Nigeria has established itself as the leading hub for technology entrepreneurship and digital innovation in Africa over the past decade. The country hosts one of the largest and most vibrant startup ecosystems on the continent, with numerous young companies developing disruptive solutions in many industries. However, Nigeria's thriving startup sector now faces significant challenges due to the steep devaluation of the naira against the U.S. dollar in recent months. The falling value of the domestic currency is posing serious difficulties for local founders and businesses as they weather the economic effects.

Worrying Trends in Currency Markets

Through 2022 and 2023, Nigeria witnessed one of the sharpest currency devaluations globally, with the naira experiencing significant depreciation against the US dollar. By the end of 2023, the official exchange rate stood at 899 naira per USD. However, by February 2024, the naira plummeted further, reaching 1,516 naira per USD, indicating a substantial 40% devaluation within a short span. This second devaluation within a year marked a turning point, suggesting a shift towards letting the naira float freely in the currency market. The move aimed to address forex shortages and attract foreign capital.

However, the devaluation raised concerns about heightened inflation, which stood at 29% year-on-year in December 2023, and increased macroeconomic risks, including potential loan quality and capital pressures for the banking sector. Additionally, measures by the Central Bank of Nigeria, such as prohibiting banks from holding net long foreign currency positions, aimed to increase the supply of foreign currency but also posed liquidity risks for the banking sector.

These developments not only affected the banking sector but also had significant implications for startups in Nigeria.

Signs of a Slowing Ecosystem

Nigeria has long been a top destination for capital funding in Africa, thanks to its large domestic market and entrepreneurial culture. Startups in Nigeria once thrived with access to local and international capital.

However, the ongoing currency crisis has disrupted this funding momentum. As the value of the naira continues plummeting, investors have pulled back capital.

The funding for Nigerian startups took a significant hit in 2023, dropping by a staggering 66%. To put it in perspective, startups managed to raise only $410 million that year, compared to $1.2 billion in 2022 and $1.7 billion the year before that, marking a stark decline since the onset of the currency crisis.

As capital opportunities dried up, Nigeria lost its spot as the nation with the highest total funding amount for startups on the continent. Kenya rose to claim the number one position in 2023, securing over $790 million in funding - more than double the amount raised by Nigerian startups. Egypt and South Africa respectively saw the second and third largest funding deals.

What does this mean to Startups?

Nigeria’s currency turmoil has had widespread economic ripple effects in Nigeria. It is particularly damaging for the country's thriving startup scene, which relies heavily on foreign capital and cross-border transactions.

Several Nigerian startups have unfortunately announced their shutdowns in 2023, citing various operational difficulties. Among these startups are Lazerpay, 54Gene, Pillow, Vibra, Bundle, PayDay, and Pivo Africa. Each of these companies had raised significant amounts of funding, totaling $79.15 million, which investors will not be able to recoup.

Let's examine some of the key impacts the devaluation is having on Nigerian startups:

Increased Operational Costs

As most startups rely on foreign services and tools like cloud hosting, email, accounting software, etc. which are priced in dollars, their costs have increased significantly. The cost of using products like Google Cloud Platform, and Slack has skyrocketed.

Even though dollar prices remain unchanged, startups now have to pay two to three times more in naira for the same cloud subscriptions and software licenses.

The increased operating expenses eat deeply into margins. Certain infrastructure-heavy startups have seen their monthly cloud bills double or triple overnight. This squeezes profit margins and profitability and forces startups to cut costs elsewhere.

Challenges to Secure Foreign Investments

Due to their reliance on external capital, most Nigerian startups raise funds denominated in US dollars from foreign investors. However, as the exchange rate fluctuates, their financial position becomes vulnerable.

The devaluation of the Naira significantly diminishes the value of their Naira revenues when converted to dollars. Consequently, startups experience downward revisions in key financial metrics such as revenue run rate, monthly recurring revenue, and overall valuation. This weakens their negotiating power with investors, making it increasingly challenging to secure follow-on funding rounds at previous valuation levels.

Moreover, investors grow cautious about investing in Nigeria-focused companies amidst currency volatility and economic uncertainty. This reluctance leads to a slowdown in deal-making activity and reduces the availability of venture capital within the local ecosystem.

Difficulty Servicing Dollar Debt

Some Nigerian startups opted to take on dollar-denominated debt like commercial loans or bonds to support expansion plans when the exchange rate was more favorable.

However, the devaluation has made it incredibly tough for naira-earning startups to repay dollar loans on time. The monthly installments now require significantly more naira than budgeted. This currency mismatch poses risks of defaults and damaged credit profiles for the companies.

Lower Purchasing Power for Customers

For startups servicing local consumers and small businesses, purchasing power has declined sharply as the prices of imported goods rise. This impacts the demand for products and services that are not considered essential expenditures.

Sales may drop as customers tighten budgets or adopt a cautious approach in an uncertain macro environment. Startups have to work harder to retain existing customers and find new avenues for generating revenues.

Considerations for Survival

To stay viable through this turbulent period, startups are pulling out all the stops and strategizing creatively:

• Diversify Revenue Streams: Startups should intensify efforts to earn revenue from international customers who can pay in dollars or other hard currencies.

• Optimize Costs: Startups must critically evaluate their expenses, renegotiate contracts, and optimize their use of paid tools and services to reduce cash burn.

• Explore Local Alternatives: While not ideal, local alternatives for software, cloud services, and other tools can help startups minimize dollar-denominated expenses.

• Seek Patient Capital: Startups should target investors with a long-term outlook who understand the temporary nature of currency volatility and are willing to back promising businesses.

• Hedge Currency Risk: Startups with significant dollar exposure should explore hedging strategies, such as forward contracts or options, to mitigate currency risk.

• Focus on Profitability: In a challenging funding environment, startups should prioritize achieving profitability or at least a clear path to it, rather than pursue unsustainable growth at all costs.

• Talent retention: Offering extra benefits and promoting the flexibility of remote work can help keep top talent onboard, even without big salary increases.

While several Nigerian startups may unfortunately shut down operations in the coming months, those displaying resilience are eagerly awaiting the economy to stabilize soon. With strong fundamentals, tailored strategies, and continued government support, Nigeria's thriving startup scene can certainly endure this testing period as well. The focus remains on navigating challenges creatively to keep the innovation momentum alive.