The Role of DFIs in Venture Capital

Abayomi-Olukunle, is Lead Transaction Advisor,  Balogun Harold  (Barristers & Solicitors)

Olubunmi Abayomi-Olukunle
By many standards, the venture capital industry in Nigeria is still emergent especially if one considers the size of the deals, number of funds and sophistication of investors in the market. Accordingly, the Federal Government must promote venture capital activity in Nigeria as a strategic policy initiative and in order to promote innovation and enterprise amongst the most productive segment of its population. As part of that process, the Federal Government should strategically engage all the stakeholders in the industry’s value chain.

This is particularly important at this time given the increasing flow and value of foreign investments into the venture capital space in Nigeria, a trend, which in our view, holds the promise that Nigerian start-ups can unleash a revolution of wealth creation and rapid economic growth in a sustainable manner. Our proposition is that local Development Finance Institutions (DFIs) are critical stakeholders in the value chain and have a significant role to play in Nigeria’s venture capital industry.

It is in this context that the decision by the board of Nigeria’s Bank of Industry (BOI) to be investors in the first-ever social innovation fund out of Nigeria, is commendable. In a financing mix of both local and foreign investors, BOI (alongside Venture Garden Group and Omidyar Network) is committing up to USD230, 000 to a USD 1 Million social innovation fund promoted by Nigeria’s foremost startup incubator, CCHub. It is interesting to note that the fund will be managed onshore. Also noteworthy, is the fact that the fund aims to invest in early-stage tech companies that demonstrate an ability to solve a social problem – Think of a company that converts heaps of refuse to clothing, shelter or other usable material.

The decision of the Board of the BOI accords with trends we see in the international venture capital space, tending towards an overall increase in the portfolio allocation by international DFIs to early-stage fund managers and ventures. This July, the board of directors of the International Finance Corporation (IFC) will be meeting to consider making a USD 10 million commitment to Algebra Ventures Fund which will target technology and technology based start-ups in Egypt, the broader middle-east and the North African Region. Similarly, the European Investment Bank is considering making a USD 10 million commitment to TLcom’s TIDE Fund, a planned 100 million venture capital fund, which will invest in entrepreneurs and enterprises that are leveraging technology.

Recently, it was announced that IFC has decided to double its venture capital portfolio to USD 1 Billion to further spur innovation in emerging markets. One of the companies in IFC’s venture capital portfolio is Andela, a company co-founded by a Nigerian. The Company recently received USD 24 Million in a series B funding in a round led by the Chan Zuckerberg Initiative.

Growing trends in this space should bring to focus debates around how DFIs in Nigeria can be used to strategically grow Nigeria’s venture capital industry especially in the area of supplying finance to the industry. There is, in our view, a shortage of risk finance to high growth tech/e-commerce start-ups especially when one considers the rapid increase in the number of Nigerian tech start-ups with scalable business models. The majority of the financing currently available from local DFIs is debt-linked. More of the risk financing available have been from foreign venture capital and angel investors who focus on Africa. On the local scene, the Lagos Angel Network and the African Business Angels Network, are gathering a more enduring appetite for early-stage risk.

Also, a growing network of solo angels, incubators and corporate venture funds in Lagos and Abuja hold the promise of soaking up some of the demand that is available in the market. Nonetheless, we think that a sizeable portion of the market is underserved in terms of the availability of risk finance. Nigeria’s venture capital industry will require a sustained injection of risk capital and local DFIs are in our view better positioned to close this gap as, by their nature, DFIs have higher risk tolerance and longer investment horizons and are able to take up investments in sectors where the private sector finds it difficult to invest.

The active involvement of local DFIs in the venture capital space can help grow the industry in a number of ways. First, there is empirical evidence that lends credence to the theory that increased portfolio allocations by local DFIs to early-stage ventures or venture capital fund managers can catalyze and help attract and mobilize other sources of capital. In addition to helping mobilize other sources of capital, the involvement of DFIs can also help provide the much needed management support and hands on experience that can help commercialize entrepreneurial vision. Secondly, DFIs can help in promoting and entrenching ESG compliance across board, thereby promoting the adoption of sound business practice, an imperative, which will further give comfort to potential limited partners.

We think that the current state of play presents a good opportunity for local DFIs to expand the range of financial products available to Nigerian start-ups, by increasing allocations to Nigeria’s venture capital sector either through dedicated venture capital funds or through participations in privately-managed venture capital funds.

It is important however to situate the foregoing within the extant legal framework for DFIs in Nigeria, especially because, there are a number of provisions contained in the CBN Regulatory and Supervisory Guidelines for Development Finance Institutions in Nigeria ( the Guidelines) that have a bearing on a DFI’s level of exposure to the venture capital patch in Nigeria. For instance, local DFI’s may only invest in a start-up business up to a limit of 10% of shareholders fund unimpaired by losses. DFI’s are also subject to a maximum of 25% holding in any enterprise. Whilst we take the view that the current thresholds are fairly acceptable given the state of development of the industry, we note that the Guidelines do not define the term “start-up business”.

In our view, it is important to define that phrase as the meaning of the phrase is not immediately obvious and also capable of multiple interpretations. Businesses at different stages can qualify as a “start-up business” depending on the indices used. More importantly, the wording of the Guidelines suggests strongly that DFIs can only take up equity directly in start-up businesses as opposed to taking up participating interest in third-party managed venture capital funds, a prospect which we think may hinder the growth of the venture capital industry in Nigeria.

DFIs would also have to do more in terms of building capacity to complement a possible increased allocation to early-stage ventures and as part of own value creation strategy. In addition to building capacity in terms of evaluating, structuring and negotiating new equity, venture-type transactions, it will be important to develop venture capital investment strategies that are not only reflective of local commercial realities but can also help to mitigate possible risks in a downside event. Overall, allocations to the venture space will have to be in the form of patient capital, an investment strategy which has now overtaking the traditional venture capital as a source of investment for tech start-ups in mature markets.