successful exits are critical, and without a viable exit strategy, investors are less likely to commit capital in the first place.
Institutional Investment and Regulatory Limitations
When discussing VC funds, it’s important to note that the limited partners (LPs) or investors are usually institutional investors, including pension funds and social security funds. However, current regulations in Tanzania place caps on the types of investments that these institutions can make, further limiting the potential for venture capital funds to thrive. Without reforming these regulations, it is unlikely that significant investment will flow into venture capital, stifling the growth of startups in the country.
Building the Right Ecosystem: What Tanzania Really Needs
Instead of focusing on creating a National Venture Capital Fund, the Tanzanian government should prioritize building an ecosystem that naturally attracts and nurtures private venture capital and private equity investments. This involves several key initiatives:
- Simplifying business regulations, providing clear and consistent policies, and reducing bureaucratic red tape are essential steps toward making Tanzania a more attractive destination for investors. Updating the Companies Act to accommodate legal vehicles suitable for VCs and PEs is a critical component of this effort.
- Addressing infrastructure challenges, particularly in energy, transportation, and internet connectivity, would significantly reduce the cost of doing business and make it easier for startups to scale. Reliable infrastructure is a cornerstone of any thriving business ecosystem.
- Investing in education and training programs, especially in technical fields, is vital for developing the talent that startups need to succeed. Enhancing the skill sets of the workforce will make Tanzanian startups more competitive and appealing to investors.
- Improving trade policies, reducing logistical barriers, and promoting regional integration can help Tanzanian startups access larger markets and scale their businesses beyond national borders. Easier access to regional and international markets can drive growth and attract more investment.
- Creating incentives for private investors, such as tax breaks, investment credits, or co-investment schemes, can stimulate the flow of private capital into the startup ecosystem. Encouraging private investment ensures that startups have access to the right kind of capital—funds that come with expertise, mentorship, and networks essential for growth.
- Implementing programs and workshops that educate entrepreneurs on corporate governance, financial management, and legal compliance can help improve the overall quality of startups. Startups that demonstrate strong governance and financial controls are more likely to attract investment.
- The NVCF could be a Fund of Fund (FoF) that invests in Venture capital and private equity funds that are investing in the Tanzanian start ups. It is a great way to increase the supply of venture capital to young growth-oriented firms, and it is fairly low maintenance compared to having an actual venture capital fund, since the role of selecting, monitoring, and exiting entrepreneurial ventures to the VC managers of the funds in which they invest. As Limited Partners, the government would typically not involved in the VC fund decision making process, but would monitor whether the overall strategy and investment principles and processes are respected. The role of a FoF is hence largely limited to selecting the VC funds in which it invests.
The proposal for a National Venture Capital Fund in Tanzania addresses a symptom—lack of capital—without tackling the root causes that make Tanzania an unattractive destination for venture capital and private equity investments. Instead of creating a government-backed fund, the focus should be on building a robust ecosystem that naturally attracts private investment. By improving the regulatory environment, investing in infrastructure and human capital, and encouraging private investment, Tanzania can create a sustainable startup ecosystem that supports the growth and success of its entrepreneurs.
Finally, having worked with a number of start ups to help them fundraise and getting them investment ready, start ups complain that their lack of growth is due to lack of funding. However, when we deep dive into the companies and really look at what needs to happen in order to unlock the growth, 99% of the time we find that the company in fact needs either corporate governance structures, legal health checks, rigorous marketing and sales before it can be anywhere near ready for investment.
If you are an entrepreneur or business owner, you should get my book which will help you build the legal systems you need to be investment ready. You can buy it here: https://a.co/d/8tivDph
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