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'Silicon Valley-style' investing is impeding East Africa's DFS startups

'Silicon Valley-style' investing is impeding East Africa's DFS startups

A report from venture capital firm Village Capital Breaking the Pattern: Getting Digital Financial Services Entrepreneurs to Scale in East Africa and India, suggests that digital finance services (DFS) startups in each of the regions continue to struggle to secure the investment required to scale.

The report, backed by the Bill & Melinda Gates Foundation, said that while over 60 million people in East Africa lack formal bank accounts and more than 50% of small businesses lack access to formal credit, DFS companies continue to face "significant barriers to scale".

It highlights a high concentration of investment in a few select companies as one of the barriers.

"Despite a few well-known DFS companies operating at scale, like Safaricom's M-Pesa in Kenya and India's PayTM, most are not receiving the investment they need to scale. For instance, in East Africa, startup investment is at an all-time high, but 72% of venture capital went to only three startups in 2015 and 2016," reads part of a statement issued by Village Capital.

Another obstacle is identified under the heading 'human capital trap and business model challenges'.

"Investors in East Africa and India consider DFS companies to be risky because of human capital challenges and structural barriers in the marketplace; but these challenges are hard to overcome without investment," the statement continues.

A pattern recognition problem is added to the list of challenges. "Because of the high cost of early stage due diligence in India and East Africa, investors often fall back on patterns to find companies and make investment decisions - relying on networks and indicators like prestigious universities or accelerator programs."

Ross Baird, CEO of Village Capital, said, "If you've been paying attention to the Economist or the New York Times, you might think we're in a golden age for digital financial services in India and East Africa. In fact, we're only at the very beginning. We'll need hundreds of companies to reach scale to truly improve the financial health of communities in India and East Africa, requiring us to look beyond the 'one size fits all' model of venture capital in markets that operate under an entirely different set of rules."

The report provides several recommendations including: strengthening the human capital infrastructure; facilitating partnerships between entrepreneurs and major financial institutions; providing alternatives to pattern recognition fall-backs; and developing alternative financing mechanisms to provide DFS companies with the right funding at the right time.

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