The challenge of financing African SMEs


January 7, 2016                                                                                                     Source: Carole Ramella

Published in Business & Financial Times:
http://thebftonline.com/business/economy/16760/the-challenge-of-financing-african-smes.html

 

Given its strong growth and the emergence of its middle class, sub-Saharan Africa arouses great interest from several investors, among which are China, the United States and Europe. However, for such investment opportunities to have a sustainable impact on the economic development of the continent, SMEs’ effective participation is essential and remains a major issue.

The perception of sub-Saharan Africa has noticeably evolved over the last fifteen years. From a lost continent, Africa is now considered as a land of opportunities -- one of the last regions in the world enjoying growth rates close to 10%. Even though the increase in raw material prices and the improvement of business governance have explained this situation for many years, one cannot ignore the impact of the radical change in Africans’ consumption habits.

According to the International Monetary Fund, the African continent should benefit from a growth rate of 5.8% in 2015, a growth rate that is largely supported by the rise of the middle class, which is synonymous with the development of a new consumer society. This represents a business opportunity that large foreign groups anxious to win new markets increasingly take advantage of. By 2017, Africa could become the region receiving the largest part of investments from European consumer goods companies. In another example, the South African retail group Shoprite Holdings (equivalent to the French Carrefour or Auchan) planned to open 35 stores in sub-Saharan Africa in 2015, of which 14 are in Nigeria alone -- up from 20 stores opened in 2014.

 

SMEs, the real African growth levers

In this context, Africa needs to provide itself with the means to meet its emerging and demanding middle class’ expectations, as the middle class aspires to consume fridges, televisions or cell-phones like its European or American counterparts. In this regard, the role of SMEs is essential to meet that domestic demand and, in so doing, to speed the pace of the continent’s economic development. In fact, 95% of African companies are SMEs (less than 500 employees); they are the main contributors to the GDP of numerous countries.

For instance, SMEs represent 91% of companies in South Africa and 70% of the manufacturing sector in Nigeria; they are the source of 61% of job creations in Tanzania and contribute to 70% of Ghana’s GDP. However, even though the essential role of SMEs in Africa’s development is widely recognised, SMEs still face numerous challenges; among which is access to funds that are vital for their growth. Given banks’ apprehensiveness when it comes to lending money to SMEs because of a very high risk perception, more and more private equity funds step into the breach to grab the growth opportunities offered by African companies.

 

The profile of investors is evolving

Local and international investment funds therefore raised US$4.2billion in 2014, which represents more than double the average funds raised in Africa over the preceding five years. But contrary to the industry’s first years when investments were mainly done in telecommunications, financial services and utilities (water, electricity, etc.), investors are now seeking opportunities in sectors growing with the emergence of the middle class such as health, education, logistics or consumer goods.

In addition, next to large funds who sometimes invest more than US$100million per transaction, we observe an increasing specialisation of the industry with the creation of funds that invest much smaller tickets (less than US$5million), the emergence of more SME-focused funds like Investisseurs & Partenaires, and the development of sectorial funds like Uqalo (consumer goods), IFHA (health), or Silk Invest (food and beverages).

For those funds that are looking to support the African consumer the issue is to get experienced teams that are familiar with local cultures, which is key to identifying the best investment opportunities. This translates into the creation of many “100% African” funds that lever on their in-depth knowledge of local environments; for example, we can mention AFIG in Senegal, Cauris in Togo and Cote d’Ivoire, or Oasis Capital in Ghana.

Inadequate funding solutions for SMEs

Despite their undisputable contribution to SMEs’ development, notably in terms of financial and strategic support, the impact of private equity funds remains limited because they can generally close not more than two or three transactions every year. It is therefore essential that banks support SMEs in a more systematic way if African economies are to grow sustainably.

Unfortunately and more often than not, African banks only support export activities or large local and international companies that intervene in infrastructure, mining and oil projects. In Africa, banks are still unwilling to support SMEs over the long-term, or they do it at very high costs (in West Africa interest rates vary between 15% and 30%). In the meantime, for many microfinance institutions (MFIs), SMEs’ funding requirements are largely beyond MFI’s capacity and countless SMEs therefore fall out of their reach.

Consequently, we observe the arrival of mesofinance institutions that position themselves as a third finance option for the missing middle between traditional banks and MFIs, and that propose financing solutions adapted to SMEs’ needs and realities. For instance, the Cofina Group that has been present in Cote d’Ivoire, Guinea and Senegal since 2013 is the first mesofinance institution in Africa and has already funded 3,500 projects from 1,509 SMEs. 

Entrepreneurs need to be accountable

Providing SMEs with appropriate financing solutions is a priority, but this should not hide the fact that SMEs rarely propose projects with a quality of financial analysis and information that is sufficient to attract interest from investors. Several capacity building formulas have been set up to support entrepreneurs, generally in the form of free training seminars.

This capacity building support must get out of the grant and ‘free money’ approach to evolve toward a model that allows it to measure effective impact and encourage entrepreneurs to ‘own’ that support, and to firmly change the way they manage their operations. By working with entrepreneurs on their governance, cash management processes and a credible strategy, initiatives like the PFI Programme[1] developed in West and Central Africa allow several African SMEs to respond successfully to the challenge of growth and become efficient market players in Africa and beyond.

The writer Founder and Managing Director

GFA Consulting Ltd