29/11/2023

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In the wake of Dash’s closure due to fraud, 5 investors talk due diligence in Africa

In the wake of Dash’s closure due to fraud, 5 investors talk due diligence in Africa

It’s been a tough year for tech startups globally. These struggles have manifested in layoffs, down rounds and complete shutdowns caused by current market conditions, utter mismanagement or fraud.

This August, SoftBank sued one of its portfolio companies, IRL, a social media platform poised to become an event organizing alternative for Gen Zs, for fraud. Earlier this summer, an internal investigation by IRL’s board of directors found that 95% of the app’s 20 million monthly users were fake (primarily bots). The company’s CEO, Abraham Shafi, was suspended in April and IRL became defunct a month later. At the time, IRL had raised several rounds, including a $170 million Series C led by SoftBank in 2021 at a $1.1 billion valuation.

SoftBank sued IRL, alleging $150 million in damages; in its legal complaint, the Japanese investment firm explains that it was moved to invest in IRL because of its impressive user numbers. SoftBank claimed it wouldn’t have been possible to verify IRL’s fake user numbers because the defunct company had “prepared for SoftBank’s due diligence and structured IRL’s business so that SoftBank could not discover evidence of their fraud.” That’s quite sophisticated if you ask me.

A similar event mirroring what happened at IRL and to its CEO recently occurred in Africa within the past few months, except for the suing.

Dash, a Ghanaian fintech founded in 2019, provided an alternative payment network with connected wallets, allowing interaction between mobile money and bank accounts in Africa. When the fintech went into the market to raise its seed round at the height of the venture capital boom in late 2021, it claimed 200,000 users across Ghana, Kenya and Nigeria while processing over $250 million in transaction volume. It secured interest from Global Founders Capital and 4DX Ventures, raising almost $8 million.

But between December 2021 and March 2022, five months after its first seed tranche, Dash topped $1 billion in transaction volume from a million users, numbers it reported during its seed round after receiving an additional $25 million from Insight Partners.

The four-year-old fintech’s troubles started in February when its CEO, Prince Boakye Boampong, was suspended after an investigation into financial impropriety and misreporting by the board. This month, Dash, which has raised over $50 million (including $20 million in debt capital from TriplePoint Capital), shut down. Local reports claim that internal examinations of Dash’s financial records revealed that Boampong had inflated and overstated the number of users and that at least $25 million was missing from the company’s account.

Most of its investors, including Insight Partners, its lead at the seed round, got burned. And what happens when the first lead investment of a firm as big as Insight’s goes burst in this manner? It’ll likely take a step back. Sources say the global software investor has taken a break from investing in African startups for the foreseeable future (the investor who led Insight’s Africa strategy is no longer with the firm).

In retrospect, Insight Partners and other investors would agree that there were warning signs they chose to disregard. For example, in 2016, Boampong founded OMG Digital, a YC-backed Ghanaian media startup that raised more than a million dollars but has since ceased operations with no reports indicating why. Similarly, Dash’s user and transaction volume numbers centupled within five months despite it being challenging to find a real-world user of the platform during this time.

This event, along with that of Float, a Ghanaian fintech launched by another OMG Digital co-founder that’s dealing with issues around mismanagement of funds, re-ignited conversations about how lax due diligence has been in African tech over the past 18 months, where FOMO and being founder-friendly became the norm.

TechCrunch spoke with four early-stage to growth-stage investors about the lessons to be learned and what local and international investors must do to avoid startup failures attributable to a lack of due diligence.

We spoke with:

The responses have been edited for length and clarity.

Lexi Novitske, general partner, Norssken22

What repercussions or ripple effects might we see from the demise of startups that result from blatant mismanagement and maybe fraud?

The past couple of years were an incredible time for Africa, where we saw global VC investors becoming excited about the African growth story. Coupled with the global correction, many VC investors are retrenching to the markets they know best. I fear that incidences of both mismanagement and fraud could scare many global VCs away when they were just starting to get to know the ecosystem.

Specifically, I think you’ll see investors doing much deeper due diligence, including live bank, checks, tougher control terms, investment agreements and overall more risk aversion from especially international venture capital firms looking to invest in the market.

What lessons can African tech startups and VCs learn from these failures?

We’re still in an early ecosystem, and there are a lot of lessons to be learned from these failures. Namely, I think enhanced both qualitative and quantitative due diligence will need to be done even at the earlier stages. But I also think it gives an opportunity to those companies who have enhanced their governance processes early in their life cycle.

Those companies should start to see a premium from investors as it’ll give those investors a lot more confidence and not only their numbers but their ability to handle rapid growth.

The thing is, if the founder is motivated to defraud their investors, they will. This means a lot more focus from investors on their portfolio companies and making sure that they’re embedded in the operations and strategy of a company. That’ll ultimately lead to much more concentrated portfolios, especially some of the earliest-stage funds.

Such closures have called more attention to stricter due diligence than ever in African tech. How significant is the role of local VCs in carrying out due diligence on African startups from early to growth stage, and to what extent should international investors rely on them?

Now more than ever, it’s important for international VCs to work with local VC partners on transactions. Local partners have a leg up and understand the nuances, being able to see business operations and market and having the relationships to do in-depth channel checks on business operations.

Also, on a side note, I think we’ve rewarded a culture of ‘fake it till you make it’ a little bit too much. I’ve seen this not only with startup companies but also with VCs. If we want to build a sustainable quality ecosystem, I think it’s essential that all actors promote a culture of truth even if, at times it’s vulnerable. Building is hard, and failing is hard, but those founders who have run their businesses promoting a solid culture around ethics hopefully will be rewarded in the long term, even if it’s at a new venture.

Eloho Omame, partner, TLcom Capital and co-founder, FirstCheck Africa

What repercussions or ripple effects might we see from the demise of startups that result from blatant mismanagement and maybe fraud?

It’s not my place to delve into specifics on these situations without all the facts. But as a practitioner in the ecosystem, I will emphasize three things. First, founders are generally good-faith actors, and VCs are typically responsible investors. When either of those assertions becomes false, the venture asset class has a severe existential problem.

Second, it’s impossible to entirely eliminate the risk of bad faith actors on either side in any system where there is massive value at stake and material informational asymmetries.

Third, edge cases don’t define an ecosystem. Discussing ripple effects from edge cases seems to me to be the wrong perspective. Bad outcomes will provide ready fodder for anyone who’s already skeptical of Africa as an investment destination or Africa VC as an asset class. But we’ve got a solid track record of success stories in Africa that far outweigh the failures. Instead of getting caught up in the negative hype, we should double down on building an ecosystem that thrives on openness and trust. By doing that, we’re setting up for success, and that’s the real path forward.

What lessons can African tech startups and VCs learn from these failures?

Company failures are a feature, not a bug, of the VC ecosystem, given the particular mix of circumstances surrounding high-growth companies. Founders and investors go on a journey together to build very large companies fast while operating at the frontiers of technology and innovation. That brings with it, of course, the need to manage multiple complexities, often in parallel.

Things could go well in the long term, and you build a company that creates massive value. Sometimes, they don’t, and companies run out of cash or fail for other reasons. That’s the model. Good VC fund managers consistently evaluate their investment processes and screens not just to minimize the risk of bad actors but also to maximize the chances of making the kinds of decisions that drive great outcomes.

What matters is that we learn from failures what didn’t work, adjust our strategies and avoid making the same mistakes. 

Such closures have called more attention to stricter due diligence than ever in African tech. How significant is the role of local VCs in carrying out due diligence on African startups from early to growth stage, and to what extent should international investors rely on them?

In the long-term, it’s obviously counter-productive for any institutional Africa-focused fund to rely on weak diligence. Improvements could always be made, but the narrative that VC diligence in Africa’s tech sector is lax is unfounded.

When fundraising markets are as liquid as they were a year-and-a-half to two years ago, the systemic challenge isn’t a lack of rigor but market pressures that sometimes optimize for a fast dealmaking pace and can increase the chances of bad outcomes. Dynamics shift, and not always for the better.

Founders become less patient, and rounds become more competitive. A faster-than-normal pace can make things tricky. In addition, international funds start to look for deals outside their core markets, and some invest in unfamiliar markets for the first time.

In Africa, there’s local knowledge, networks and context to contend with, so I’d encourage international funds to work with experienced local funds as they evaluate companies and make investments. It’s just good sense. That said, as local VCs, we’re not responsible for the due diligence of international funds or for their mistakes if and when they make them. Every VC fund — local or international — should rely on the weight of its own diligence when making investments. Anything else is a failure of its fiduciary and moral obligations to its LPs. 

Peter Oriaifo, principal, Oui Capital

What repercussions or ripple effects might we see from the demise of startups that resulted from blatant mismanagement and maybe fraud?

The repercussions are clear, global capital will pull back on investing in African startups in the short term, and will subsequently scrutinize both the startup opportunities and their endorsers heavily before engaging in the future. Furthermore, more emphasis will be placed on founder behavior past and present, as controls are established around finances and operations.

If I were an LP at any VC fund that had exposure to the aforementioned shutdowns, especially the local VCs (as the relative loss in terms of percentage of the portfolio would be significant), I would demand a comprehensive audit to understand what happened exactly, what could have been done better and where investors may have fallen short so that actionable steps can be taken to prevent or better contain such incidents in the future.

What lessons can African tech startups and VCs learn from these failures?

I have long held the belief that Africa is a nurture versus nature market; as such the approach to venture capital on the continent needs to be hands-on. Founders certainly don’t have it all figured, but given the volatility inherent in Africa, I find that they are often in need of a steady hand; this is where VCs ought to play an outsized role, providing actionable advice, helping set structure and controls either informally or more formally via board observer or full-blown board director seats.

Such closures have called more attention to stricter due diligence than ever in African tech. How significant is the role of local VCs in carrying out due diligence on African startups from early to growth stage, and to what extent should international investors rely on them?

It is significant in my mind. Much has been made about how some of these shutdowns highlight the misadventures of global VCs entering the African VC market; however, I think about it very differently. If anything, I see it as a failure in part of the fiduciary duty of VCs local to the African market.

I would never expect a VC whose core business is investing in the U.S. or Europe to understand the intricacies of operating in the African market, nor would I expect them to be able to maintain tight oversight from afar. This to me is the role of local VCs in Africa: to effectively block and tackle global VCs who invest upstream (whether it be seed or growth stage). By being the eyes and ears on-ground for global VCs, local investors should have a tighter grasp on governance and operations.

A failure to deliver on these key tenets in my mind destroys the value proposition of the local VC; if you can’t exert all the advantages of being local to the benefit of an international investment syndicate, why should you be in the equation to begin with? Venture capital is a reputation business, every deal is an endorsement levered against your good name, something I think we all should strive to protect meticulously. 

My guiding principle for investing on the continent is that I don’t do a deal unless I have the same level of buy-in as the founders, nor do I endorse deals for follow-on capital unless I can vouch for it in its entirety. In a nascent venture capital market such as the one we have in Africa, credibility is the prize we are all fighting for on a global stage, both founders and investors — an erosion of said credibility sets the ecosystem back, globally.

My sincere hope is that local VCs think more deeply about their role in the ecosystem and work to (re-)earn the trust of global VCs. Success to me in African VC is one wherein both local and global VCs share in the successes of venture-scale outcomes, not one where local VCs benefit at the expense of global VCs.

To this end, I think there has long been a tendency in this ecosystem by local VCs (most of whom operate at pre-seed/ seed) to run a factory of sorts, where there is haste to flip to the next buyer/ investor up the value chain. I certainly do understand how we got here, as most local VCs were but mere angels a few years ago and have yet to really take on the role and embodiment of what it means to be an institutional investor. I think there needs to be a shift away from this” factory approach,”  to a much more intentional approach to company building ensuring that the I’s are dotted and the T’s are crossed; then and only then will we start to see trust deepen between local VCs and their global counterparts.

Aaron Fu, VP, fintech ventures, DCG Expeditions

What repercussions or ripple effects might we see from the demise of startups that result from blatant mismanagement and maybe fraud?

Fraud and mismanagement of startups occur in ecosystems across the world, Africa’s ecosystem experiencing this is a part of its maturing experience. Will some global VCs take this as validation of pre-held biases around fraud and corruption in Africa? Absolutely. Will VCs like DCG which truly know Africa and believe in its long-term growth story continue to invest? Absolutely.

What lessons can African tech startups and VCs learn from these failures?

A framework for robust, active governance of startups should be in place even at early seed rounds. During the boom of 2021/22 many founders did away with this and while it perhaps accelerated their agility, it came with a cost. Some of the best founders I know (especially serial founders), consciously build a pathway towards a pre-IPO governance structure from day 1.

Such closures have called more attention to stricter due diligence than ever in African tech. How significant is the role of local VCs in carrying out due diligence on African startups from early to growth stage, and to what extent should international investors rely on them?

It’s a time for reflection for sure. We certainly believe that many local VCs have a comparative advantage when it comes to certain elements of early-stage due diligence, including being more embedded with their customers and broader value chain; many also have a wider breadth of local networks through which to conduct team reference checks. At DCG Expeditions we believe in a co-invest strategy with local investors and will continue working with the leading VCs in Africa, many of whom we tag team within tight coordination on diligence efforts, to back some of the most ambitious founders on the continent.

Maya Horgan Famodu, founding partner, Ingressive Capital

What repercussions or ripple effects might we see from the demise of startups that resulted from blatant mismanagement and maybe fraud?

The problem with implementing stricter due diligence is that we’re investing at the very early pre-seed and seed. So it’s more of a matter of character and making sure that they have strong fundamentals and savviness when it comes to financial operations. 

Most of the issues that have happened in the ecosystem are consequences of founders who do not have strong financial backgrounds and do not have an idea of burn cash management, cash flows, and things like that. 

Historically, really early-stage investors and I speak for ourselves, we optimize for a product person, technical person, somebody with experience in the sector who can sell to the target demographic, and later stage like at the pre-series A is when we were focused on a CFO or finance talent. Now, the main difference for our firm is ensuring that there is a financial operator as a core member of the team from day one, a decision maker with equity, and at minimum having a contract or an outsourced CFO from the initial stages. We’re working with third-party professionals so that we can have these implemented in companies from the jump.

What lessons can African tech startups and VCs learn from these failures?

What’s interesting is that these companies didn’t just happen to randomly fail. Most of them were a decision to shut down and by investors to stop funding the company. They didn’t just explode overnight and you know, missed all the cash, etc. It was a decision to stop funding.

​​And I want this to be very, very clear, this isn’t an indication that there is not capital coming into tech in Africa. On the contrary, we have more venture capital funds targeting Africa, dedicated Africa funds, and more grow-stage African funds than we have ever had. So the amount of dry capital targeting Africa is at an all-time high. What I can say with this capital is that like global investors, It is prioritizing now instead of growth at all costs. We are going back to where we were pre-COVID. Because Africa didn’t have the luxury of building high-in-the-sky businesses pre-COVID, we’re going back to that time when we were looking for near-term profitability, even when investing at the pre-seed and seed in companies that were at least EBITDA positive or had a near term to profitability, or financials such that if they didn’t get funded or raise follow-on funding, they will be sustainable. 

So we are actually just coming back to a few years ago. Fortunately, it’s not our first rodeo and Ingressive capital, I can say this is actually how we built our fund. And a lot of Western investors were really confused when we were backing companies and asking for their financials at the pre-seed or at least, their models, and asking when they will get profitable. And people are like, “This doesn’t make any sense. Why do you care about that? It’s a tech startup.” But now at least it’s becoming more standard across the industry for those finance conversations to be had at these pre-seed stages. 

And another thing that we’re working to implement is teaching. Establishing some type of training for pre-seed founders when it comes to financial prudence, even in their own personal financials because the way a founder does one thing is the way they do everything. If we can assist in giving financial training and help them develop a keen understanding of cash flows and cash management.

Such closures have called more attention to stricter due diligence than ever in African tech. How significant is the role of local VCs in carrying out due diligence on African startups from early to growth stage, and to what extent should international investors rely on them?

There was a lot of unsolicited capital that came into the ecosystem over the last few years and allowed investors and founders to get a little too comfortable. Now, I think this is a good thing. Cash goes to great businesses, and companies that don’t make sense and are not sustainable are much less likely to get funded. 

People are spending more time and diligence and most especially more time getting to know founders. Before we would make decisions in six weeks, eight weeks max. Now, it’s like the eight-to-ten week period we have to look at companies to really spend time with the founder to understand the way they’re thinking about the business to understand the way that they’re looking at their own financials and thinking through the sustainability of the business in a down market.