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Startup funding Ponzi scheme

May 9 · Issue #2 · View online
iAfrikan Daily Brief
Pyramid schemes, or rather Ponzi schemes as they are sometimes widely referred to, are mostly a confidence trick and investment scam that involves promising higher than normal returns on the money a person invests. The only risk typically is the money invested and little else, with a not so clear business model as to how the “scheme” actually generates value and profits. 

The key part of a Ponzi scheme (named after the Italian conman, Charles Ponzi) is making sure that early investors into the scheme are paid (at the returns promised, or exceeding them) using the money that later investors pumped into the scheme. This part is what entices more people to invest in the Ponzi scheme as there is “proof” that it works and pays out the returns on investment as promised. Before long, once the founder of the scheme and his collaborators feel there is enough money invested in the scheme, they make a run for it with “investors” money. Some just reinvent the scheme and do it all over again.
Charles Ponzi, after whom the fraud is named, is an Italian swindler who infamously conned American investors into giving him millions in dollars only to pay them what he promised from other investors money. 📷 Wikimedia Commons
I mention Ponzi schemes because, in his first annual letter, Chamath Palihapitiya (CEO of Social Capital and owner of the Golden State Warriors basketball team) highlights an important point about high-cost/high-stakes user acquisition venture funded “arms race” that is happening in Silicon Valley. This arms race is also taking root in Africa as we are witnessing more and more startups (some without revenue, some making losses every year) receiving venture capital funding that ends up valuing them in the millions of dollars. Chamath writes:

It’s not who you think, and the dynamics we’ve entered is, in many ways, creating a dangerous, high stakes Ponzi scheme. Over the past decade, a subtle and sophisticated game has emerged between VCs, LPs, founders, and employees. Someone has to pay for the outrageous costs of the growth described above. Will it be VCs? Likely not. They get paid to allocate other people’s (LPs) money, and they are smart enough to transfer the risk. For example, VCs habitually invest in one another’s companies during later rounds, bidding up rounds to valuations that allow for generous markups on their funds’ performance. These markups and the paper returns that they suggest allowing VCs to raise subsequent, larger funds, and to enjoy the management fees that those funds generate.

Now, I don’t know about you, but to me, and having observed venture-funded startups for some years, this sounds exactly like a Ponzi scheme. That is, early investors into a tech startup only make their money back when more money is invested into the startup during later investment rounds. They don’t, in most venture-funded startups, make their money from profits generated from customers purchasing the products that the startup sells. Actually, in most cases, the startups make losses for years on end but investors continue to reap returns on their investments as the startup “grows” and more people invest.

A recent example of this is the listing of JUMIA, an e-commerce company that operates across Africa, listing on the New York Stock Exchange. For a long time, the Rocket Internet founded company has been struggling to make a profit from the markets it operates in across Africa. With few exit opportunities available, especially when you’ve absorbed the volume of investments that JUMIA has received from the likes of MTN Group, the only options really left for the “Ponzi scheme” to continue working is for either a much larger company to acquire you (think Amazon) or to list on a liquid and large-enough stock exchange.

Without any buyers in sight, JUMIA listed on the NYSE, the stock price skyrocketed 200% within a week of listing, still not making a profit. More revealing, is that MTN is now possibly looking to sell half its stake in JUMIA after this stock price run later in 2019.

There are exceptions in my opinion, and they are family (investment) offices and technology holding companies. Unlike VCs who invest other peoples’ money and earn based on management fees. Family offices and technology holding companies tend to have more skin in the game and thus more interest in actually seeing the startup making real money, not paper valuation.

Perhaps I’m too cynical. Maybe I don’t quite understand how this all really works. My fear, however, is that many an African startup could die prematurely chasing paper valuations at the expense of building things that customers actually pay for.

What do you think?
🐋 Many people have tried to convince others that Bitcoin is a Ponzi scheme, it isn’t. In fact, in Africa, it is quite a good case study for remittances and money transfer. The story of this Bitcoin whale transferring 40,000 Bitcoins (approximately $212 million) and only getting charged $3.93 in transaction fees is one of many examples of why it could solve the money transfer issues across the continent. Link

💸 What is definitely a scam (or rather a high risk gamble) and unfortunately many people fall for it, is betting on sports. What is shocking is how Kenya leads the world when you check Google Trends for “betting tips”. Not only that, according to research, Kenya leads Africa as far as betting is concerned. Link

🗳️ Today was national elections day in South Africa. It’s been peaceful except for the odd SMS/MMS from political parties trying to convince you to vote for them. According to this researcher, South African voters feel that mobile political campaigns are intrusive, violate their privacy and make them feel disillusioned with the political process. Link

📱 A new South African app named Guardian says it can protect users against mobile airtime theft. Link

🧠 Nigeria’s Emmanuel Gabriel has launched an Artificial Intelligence powered human language translation platform that can translate over 2,000 African languages. Link

That is it for today’s newsletter. Do get in touch and let us know your thoughts on what we covered today. Cheers!
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