Managing Funds Through a Semi-autonomous Operating Entity: A Viable Solution to Ethiopia’s Capital-constrained Start-up Ecosystem?

Ethiopia relies on its startup sector to create jobs and build a digital economy through the development of innovative digital products and services. This is hampered by a lack of access to finance at all stages of the start-up journey. 

A lack of investor support and limited access to early-stage capital from banks or other sources compel most entrepreneurs in Ethiopia to self-fund their new enterprises. 

Entrepreneurs often turn to their financially limited networks of extended family, professional contacts, and friends to supply their seed capital. This results in inequality of opportunities, as founders with more established professional contacts and families will have much greater access to early-stage support than those with more modest networks, regardless of how promising their business venture may be.

Reluctance to invest on innovation by institutional or individual investors as well as financial institutions (majorly due to lack of expertise to accurately assess risks) is another predicament faced by startups in Ethiopia. 

A technical note published by the Ministry of Finance (MoF) and Digital Pathways at the University of Oxford in 2021 outlines this continual cycle is not only prohibiting the country from reaping economic benefits from these ventures but discouraging future generations of innovators.

The Note recommends that the Government of Ethiopia establishes a comprehensive framework of funding and support programs managed by a semi-autonomous operating entity (SAOE). 

The SAOE would provide a wide range of services and support for startups, under the oversight of a board comprised of both public and private sector stakeholders. The board could report to the Ministry of Innovation & Technology or the National Startup Council, proposed by the yet-to-be-implemented Startup Act. 

Having a managing and operating entity at an arms-length from the government helps to overcome the reluctance of international investors to participate in economies where they would otherwise have concerns around undue influence by powerful public sector actors. On the other hand, some distance from the staffing, funding, and investing decisions protects the government from allegations of favoritism and reputational risk. The Government will also be up-to-date with the fast-changing needs of the startup ecosystem as the private sector participates in the SAOE. 

The recommended “Jumpstart Ethiopia” SAOE would have three divisions: an Investment Unit; an Ecosystem Unit; and a Marketing Unit. The Investment Unit is divided into a Priority Investment Sub-Unit and a Secondary Investment Sub-Unit. The Priority Investment Sub-Unit would establish and manage a Venture Capital Fund of Funds (VC FoF) for broad investment in Ethiopian digital startups and a smaller co-investment fund to leverage investor interest in exceptional startup opportunities. 

The VC fund of funds model has proven a successful market- and evidence-supported method for initiating a vibrant, domestic venture capital market in various economies. Ghana created a fund of funds, the Venture Capital Trust Fund (VCTF) in 2005. 

The Ghanaian VCTF had a short run as it was funded via a 25% tariff on the National Reconstruction Levy, repealed due to public pressure. However, it delivered many benefits for the startup ecosystem and proved to have been a worthwhile investment in the development of the Ghanese economy in the long run. Ghana ranks 6th among nations in Africa for total venture capital and 84th on the Global Startup Ecosystem Index. 

The note tasks the Secondary Investment Sub-Unit of the SAOE with facilitating smaller funds that build domestic investment capacity through the employment and mentoring of Ethiopian investment professionals.

Read the full technical note here

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