Capital exists in Africa, but priorities are wrong

By Ben White on August 19, 2011

The funds required to make a tangible impact in Africa exist, however, the prioritization of this capital is imbalanced.

This is according to Guido Boysen, CEO of GroFin Africa. GroFin is an organisation that provides an integrated solution of finance and support to small and medium enterprises (SMEs) in Africa.
“The capital needed to drive economic growth in Africa certainly exists, but could be invested in an asset class with a potentially greater impact,” he states.

He notes that foreign direct investment in Africa has increased from $9 billion in 2000 to $62 billion in 2008-almost as large as the flow of capital into China, when measured relative to GDP. “For example, there are roughly 10 private equity funds active in East Africa alone, with about $200 million of committed capital looking for investment opportunities in the region. Assuming that these funds typically do not take more than 20% ownership in an investee company, this capital targets companies with total value up to USD 1bln. This is half of the total market capitalization of the Nairobi Stock Exchange, Africa’s fourth largest stock exchange in terms of trading volumes, and fifth in terms of market capitalization as a percentage of GDP. We need to ask ourselves whether there are sufficient opportunities available to deploy such capital?”

In his address at Private Equity World Africa conference, held in Johannesburg last year, he called for a fresh perspective, emphasising that SMEs would benefit greatly from these funds, and would simultaneously drive economic growth.

“The SME sector is ripe for investment, and the capital exists for this investment to take place. However, before this economic engine of growth kicks into gear, a few myths surrounding the sector need to be dispelled. Firstly, the owners of SMEs are not just unsophisticated entrepreneurs in need of hand holding, they are often good entrepreneurs with sizeable, successful businesses.”

He cites an example of one of GroFin’s clients, a petroleum business in Uganda that approached GroFin for funding to the value of about $400,000 to start two wholesale outlets. Prior to approaching the organisation for support, the business had successfully established eight petrol stations, illustrating the sophistication of the SME. Working with an established business and entrepreneur proved successful, with an overall annual rate of return of close to 40%,

Guido added, “The second myth is that SMEs do not constitute profitable investments. On the contrary – if these entrepreneurs merely receive appropriate assistance in executing their long term plans, they can reap a return on investment (ROI) that benefits both the investor and the entrepreneur.”

This was illustrated in one of GroFin’s Kenyan clients, a borehole drilling business that required $235,531 to purchase its own equipment. The business owner was well-established in the industry, with a solid network of contacts. Their assistance in purchasing his equipment allowed him to reduce his expenses, boosting his cashflow and their management support ensured the extra cash went back into the business and was put to good use. The final IRR on exit was 33.20%.

A third myth surrounding SMEs is that they are difficult deals to exit, as they don’t have the governance structures conducive to clean structuring. However, this is a setback that can be overcome, by structuring deals using debt instruments, as opposed to traditional equity.

To fully realise the potential of SMEs, the sector needs to be approached with a fresh perspective attuned to the challenges it faces. There is a need for the focus to shift from the available collateral in the business to the viability of the business and the ability of the entrepreneur. Each business needs finance tailored to their unique challenges,. In addition to this, the business owner needs access to the expertise and market knowledge required to make their business a success.

In the African context, certain challenges need to be overcome for the SME sector to flourish. The private sector’s enthusiasm for investment in SMEs needs to be encouraged to afford GroFin and its peers the opportunity to expand into further developing markets. Developing countries in the rest of Africa need to realise the tremendous economic potential of supporting and expanding the SME sector, and enhance their policy environment to sustain and encourage transactions of this nature. Effective partnerships, appropriate structuring and SME-friendly policy environments are essential to promoting the SME sector, to the point that it rivals the growth and global impact of Microfinance as an asset class.

Guido will speak again at the Private Equity World Africa conference in Johannesburg this year, taking place on 6 and 7 September. Want to join this conference?

This article was a contribution from Amy Heydenrych, GroFin

Not a member? Join VC4Africa