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A recent switch

The actual impact foreign aid has had on countries receiving vast sums of it has been a hotly debated topic for decades. In recent years, prominent thinkers such as Dambisa Moyo and William Easterly went even further by stating that not only did foreign aid not help, but it made the situation worse.

One of their main arguments lies in the fact that aid traps recipient countries in cycles of dependency. The focus on non-profits makes the model unsustainable and causes recipients to be forever attached to external aid money. Other points of contention surround the fact that material donations severely hurt local producers, stunting growth, or that aid decreases government accountability and increases corruption.

Foreign aid organizations were forced to take note of these critics, as they severely damaged support for their actions and their subsequent capacity to get funding back home. The sector had to reinvent itself, breaking away from the donation and grant model that had failed to prove its efficacy. This impetus to adapt was also bolstered by new actors entering the development/philanthropy space.

“A striking feature that is already disrupting the development landscape is the expansion in the number and diversity of development actors (…) middle-income countries are increasingly taking control of their own development; the expansion of donor governments to China, the other BRIC countries, and Middle Eastern countries; growth in the number of foundations and high-wealth philanthropists; and the entry of corporations into the development arena. Raj Kumar characterizes this phenomenon as a change in the marketplace, a move away from a few dominant large foreign aid donors and foundations to “more open competition,” producing greater diversity in approaches.” - Brookings

The new paradigm foreign aid organizations unofficially agreed on was to support “local entrepreneurship”, with the stated ambition of empowering locals to build up their own economies instead of sending Harvard grads to build wells. This search for a more effective form of aid focused on local empowerment and business creation is exemplified by the myriad of new concepts such as microfinance and Effective Altruism.

This switch to support “local entrepreneurs” coincided with the rise of startup ecosystems in many emerging markets. Aid organizations saw the support of these nascent startup ecosystems as a perfect way to channel their new mission. However, their involvement in the sector so far has been flawed.

Startups are not SMEs

A large part of foreign aid orgs’ support for “entrepreneurship” falls within the realm of SMEs. Missions can include formalizing informal roadside vendors, financing women-led small businesses, or upskilling a local population on a monetizable skill such as shoemaking. One of foreign aid’s cardinal mistakes has been to mix initiatives aimed at these types of businesses with support for startups.

Startups are an extremely special breed of businesses, whose business fundamentals go against many traditional business teachings. Hypergrowth, focus on operational leanness, and initially non-profitable business models are not compatible with the ways in which a typical SME operates. The startup world has its own literature (“The Lean Startup”), its own lingo (“blitzscaling”), and its own champions (Y-Combinator).

Support for SMEs and support for startups are thus two completely separate beasts, which require an entirely different set of competencies. Not only that, but by putting SMEs and startups under the “entrepreneurship” category, aid orgs end up transposing irrelevant KPIs on the startups they claim to support.

“This becomes problematic when company registrations are used by training organizers or funders as important Key Performance Indicators (KPI) for entrepreneurship support. Formalizing the informal SMEs is an important economic discussion, but it needs to be separated from the discussion on startup support.” - Auri Evokari, founder of the Omeho Project

Following their new “support local entrepreneurs ethos”, foreign aid orgs have thus charged on with funding business incubators, organizing pitch competitions, and "mentoring” startups in emerging markets. Three factors should be considered when analyzing these initiatives so far.

Point 1: An imperfect but necessary funder

Whatever the criticism raised against prominent aid orgs such as GIZ (Germany), AFD (France), or USAID (USA), the truth of the matter is that these organizations are often the first ones to put money into emerging market startup ecosystems. Indeed, in embryonic ecosystems, institutional investors such as banks, pension funds, and HNWIs are frisky about the VC asset class due to the absence of local startup exits.

In these geographies, aid orgs are often first movers in funding the country’s first incubator, carrying out the first ecosystem mapping, and funding the first pitch competition. For founders, they often represent the most accessible source of early-stage capital due to the lack of local “proper” investors.

Point 2: Incentive misalignment

The veracity of point 1 subsequently pushes many startup founders from emerging startup ecosystems into the realm of foreign aid, whether by participating in an aid-financed startup incubator or by receiving a grant. Unfortunately, this can turn out to be detrimental.

As stated in the first paragraphs, there is a severe misalignment between KPIs expected by donors and KPIs founders care about. A simple example is donors’ focus on solving “unemployment”, which is in total contradiction with a startup’s need to stay lean. The strings that come attached to foreign aid grants can impede founders’ growth by distorting the KPIs they internally measure.

“It remains, however, that what is rewarded at many innovation competitions is what is socially desirable in the eyes of jurors (and, by extension, the funding party) rather than what is economically viable. Many entrepreneurs we interviewed were very conscious of “what donors want to hear,” leading them to develop a pitch that fits into these perceived expectations. Entrepreneurs made pragmatic compromises, diverging from their original intentions as much as they felt they had to to obtain donor support.” - “Digital Entrepreneurship in Africa”, a book written by Nicolas Friederici, Michel Wahome and Mark Graham

By doing so, founders travesty the core of their business model, falling prey to so-called “grant-hopping” instead of measuring themselves to the tough and ruthless law of the market. The focus on the “impact” donors want to see denatures what the founders wanted to build in the first place. “Impact” is also a very subjective term, and aid orgs seemingly fail to realize that hyper-growth tech startups can have a major impact on a country’s economy, even if they don’t operate in a so-called “impactful” sector.

Point 3: Geopolitical considerations

Foreign aid orgs are inevitably tied to a sovereign state, European or American in a vast majority of cases, and are by extension a tool for the donor country’s foreign policy. I believe this puts a cap on how far aid orgs are willing to go to support these emerging startup ecosystems.

Does USAID really want to see Palestinian startups competing with Israeli ones? What would the AFD do if a local green startup challenged Total’s interests in the region? These geopolitical considerations tie foreign aid orgs to macro-interests that might not always benefit the ecosystem they are supporting. From my experience, many people working on the ground have good intentions, but orders coming from the top can be more problematic.

It is also interesting to compare the Marshall Plan, through which the US helped reconstruct Europe following WW2, and the current aid doctrine in emerging markets. The Marshall Plan had an unapologetically geopolitical goal of propping up capitalist and competitive European countries that would trade with the US instead of turning to communism.

“In its simplest terms, then, the Marshall Plan was, as its official title implies, an economic recovery program rather than a humanitarian relief effort. It grew out of a consensus that developed within the Truman administration that, without help, struggling European economies with dwindling reserves of hard currency would be unable to participate in an international economy based on increased production, efficient global distribution of products, and an integrated global economy governed by liberal trade policies. That handicap, in turn, would render those governments vulnerable to communist takeovers.” - American Foreign Service Association

I often wonder why the market-oriented ethos of the Marshall Plan, which placed a responsibility and a timeframe for recipient countries to make the most out of their aid money, was replaced by a “social impact/philanthropy” ethos when it comes to aid to countries in Africa for example.

I find it belittling and damaging, translating a subtle neocolonial view that African countries aren’t capable of building themselves up. When applied to startup ecosystem support, this translates into the prominence of “grants” rather than honest and demanding investments.

A new paradigm

I believe that the creation of dynamic and vibrant startup ecosystems in emerging markets will be the biggest lever of economic and social improvement this century will experience. As the founder of Indian conglomerate Tata once said:

“Freedom without the strength to support it and, if need be, defend it, would be a cruel delusion. And the strength to defend freedom can itself only come from widespread industrialization and the infusion of modern science and technology into the country’s economic life.” - Jamsetji Tata

While foreign aid orgs have been the first movers in the support of this new ecosystem, I am skeptical about the need for them to continue operating in the space. Rather, I would advocate for an exit plan, with a focus on launching the potent ecosystem flywheel whereby exited founders reinvest knowledge and capital back into the ecosystem. In short, this exit plan would involve aid orgs financing local VCs, led by local GPs, with little strings attached.

These young VCs would fail, learn, and eventually get a first exit that enables them to stand on their own and raise institutional money. Initiatives such as the IFC’s $225M VC initiative are encouraging. Private initiatives such as Seedstars Capital are also direly needed.

Aid orgs can also help in the drafting of relevant startup legislation, exemplified by the myriad of “Startup Acts” popping up across a number of African countries such as Tunisia and Senegal. Their experience with different markets can bring regulatory uniformity in regions that are strongly lacking such, such as the Maghreb.

Aid orgs will inevitably continue being a driving force in many startup ecosystems for the foreseeable future. They should shift their focus to more investments rather than grants, giving founders the freedom to test and learn rather than being tied down to “impact standards” which don’t make much sense for a startup without Product-Market-Fit. Moves such as the IFC investing $1M into the first Palestinian VC are encouraging.

Founder’s Cornelian dilemma

As a result of this convoluted situation, startup founders in these emerging ecosystems are faced with somewhat of a Cornelian dilemma. On the one hand, they want to detach themselves from aid and the strings it attaches to its funding. On the other hand, some founders don’t necessarily want to copy-paste Silicon Valley and its subsequent flaws such as the Valley’s excessive focus on valuation rather than actual value created.

“Will Africa ever fix challenges facing their startup ecosystem and create wealth locally, or we will forever celebrate two or three startups that make it to the London or New York stock exchange? Are we going to build robust support systems locally, or we will forever celebrate ten African startups that made it to the Y Combinator?” - Jummane Rajabu Mtambalike, founder of Sahara Ventures

In short, founders in these ecosystems want to build up their own ecosystems, on their own terms. Unfortunately, the lack of local VC money and lack of startup competency within governments forces the ecosystem to look abroad for resources and thus ends up indirectly adopting their funders’ ways.

In recent years, successes such as Paystack in Africa, Careem in MENA, and Nubank in LATAM (I wrote a piece on all 3) have created mafias of local startup operators, armed with knowledge, cash from the exit, and a vernacular point of view. These people are turning into the next generation of founders, angels, and VCs that can enable these ecosystems to regain control over their own narrative.

Conclusion

Foreign aid orgs have been responsible for placing the first bits of startup infrastructure in many nascent ecosystems. While operators on the ground are undoubtedly filled with good intentions, the lack of actual startup expertise within these aid orgs led them to make avoidable mistakes that created a bunch of “zombie” startups optimizing for grants and competitions rather than actual market performance.

In the long term, I think foreign aid orgs will be gradually phased out by more experienced ecosystem actors either coming out of their own startup exit or even coming back from abroad to contribute to building the local ecosystem. This will allow these ecosystems to finally do what they want to do: write their own startup ecosystem story.

The Realistic Optimist provides weekly, in-depth analyses of some of the hottest stories in our now-globalized startup world. Subscribe below to receive it directly to your inbox and don’t hesitate to share it with your colleagues :)