Startups in Ethiopia: 5 obstacles the government should remove

"Addis, we have a problem."

According to one report, the total venture capital invested in Ethiopia in 2022 was $4M. Less than a single startup does on average in a "series A" VC round:

Lest you think this is an unfair comparison with the rich world, in Africa, there are 21 countries with a smaller population but larger amount of venture investing. There are 15 countries with a smaller GDP and more investment. Within Africa, while Kenya, Senegal and Ghana are punching above their weight, Ethiopia is so far below it literally falls out of the picture:

To be sure, total VC investment is not the most important metric. Only a tiny minority of companies ever need professional early stage investment. Still, the absence of venture capital is a symptom of the broader reality. Another indicator is that all of the companies in Ethiopia with more than $1B/year in revenue are state owned (Ethiopian Airlines, Commercial Bank of Ethiopia, Ethio Telecom and Ethiopian Petroleum Supply Enterprise, etc.). More than three decades after the end of communism, there's still not a single company that began as a startup and ended up very big. 

There are many problems, like the foreign currency regime, war, politics fubar, and education, that go much beyond startups. Still, the GDP is growing! And you can't spend one day in Ethiopia without noticing huge opportunities for startups to address. There are so many things to do. So what is wrong when it comes to startups? Any entrepreneur in Ethiopia knows the answer first hand: Ethiopia is extremely unfriendly to startups.

Here are few examples, based on my experience, of obstacles the government could eliminate. I'm sure you could come up with a lot more. The key feature of my examples is that none of them require money or new technology or new powers to solve. They are just bureaucratic problems that in principle could be eliminated with the stroke of a pen.

Simplify company registration

To formally register a company you have to register the name at the Ministry of Trade. Then you to do a "Principal Registration". And third you have to do a tax registration.  While these are not the biggest problems, it could easily be made into a single step instead of three. 

Furthermore, in the registration process, the company address is a surprising complication. In most countries you can legally start a company with pretty much any valid address. It could be your house, your friend's apartment, a corporate agent or lawyer's office, a post office box, whatever.  Google started in a garage. Dell started in a college dorm. The vast majority of technology startups don't get a long term office until they have at least gotten some traction with a product or customers.  Nowadays, with the growth of remote work, it may be a long while before you need a traditional office. But in Ethiopia, you have to have a formal commercial lease in the company's name, and it can't be a residence. You have to make a legal long term real estate deal before you can do anything, even if the business doesn't actually need it nor can afford it.

Document authentication

Not only that, the lease has to be authenticated by the government. If the lease is signed by a building manager, you have to prove the manager has a power of attorney from the landlord. If the building has more than one owner, each owner must provide the power of attorney. If one of the owners is outside the country, the power of attorney must go through the "apostille" process, involving the ministry of foreign affairs of the other country, the Ethiopian embassy in the nearest country, and  the Ethiopian foreign ministry in Addis Abeba. The process takes weeks or months. 

The same process is required for many other company documents, like shareholder agreements, investment agreements, etc. It's hard for people from normal countries to even imagine this. It's absolutely insane.

In most countries, business agreements are mainly up to the parties involved. Whether they write their agreement from scratch, use templates,  hire lawyers, notarize etc. it's really up to the two parties to be as formal as they need. If there's a misunderstanding or dispute, the two parties negotiate a common understanding of what the agreement was and settle it. Very rarely, the dispute goes to court. But even then the court can interpret business agreements even if they weren't authenticated by the government. There's almost never any a priori authentication or approval by the government of a simple business agreement.

But in Ethiopia, one spends countless hours at the "Document Authentication and Registration Authority". This government office is often praised for being relatively well managed and efficient compared to most bureaucracies. So this is not a criticism of their performance. The issue is that too many other government functions require you to go there. Even the simplest deal that you could document on the back of a napkin has to be treated as if it's the last will and testament of Croesus. Why do so many business agreements have to be verified and approved by the government, even when the parties involved don't need that? This is ridiculously time and effort consuming. A burden that startups can ill afford. 

Business license 

A bigger issue is that every business requires a business license. In most countries, you can just register a company and get to work. You may need a license if you sell alcohol, or weapons, etc. You need a license to drive a car or to perform surgery.  But those are activities where there's a specific concern for the safety or health of others, and that justifies preemptive government control of that particular activity. Outside of those, in a normal country, by default things are allowed unless explicitly forbidden. In Ethiopia everything is forbidden unless explicitly allowed. You must get a license in a predefined category. If the right category doesn't exist, tough luck.  If you are expanding vertically, you need to get another license instead of just doing it. When you are doing something new, or growing, this is a real barrier.

Investment license 

There's a concept of "investment license". You need to ask permission from the government to invest! If you are used to a relatively free economy this is bizarre.  Why? There's already criminal law to prevent or punish specific things. Why should the act of investing in a completely legal activity require permission? Everyone will tell you investment licenses are very important in Ethiopia, but almost no one can explain why the concept exists. Like in the parable of the gorillas in a cage, that's just the way it's always been. 

If you are lucky enough to find a rare person who can explain it, you learn it was intended to encourage investment. And licensing was meant to regulate who can get tax breaks and other incentives. So it was supposed to be an optional positive incentive mechanism. But it has evolved into a barrier, you have to overcome it whether you want the incentives or not. Random government agencies routinely say: show me your investment license or else you can't do this or that.

To make matters worse, there are state and federal level investment licenses,  and maybe a dozen different commissions who give them. Which one do you go to? It is surprisingly difficult to get the answer.  It depends on whether you are classified as foreign or domestic investors, and on where your operations are. What if they are in more than one state? What if you are a person of Ethiopian origin but established abroad, are you domestic or foreign? It all depends. And making the wrong guess can be very dangerous. You have minimum investment amounts, in some cases it's US$150K, in others US$200K.  If you invest US$149K, could you be breaking the law? It is very hard to make sense of it all.

To get an investment license,  the company has to pass an audit by the ministry of revenue. Even if your company was founded yesterday and has zero revenue, you have to do this audit which can take weeks. In a normal country, you pay taxes once a year. If the government suspects the payment is incorrect, it does an audit after the fact. The principle is: If you cheat, you get caught and pay the penalties. In Ethiopia, investors are treated like they are cheating before they get started. Imagine if the police arrested you every morning because you might decide to commit a crime that day. And then you prove your future innocence and they let you go to work.

By the way, is the license for the company or for the investor or both? Most people can't even answer that.  It's very difficult to even find the right rules, let alone understand and obey them. 

Far from being a positive incentive mechanism, the investment license has become a Kafkaesque bureaucratic weapon. And when such a weapon is available, it creates a pockets of  bribe-seeking criminals in government.

Unrealized valuation increase may be taxed

Say you found a startup. You register the company with shares divided between you and your co-founders, with a nominal value like $1 per share. After some progress, an investor comes in with a $500K investment for new shares of the company at $10 per share. On paper, your founder shares increased in price from $1 to $10. But this gain is not "realized", no shareholders received any cash. The $500K goes to the company's expenses to help it grow. Of course, if there are salaries, every employee, founder or not, pays ordinary income tax. But no one pays capital gains taxes yet. It's only if the company succeeds and you sell your shares for more than the original price ($1 for founder, $10 for the investors) that you pay capital gains tax. If the company fails, there are no gains and no capital gains taxes. This is how it works in most places. 

In Ethiopia too, in theory, capital gains are only taxed when realized. But apparently the tax authorities sometimes demand that, when investors buy new shares for $10,  the company pay 30% tax on the capital gain from $1 to $10. And this payment is required up front. So $150K goes to the government, and the company only gets $350K to work with. Obviously no one wants to make an already risky investment where you lose 30% on day 1.

One solution is to simply not increase the share price. Keep it at $1. But that means the most basic mechanism of tech startups, which is that founders and employees get most of the value through their "sweat equity" doesn't work. 

What if you don't ask the government for permission? Investors could just do the stock purchase agreement and simply wire the money to the company? In the US, there is no government involvement, you just do it. It doesn't mean anything goes of course, you have to make sure your investors are accredited and that you are not misleading them or committing fraud. But all these are things that you can just do. There's no prior approval. In Ethiopia, that is very risky. If the investment money is given to the company without a government license, it may be treated as corporate income and taxed at 30%. Or worse, you could be accused of some kind of financial crime.

What is to be done?

Entrepreneurs love to take risks, to solve hard technical problems, build products, serve people, improve the world, make a small dent in the universe. And in Ethiopia, God knows there is so much to be done, it should be an entrepreneur's paradise. But what you end up working on are these pathetic artificial problems created by bad government. No one grows up dreaming of getting a license from the government or a letter from this bureaucrat or a stamp from that office. The striking thing when you talk to entrepreneurs in Ethiopia is how often you encounter dreams ground to dust.

But here's the silver lining. Solving these problems does not require any money. In fact, nothing here is asking for help or any favors from the government; every single idea here is about something the government should not do. Specifically 

1. Delete the requirement for an office lease and combine the trade and finance ministry process into a single step. Let startups be startups. 
2. Delete the requirement for document authentication for business agreements. The government has no business getting involved in private business agreements. 
3. Abolish investment licenses. Convert the investment commissions into consulting bodies that the private sector can go to voluntarily for help. They should provide service and not have any power  to license, to permit or forbid. If that means tax incentives go away, so be it.  Don't let the tax tail wag the business dog. Real entrepreneurs don't do stuff for tax breaks. They do it because they want to do the thing.
4. Abolish business licenses as the general case. Licensing should be limited to areas where there is a clear potential for harm to the public or third parties not involved in the business.  The government should be forbidden by law from imposing licensing requirements unless they can prove this potential harm.
5. Eliminate pre-emptive audits, taxation, clearance etc. The tax authorities already have plenty of power to catch cheaters after the fact. There is no need to involve them in any aspect of gate keeping investment.

It's simple. But it is not easy. It requires a lot of courage and wisdom. The wisdom to understand that the government needs to do less and get out of the way. The courage and skill to implement reforms where special interests who benefit from inefficiencies will resist. DELETE is the missing key in Ethiopian bureaucracy.

P.S. Thanks to Tessema Getachew and Henok Assefa for feedback on a draft of this post. And to Addis Alemayehu and others for previous discussions (e.g. here and here).  All inaccuracies are my own. Comments and feedback welcome!