Political & Regulatory Barriers

The pain and (dis)ease of doing business is improving, but from a low base 

Business conditions in most African economies have improved significantly over the last 15 years, as indicated by Figure 19. But they remain relatively unconducive to a thriving entrepreneurial ecosystem bustling with gazelles, camels and unicorns (in contrast to related activity across a number of mature markets). Countless key pain points have been repeatedly identified by those we interviewed. Many of these relate to the peculiarly African requirement for ventures to internationalise early in their scaling journeys in order to acquire sufficient customers to scale.  

The African Continental Free Trade Agreement (AfCFTA) means the continent hosts one of the world’s largest free-trade areas. Prior to its formation in 2018, only 17 percent of trade in Africa was intra-African trade. 

“Historically, businesses wanting to trade across African borders face insurmountable barriers. That has always been a major issue. African countries trade more with Europeans than they trade with their neighbours, because of the many barriers on small businesses. The disincentive is simply massive.” - interviewee 

Individual governments need to properly implement AfCFTA’s provisions for the single market to fulfil its potential. It has been suggested that policymakers need to implement transformative measures to improve the business environment, addressing the challenges that limit growth: the digital-skills gap, insufficient infrastructure, mixed institutional capacity, restrictive or inconsistent policy conditions, and an inability to access competitive regional and international markets. 

“Issues around integration across countries on the continent limit opportunities for African businesses to scale across markets. We have the AfCFTA plan more recently, but when it comes to the operational level, there are always issues.” - interviewee

AfCFTA does offer the foundational elements of a single digital market, which could facilitate the free movement of goods, persons, services and capital to lower costs and increase market access.  Smart Africa, which has a commitment to creating this framework by 2030 through the adoption of national and regional digital-economy frameworks, has a heavy workload ahead. 

Significant work is needed to create the right enabling environment to help ventures scale into new markets. Whilst trading under the AfCFTA Agreement only began on 1 January 2021, the UN Economic Commission for Africa (ECA) recently released its first AfCFTA Country Business Index. This assesses how easy it is to do business between African countries to identify bottlenecks and issues to address. Its early evaluation work indicates the size of the uphill climb. Concerningly, the private sector still has a negative perception of trade in goods, which suggests much more work needs to be done to remove tariff and non-tariff barriers, and encourage deeper engagement with the private sector and business associations. Reliance on legislation, policy, and government communication strategies alone is a mistake. Facilitated market and systems innovation approaches will be essential to make the progress necessary.

“It's crazy, because so many countries say they want access to foreigners, and we're open for investments; but setting up a company in that country is just so hard. So, it begs the question, are you really open for investments?” - interviewee

Entrepreneurs and investors want certainty when entering new markets. They seek cooperative, transparent and standardised processes, with clear timelines to which decision-makers can be held to account. This allows them to plan ahead and allocate resources appropriately. In reality, regulatory requirements are anything but certain. Neighbouring countries differ wildly from one another, regions even more so. It can be easy to open a company, but hard to get a visa or bank account. Or vice-versa. 

The depth of complexity varies per vertical, with payments ventures involving particularly high cost and complexity per market, given that they require licences, agency agreements, customs clearances and a range of banking and regulatory approvals. These complex compliance requirements increase cost and reduce competitiveness. In the words of one of our interviewees, “regulators in this part of the world are a bit reckless”. Indeed they are.

We point to the sensible actions of the Kenyan Government which, with the support of the UK Tech Hub, has developed a free online Business Regulatory Toolkit aimed at helping businesses navigate the environment at different stages of development of a business. Other countries which have not adopted such supportive mechanics should consider directing their attention in similar ways.  

Innovation agencies can play a fundamental role in implementing those types of initiatives, as successfully demonstrated in Latin America. Agile and experimental approaches to regulation need to be considered as part of the innovation policy mix to help scaling ventures. 

It may also be useful to distinguish between ex-ante and ex-post regulation. Regulators are not business strategists, nor often even economists. They are not better placed to predict what the future of a market holds, who the new market entrants will be, or how they will be entering into a certain market. The norm is that regulatory action takes place once a market failure or distortion arises – this is known as ex-post regulation (“after the event”). Until a certain undesirable effect is actually established, consumers and producers are allowed to act according to what they believe maximises their welfare in accordance with well-known and pre-defined sets of rules. 

In contrast, ex-ante regulations (“before the event”) broadly aim to identify problems beforehand, and shape stakeholder behaviour and responses through regulatory intervention. Ex-ante regulations standardise certain practices and policies that solve sector-specific problems by specific predetermined outcomes. 

In short: Ex-ante regimes tell business precisely how to behave, or “what to do”, whereas the norm is ex-post where regulators tell them “what not to do” by describing the situations the society wants to avoid.

In general, ex-ante regulation approaches are poorly fitted for sectors that are rapidly evolving. This has led to an increasing number of regulatory sandboxes being developed - in short, facilitated partnerships which enable businesses to test products and services in a controlled environment. There are many learning (and cost) advantages to live prototyping. Regulators can understand market developments to ensure consumer protection safeguards are built into new products and services. Several trials are in place across Africa, typically in fintech, with Reserve Banks (e.g. South Africa) establishing dedicated advisory units.

One interviewee warned us that regulators are establishing sandboxes, “without clear processes in place for escaping the model”, which somewhat defeats their purpose. 

Innovation test-beds unquestionably have their place. The field of anticipatory regulation emphasises more flexibility, collaboration and innovation. The U.K Innovation Foundation, Nesta, has pioneered its work built on six principles: inclusive and collaborative; future-facing; proactive; iterative; outcomes-based; and experimental. Such approaches contrast significantly with traditional regulatory practices. Innovative approaches must extend beyond fintech and into broader public and private spheres. Innovation agency, Dark Matter Labs, attests that the role of citizens should extend beyond mere participation; rather, citizens should become the agent of civic experiments. Accordingly, they are developing new frameworks and strategies for cities through combining technology and civic innovation.

Sandboxes offer no panacea. Typically they are small-scale programmes that target relatively few ventures. Unfortunately, there are no rigorous, cross-country and cross-sector evaluations of sandbox programmes, which makes it difficult to unambiguously determine that they are always the best way to approach regulation. 

Scaling ventures need regulatory and licensing certainty. African governments need to solve intra-governmental competition, poor coordination efforts, regulatory inconsistencies, and high unpredictability issues. Governments and regulatory agencies can help by standardising their processes (with clear guidelines), improving transparency, and being more open and consultative with their approach.

“One aspect that can work very intelligently is around governments standardising their processes around cooperation and providing some transparency to that process, with clear timelines”. - interviewee

An interviewee from a fast scaling financial services company told us that “the more these [regulatory sandbox] initiatives are done in consultation with stakeholders, the better they end up being. The biggest risk is these efforts are devised in an ivory tower”. As a rule of thumb, the deeper the collaboration, the better the outcomes. Greater collaboration mechanics can be designed to facilitate this desired impact. 

“There is a difference between what the law says and what really happens”. - interviewee

Contributory factors to the creation of such chasms include the following:

• As is the case in many countries, delays in: (1) promulgating new policy into legislation; (2) operationalising statutory law (‘Acts’) into the array of regulations, licence frameworks and enforcement mechanisms needed to make the new law function; (3) building human and procedural capacity within the concerned government departments and agencies to both implement and enforce the framework; and (4) communicating and creating awareness of these changes to industry and stakeholders.

• So much confusion and lack of clarity on what the applicable requirements are that some scaling ventures have learned from experience to “triangulate the truth”, as one of our interviewees told us. They do this by commissioning a number of legal opinions from local legal experts, and then plot what they think the true path might be from that. This approach lowers risk and increases certainty, but comes at a significant cost: “Most legal services in these markets are not built for foreigners. They charge an exorbitant price.”

• Opaque, murky and archaic approval processes for licences, permits and the like, without clear timeframes within which a formal decision must be made on applications, and too much discretion given to officials. Corruption thrives in contexts like these, so there is little incentive on the part of officials to make the process a more transparent and accountable one.

• Low inter-departmental cooperation, which negatively impacts industries that cut across multiple functional areas, as is the case with many digital verticals, e.g. edtech and agritech.

“Exchange controls, in my opinion, are possibly the one of the most damaging things to an African startup.” - interviewee

Wildly fluctuating currencies - as indicated by Figure 20 - deter investors, especially international ones, as they impact the bottom line and introduce more uncertainty into the operating context. So much so that in venture capital industry body AVCA’s 2021 survey, approximately half of the respondents indicated they had to amend their exit plans because of political or currency risk. 

The effectiveness of commonly-used currency risk mitigation tools like hedging is thwarted by exchange controls. 

“So exchange controls are horrible, they discentivise international investment. Everyone gets scared because suddenly you've got to put your money through some weird system that no one knows about. This only exists in Africa, nowhere else in the world. Your investors just say ‘no thanks” - interviewee 

These factors all influence the “Africa discount” that international investors weave into their African investment strategies.

Tax guidance and support is also thin on the ground, with scaling founders we spoke to calling for governments to better articulate their taxation requirements, especially for digital services. Tax incentives to encourage investment, and support ecosystem actors like corporates to engage in the sector, are also insufficient. Improvements have been baked into AfCFTA, although it remains to be seen if, and how, these will be enacted and operationalised in national jurisdictions. 

Economic growth is closely associated with progressive intellectual property (IP) systems, which must be geared towards fostering technology, industrial development, and innovation.

Unfortunately, it must be acknowledged that IP records of many African countries are not completely digitised, and efficiencies at IP offices are affected by a lack of infrastructure and personnel at registries. IP awareness on the continent is, generally, low. There are limited mechanisms in place to finance pilot and demonstration projects in Africa in a systematic way. Few comprehensive research and innovation funds exist. More efforts akin to the Nigerian government’s plans to launch a nation-wide wallet to enable the international commercialisation of all IP forms being created and registered within the country, both locally and internationally, are needed.

Whilst there have certainly been improvements in Africa’s IP laws in recent years to meet international obligations and standards, these changes have not yet trickled down sufficiently to ease foreign investors’ discomfort. Many of Africa’s most successful ventures, including unicorns like Andela and Flutterwave, are registered abroad.

“Over 75% of our businesses are registered outside of Africa, because IP protection rules are ridiculous, including in mature markets like South Africa. So we need governments to realise that if they want to retain IP, and wealth creation in Africa, they're going to need to change policy quite quickly.” - interviewee

In order to reduce risk, investors often require ventures to register in the U.S state of Delaware. This is common VC practice globally, not only for African ventures. For example, it is a standard requirement for entry into gold standard accelerator Y Combinator. The usual model is for the Delaware company to be re-structured as the holding company, with the African companies becoming its subsidiaries (‘the flip’). It is the Delaware company that will normally hold the venture’s IP, namely its commercial and technological secret sauce. Whilst there are many practical commercial benefits to doing so, an IP exodus from the continent has ideological and macroeconomic implications that cannot be ignored.

“My hope is that, eventually, we could have businesses that are being built in Africa that are serving other markets, but the IP still remains in Africa. So that the movement of capital and the growth of the economy is based on who owns the IP.” - interviewee

Most companies that operate in Nigeria, Kenya, South Africa etc, have a holding company off the continent, which owns 100 percent of the operating company. Leading investor, Zachariah George, Managing Partner at Launch Africa Ventures, acknowledges that investors are often comfortable if the IP of the companies sits outside of the operating company:  “If you're a Nigerian company, you want to create jobs locally, pay your taxes locally, but investors want to be investing in a country that has favourable double taxation treaties, favourable capital gains tax, favourable IP control laws. This arrangement works; the local governments are happy because taxes are paid locally. The economies are happy because jobs are created, and the investors are happy because the money is actually going into an overseas entity. So when they want to exit prior to a liquidation event, it's easy to take money out of a UK or European or an American domiciled company.”

The ecosystem is witnessing strong signals of change on the horizon. Startup legislation has been promulgated or is under development in 35 countries in Africa. These laws are intended to breathe life into policies designed to create a conducive environment for startup businesses, including increasing incentives for investors and making it easier for startups to operate. Measures include tax holidays and other tax incentives, revised intellectual property laws, improved processes and one-year leave periods for entrepreneurs with the right to return to their previous jobs.

We welcome these initiatives whilst also acknowledging the strategic inputs from experts, such as the Innovation for Policy Foundation, who are working assiduously to improve different enabling environments. We also reserve the right to ask to what extent these new laws and policies serve the specific needs of scaling ventures and what consideration, if any, has been afforded to supporting their unique interests and requirements? We believe scaling firms have been overlooked in favour of early-stage startups. This is a serious omission in need of repair.  

It is recognised that most policies focus on increasing the quantity rather than the quality of new ventures, providing "a little help for everyone." There is little doubt that governments can better support job creation by being more selective and devoting more resources to ventures with high-growth potential. 

It is incredibly rare for recent graduates to start high-growth ventures. Despite this, many governments attempt to support high-growth ventures by supporting universities and their graduates. Instead, governments should also consider promoting spin-offs of ideas, capital and talent from existing companies. There have been few, if any, such initiatives to date. There are evidenced-based recommendations that policy-makers disentangle the drivers of entrepreneurship and encourage a selected subsample of the most promising potential entrepreneurs. 

In short, there has been very limited consideration of what type of support should be directed toward ventures displaying high-growth (or potential) - these enterprises require different policy levers compared to the support for startups in general. An evidence-based approach would better distinguish between each. 

This will require a holistic yet segmented approach, where different initiatives and instruments – ranging from financing and innovative public procurement to support and mentoring programmes – are targeted to the different needs of different sectors and companies. This will also require a rethink of how national innovation agencies work in practice to support these ventures.

It has been proposed that centres for entrepreneurship should be set up by various government bodies responsible for promoting entrepreneurship programmes with a dedicated mandate to coordinate all entrepreneurship initiatives. This includes promoting dialogue and networking between the private and public sectors and bridge the gap between these two sectors. Systems interventions like this are much needed. We commend Botswana for recently establishing a Ministry of Entrepreneurship. 

A public debate on whether or not public interventions should directly target potential high-growth firms would be highly valuable. One option for public intervention is to provide early-stage financing directly to growing firms (there is ample evidence of functional schemes around the world). Complementary interventions by governments can be designed in terms of improved policy frameworks helping to impact new ventures early in their life-cycle - such as through reforms to labour laws and social security regimes, and through the provision of quality (innovation) infrastructure. 

Evaluations of targeted interventions are limited. One study that analysed the impact of entrepreneurship across 44 countries similarly concluded that growth-oriented entrepreneurship did not generate as much impact in emerging economies as it did in developed economies, and that regions generally only benefit from high-growth entrepreneurship after reaching a certain threshold level of development. Some scholars argue that many policy interventions fail as they address only a part of the ecosystem, instead of approaching it holistically. Some question whether it is indeed possible to identify growth firms ex ante at all. However, substantive World Bank research using data on individual and firm-level traits seem to make it possible to narrow down the pool of potential growth firms. It would therefore seem entirely logical for African policy-makers to consider what specific scale-up policies are necessary to targeted (and segmented) ventures and verticals. But without the requisite data - which is unavailable - this task is, unfortunately, currently impossible. This can, and should, be fixed.  

Governments shape demand for innovation through public procurement, fiscal policy, regulations, standards, and fostering new social norms and values. These policy levers can either inhibit or drive innovation. The role of the entrepreneurial state in supporting innovation is well-documented. The prominent innovation academic Professor Mariana Mazzucato has written extensively about how the private sector only finds the courage to invest after a government has made the earlier high-risk investment. 

Government should be prepared to take on more up-front risk, both in applying technologies to existing activities and growing new ones to scale. This should be done within a set of “guard rails” which ensure that investments are made with appropriate due diligence and judgement. The risk taken must be compensated by back-end participation in profits. As was the case of Kenya’s M-PESA, Governments should act as the first investor champion and take bolder risks. 

Governments can incentivise and support scaling ventures by improving grant and procurement structures, as well as co-investing with enterprises which are building the infrastructure and networks necessary for these businesses to be successful. Government should use its own procurement to create appropriate demand from innovative enterprises - from early-stage challenges and prizes to large-scale but via agile procurement. This is particularly important in sectors where the Government is one of the largest customers, such as health, education, or infrastructure. 

The power of a long-term strategy is to send a demand signal that drives businesses and investors’ confidence to invest. It can also be used as a method to boost innovation by bringing contractors into the market. Government has the capability of using the scale and breadth of its procurement power to shape future markets, crowding-in solutions to address challenges, taking a whole-systems approach, recognising value to a broad set of actors - from academia, investors, and businesses through the supply chains and delivery systems. 

The Tony Blair Institute for Global Change proposes a simple three-step approach to create demand for venture firms offering solutions: 

Such strategic approaches are too rare in Africa. Poor public sector innovation capabilities, weak institutions, poor governance and low accountability - collectively - are root cause problems. To solve for tomorrow, it would be advisable to devise mission-oriented innovation approaches grounded in proper systems thinking to design new pathways. 

Weak formal institutional capacity, caused by governance failures, has allowed informal practices to take root in many parts of Africa. Both formal and informal institutional factors greatly influence the ability of ventures to scale sustainably. The interaction between them certainly influences the prospects of scaling businesses to flourish.

Formal institutions can both constrain and enable venture growth, including having a direct influence on the internationalisation process. Heavily regulated economies have lower rates of market entry. A weak formal institutional environment is often marked by excessive regulatory burden related to business operations. Frequent changes in laws, regulations and even procedural rules create uncertainty and raise the costs of acquiring accurate information and ensuring compliance. Weak or ineffective formal structures enable the informal environment to step in and regulate behaviour. 

Research has shown that informal institutions substitute underdeveloped formal institutions. Corruption is a prime example, which directly harms growth given its anti-competitive nature. It is proven that the scourge of corruption increases business transaction costs. It also deters those who do not want to engage in such practices from doing business on the continent. Unsurprisingly, there are calls to reduce corrupt practices across the public sector. But little has really changed. The 2021 Corruption Perceptions Index (CPI) released by Transparency International shows that corruption levels in Sub-Saharan Africa remain rampant, with 80 percent of countries not having made much progress in the last ten years. This type of systemic corruption is deeply harmful.