A large majority of digital financial services (DFS) startups in Africa and India do not receive the investment they require to scale, according to a report released by global venture capital firm Village Capital and supported by the Bill & Melinda Gates Foundation.

The report Breaking the Pattern: Getting Digital Financial Services Entrepreneurs to Scale in East Africa and India states that companies like M-Pesa are the exception, and over the past two years in East Africa, 72% of venture capital went to only three startups.

Another key takeaway from the report is that investors often fall back on patterns to make decisions (relying on networks or indicators like accelerator programs), and again, in East Africa, 90% of disclosed investments in the past two years went to American or European founders.

Researchers claim that more than 60 million people in East Africa and 233 million in India lack formal bank accounts, with more than 50% of small businesses have limited access to formal credit.

Village Capital underlines several key points including that investment is highly concentrated in just a few companies, that investors consider DFS companies to be risky because of human capital challenges and structural barriers in the marketplace, as well as what the firm calls the 'pattern recognition problem.'

"If you've been paying attention to the Economist or the New York Times, you might think we're in a golden age for digital financial services in India and East Africa. In fact, we're only at the very beginning," said Ross Baird, CEO of Village Capital. "We'll need hundreds of companies to reach scale to truly improve the financial health of communities in India and East Africa, requiring us to look beyond the 'one size fits all' model of venture capital in markets that operate under an entirely different set of rules."

The report provides several recommendations for ecosystem stakeholders including strengthening the human capital infrastructure; facilitating partnerships between entrepreneurs and major financial institutions; providing alternatives to pattern recognition fallbacks; and developing alternative financing mechanisms to provide DFS companies with the right funding at the right time.

Renewed approach

Recently ICT professionals have also advocated a renewed approach to take advantage of opportunities while at the same time lowering the risk factor when supporting local startups.

Floris Buys, Founder and Executive Director of Telkom's new Innovation Ecosystem SpliceWorks said corporates find it challenging to capitalise on the innovations provided by startups.

"The question is how do you know what is happening in different countries and how do you absorb the innovation into a corporate environment? It is difficult because anything that comes into a well-oiled machine like the corporate environment is dispelled if it seeks to change the status quo. Traditionally corporates have followed three approaches of funding, buying or partnering when it comes to startups, but they are really struggling to keep up as the startups innovate faster. Everybody realises we need to tap into the startup ecosystem."

At the same time Brett Parker, MD of SAP Africa, has referenced research by the World Economic Forum which states that there are roughly 200 African innovation hubs, 3,500 new tech-related ventures, and US$1 billion spent in venture capital. In 2016, startup investments were up 17% from the previous year.

A report by Disrupt Africa, Finnovating for Africa: Exploring the African Fintech Ecosystem Report 2017, states that there are 301 active African FinTech startups and since 2015 these startups have secured US$92,679,000 in investment.

The data shows FinTech startups are spread across the African continent, with the Southern, West and East African regions equally active, while North Africa lags behind. South Africa, Nigeria and Kenya remain the top three hotspots for FinTech startup activity, although a number of other markets are emerging as vibrant FinTech destinations.

Of the nine FinTech categories covered by the report, payments and remittances startups dominate the market, with 41.5% of all startups focused on this space. Lending and financing also proves a popular priority for Africa's FinTech innovators.