If you’ve been reading The Economist or the New York Times, you might think we’re in a golden age for digital financial services (DFS) in India and East Africa: with a mobile phone, everyone could have an entire bank in their hand.
In fact, very few FinTech startups in these countries have reached meaningful scale. We're only at the beginning.
We'll need hundreds of DFS companies to reach scale to truly improve financial health in India and East Africa. Yet, despite a few success stories, the vast majority have trouble reaching more than a few thousand people.
Village Capital, with funding from the Bill & Melinda Gates Foundation, sought out the first-person voices of DFS entrepreneurs in India and East Africa to learn why.
Mobile phones and mobile money have revolutionized how East Africans connect to the economy and to each other.
Over the past five years, entrepreneurs in East Africa have built tech solutions around credit, savings and insurance. They have also developed innovations in mobile payment technology for essential needs like energy and healthcare.
“We’re trying to replicate Silicon Valley, and it doesn’t work right now in Africa.”
Yet in 2015 and 2016, 72% of all startup investment in East Africa went to only 3 companies. (Source: Disrupt Africa)
Financial inclusion is a policy priority for the Indian government, and this attention has spurred activity from entrepreneurs and investors: today there are more than 1,500 DFS startups in India.
Despite an active investment landscape, in 2015 and 2016 only five companies that raised follow on investment were focused on improving the financial health of the underbanked.
"There are really two Indias: One, I call India [where there are rich people] and one I call Bharat [the local name for the country]. Most of the money is going to India and much of it doesn't extend to Bharat.”
Only 5 Indian DFS companies that raised a Series B or greater in 2015 and 2016 were focused on improving financial health. (Source: Traxn)
Through interviews, we heard entrepreneurs identify four main hurdles to getting the investment they need:
There’s a chicken-or-egg dynamic: companies can’t raise money without the right team, but can’t afford the right team without raising money.
Another chicken-or-egg: investors want to see proof of a profitable business model, but building a DFS business in East Africa and India means moving the markets from an analog to a digital economy. The cash and paper-based nature of the two markets requires time, capital, and agility to overcome - in other words, investment.
The foundation of a digital payments infrastructure are the following:
Digital Connectivity, which is necessary to reach end users (e.g.: mobile phone networks);
Cash In/Cash Out Networks that allow end users to exchange cash for digital value, and vice versa (e.g.: banks, ATMS, agents);
Digital Account, which stores digital value of cash (e.g. mobile wallet).
As a final chicken-or-egg: Investors want to see proof of traction and scalability, but DFS companies in India and East Africa need innovative and risk tolerant financing to pilot their products and show traction.
Most DFS companies don’t fit patterns that investors recognize. Many investors in India and East Africa fall back on pattern recognition to find companies and make investment decisions – relying on networks and indicators like prestigious universities or accelerator programs. If you’re not part of a well-connected elite, it’s difficult to build trust and relationships with investors, advisors, and other partners.
There is an estimated $50 billion funding gap for smallholder farmers in Africa. The result is that smallholder farmers are unable to invest in the quality inputs, seed and fertilizer they need to improve their yields.
Rita Kimani and Peris Bosire launched FarmDrive to solve this problem. Born out of their firsthand experiences growing up in farming communities in rural Kenya, they built an agricultural data analytics company that uses alternative sources of information to build credit profiles for smallholder farmers in East Africa.
To realize their potential and continue to attract investment, FarmDrive must overcome each of the four hurdles.
The Human Capital Trap: For FarmDrive, this means overcoming challenges in finding experienced data scientists. “Everyone is recruiting from a small pool of data scientists,” Rita says, which means they are expensive and hard to find.
Business Model Constraints: FarmDrive is operating in a data-scarce environment, which means they don’t have access to readily available digital information that can inform a credit algorithm, such as cash flow, sales cycles, or even weather data. FarmDrive sees this as an opportunity and is seeking strategic partnerships to build these data sets.
Debt Capital Gap: It’s difficult to partner with financial institutions to test new customer lending products. Rita noted, “it’s not easy to get financial institutions to understand that yes, there will be some product loss in the beginning, but there will also be a potentially high upside downstream, once our algorithm is perfected. We need time to gather enough data first."
Pattern Recognition Problem: FarmDrive spoke about how it was initially difficult to get through to investors. Eventually, they participated in accelerator programs to help them build their network and credibility with potential investors - one of our recommendations for getting past the pattern recognition problem. “The relationships we developed from these programs were vital to our fundraising efforts” Rita highlighted.
Too many DFS companies are unable to attract the investment they need to grow.
This is bad for everyone: the investors who are missing out on good deals; the DFS companies who can’t attract the capital they need to grow. Most of all, it’s bad for the hundreds of millions of people lacking access to formal financial services in these markets.
What can we do to support entrepreneurs improving financial inclusion? Here are a few ideas. We invite investors, foundations, governments, and entrepreneur support organizations to build on these recommendations and help us develop more.
We need to break the “chicken-and-egg” stalemate of companies needing cash to hire talent, but not being able to raise money without the right team. What if we build an integrated talent management network, to strengthen the human capital infrastructure, to start to overcome the human capital trap? What if investors and foundations fund strategic human capital hires?
We need to help facilitate partnerships between entrepreneurs and the owners of the digital payments infrastructure to enable companies to make faster traction in proving their business model. What if we develop programs to facilitate strategic partnerships with financial institutions and mobile network operators, to improve the development of profitable business models?
We need to move past the “one size fits all” nature of venture capital, by developing other tools. What if we increase the availability and subsidies for different types of venture and debt capital, and innovative financing models, to encourage more investments?
We need to move past pattern recognition fallbacks as a proxy for potential. What happens if a startup founder doesn’t follow a specific pattern? What if we support initiatives to bring more transparency and build more in-country networks?