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Chasing Unicorns: The Emerging Market Myth of Venture Capital

4 October 2018

Traditional Venture Capital doesn’t work in emerging markets – yet.  Here’s why

‘Saying that traditional venture capital doesn’t work in emerging markets is taking a very hard line,’ begins Manuel Koser, MD and cofounder of Silvertree Internet Holdings. ‘But I will say this: VC doesn’t work in emerging markets yet.

Silvertree, the investment growth partner behind some of South Africa’s most successful digital brands, counts digital giant,,,,,, and among its investments. Together, Silvertree’s brands amass six million unique visitors online each month and form one of the largest internet businesses in South Africa.

Unlike traditional VCs, Silvertree acts as an entrepreneur-led business growth partner that reinvents how consumer and digital brands unlock exponential growth – a key differentiator, argues Koser, in an emerging market like SA.

In search of unicorns

‘There are a number of perspectives on why VC doesn’t yet work in emerging markets,’ Koser notes, beginning by considering the emerging market entrepreneur who starts a VC fund himself.

‘To have a fund that is self-sustaining, you need in the region of 25 million USD in assets under management. But in an emerging market context, it’s incredibly difficult to find enough quality businesses to invest in to hit that number.’ At smaller numbers, however, say two or five million dollars deployed, the fund’s economics cease to make sense. ‘The 2%/20% structure is simply not sustainable at this scale,’ Koser explains, ‘and often leads to poor risk-adjusted investments, as well as limited due diligence due to cost constraints.’

‘In funds operating with, say, ten million dollars or less, the entrepreneur – the fund’s general partner – also often starts to overcharge the fund,’ Koser explains. ‘This suppresses returns. Investors soon begin to feel that they should rather have put their money in, say, the JSE, given that the All Share Index earned an annualised return of around 10% per annum over the past 10 years.1 And which would have been a liquid investment too, versus the illiquid private investment of a VC.’

The core is this: ‘Most emerging markets are simply not ready. You’re often chasing unicorns in a small market that’s not yet scaling.’

Implications for startups

Far too often, says Koser, startups in emerging markets are also coached to follow the ‘Silicon Valley’ model – finding a disruptive idea, building a proof of concept or ‘minimum viable product’, and then hitting the pitching circuit to secure VC funding.

If the VC model doesn’t work, however, what does this mean for these startups? ‘New businesses in emerging markets normally need to focus much earlier on viable unit economics and even profitability than in established VC hotspots. Secondly, they need to look beyond classic VCs to other capital sources – which absolutely do exist. Complaining that, “VCs don’t support startups,” misses the point that the VC model itself struggles – so startups need to change their approach to capital access.’

A reality check on returns

There’s a lot of VC hype, too, Koser notes. ‘Despite what many believe, VC is a surprisingly poor asset class in general,’ Koser notes. ’The European Investment Fund, for example, recently released 10-year net annualised VC returns of 5%2, though the numbers are picking up a little more, now. Even on global basis, venture capital as an asset class does not outperform the S&P 500. Meaning VC on avergae also doesn’t justify the risk, given the illiquidity of the investments.’

So, why the glow? Why invest in VC at all? ‘Because the top funds – even the top quartile of funds – are completely outperforming,’ notes Koser. ‘There, you’re seeing exceptional returns, which are becoming self-fulfilling prophecies.’

Write-ups and write-offs

‘Take a typical group of 10 companies in which a VC firm invests. In a normal scenario, many of those companies will simply be written off,’ Koser explains. ‘One or two will pay back their investments. One may double or triple investors’ money. So then, out of those ten, one company needs to make fifty or a hundred times its investment if the fund is to make decent returns. This is very hard to do in a small market as exits north of 100 million USD are very rare.’

Koser emphasises: ‘Exits of that magnitude are only possible with scale. Which is why emerging markets often can’t deliver. Of course, it’s possible for a South African entrepreneur to create a world-beating product with global scale, but it’s incredibly difficult. You’re at a disadvantage if you’re trying to build a global business out of an emerging market because you’re competing with developed market networks and capital. If on the other hand, if you’re in an emerging market trying to make a product for that emerging market, the local market is often very small. It’s the reason why many emerging market VCs with only five to 10 million USD on their books are unhealthy – they’re scrambling for cash.’

A question of capital – and support

The final consideration is this: is venture capital the right path for emerging market entrepreneurs anyway? ‘Remember this – a venture capitalist is not an entrepreneur, he’s an asset manager,’ Koser explains. ‘He gets paid fees and manages others’ capital – it’s rare for a manager to have invested a substantial chunk of his own money in the fund he manages. This leads to the classic principal-agent problem – there’s a conflict of interest.’

Whereas the venture capitalist wants to grow and scale businesses as fast as possible, for example, the entrepreneur most often wants risk-adjusted returns, and to grow at a sustainable rate. ‘A traditional VC fund has a lifecycle of seven or eight years, after which entrepreneurs are pushed to sell. Even if there’s a bad political climate, the VC may push you to cash out,’ Koser notes. ‘This is a key reason that Silvertree is structured as a holding company with a permanent capital base – we don’t want to be forced into exiting an investment at the wrong time.’

There also come issues including understanding market fit, how to manage a team, how to hire and fire, and how to build good processes. In emerging markets, access to that expertise – even from investors, Koser notes – isn’t often readily available. Also, what works at 30 employees doesn’t work at 100 or then at 1000. Entrepreneurs also need to constantly relook at culture, business models, scaling and more. ‘How much benefit will a sub-scale VC provide this entrepreneur? Not much.’

Primarily, it’s about building a sustainable long-term company, with a product consumers love, Koser emphasises. But getting there is a complicated journey. ‘In an emerging market, you need an ecosystem provider. More than that, you need a true “co-founder” as your capital partner – someone who doesn’t just rock up at the quarterly board meeting and do a few introductions. Executional excellence is what separates the wheat from the chaff. But you also need a partner able to supply capital at different stages of the business lifecycle – from seed to growth and finally buyout capital. That’s what we at Silvertree do, and it’s been the foundation of our success.’

Traditional VC may not yet work in emerging markets, Koser concludes, but there are models for business investment and growth that do. ‘If you have a consumer brand or are a digital entrepreneur looking at scaling your business, we are always interested to meet. As a team of entrepreneurs for entrepreneurs, we understand the pitfalls, challenges and benchmarks that need to be in place in order to scale and grow,’ concludes Koser.