Report on entrepreneurship in Africa: lack of capital, lack of fundable business plans

By Nur Bremmen on April 23, 2013


This piece by Nur Bremmen originally appeared on Ventureburn, a VC4Africa publishing partner.

Omidyar Network has released the report “Accelerating Entrepreneurship in Africa”, promising to be one of the most comprehensive studies done on African entrepreneurship to date. Below an abridged version of the report’s section on financing. 

The Accelerating Entrepreneurship in Africa report was compiled by the Omidyar Network, the philanthropic foundation established by Pierre Omidyar — the founder of eBay — in partnership with global strategy consulting film, Monitor Group. This epic 48-page report is the result of a three-phase research project launched in 2012 aimed to better understand the state of entrepreneurship in Africa.

The project started with a survey of 582 entrepreneurs across six Sub-Saharan African countries: Ethiopia, Ghana, Kenya, Nigeria, South Africa and Tanzania which was then augmented into 72 in-depth interviews. The second phase invited business, government and thought leaders to the 2012 Entrepreneurship in Africa Summit, held in Accra Ghana, to analyse the survey findings, and offer proposed solutions.

The report presents the findings of the survey, as well as the outcomes and solutions given at the Accra meeting. The report lists financing, skills and talent, and infrastructure as Africa’s greatest challenges. Below an abridged version of the section on financing.

Lack of capital, lack of fundable business plans

The study quotes research by the International Finance Corporation that estimates that up to 84% of small and medium-sized enterprises (SMEs) in Africa are either un-served or underserved, representing a value gap in credit financing of US$140- to 170-billion.

So there’s not enough capital right? While, 71% of the entrepreneurs surveyed agreed, the report says something rather interesting: financiers argue that many of the new ventures are simply not fundable. Financiers note a lack of fundable business plans, pointing to issues ranging from the quality and feasibility of the business idea to the commitment of the entrepreneur and his or her team.

Of the six countries surveyed, Kenya seems to fare the best in terms of capital supply — only 52% of Kenyans sees this as a challenge.

Sources of financing

The main sources of financing are personal and family loans (45%), private equity (19%), bank debt (18%), government funding (5%), venture capital (5%), angel seed (4%) and other (4%). “Other” funding sources include corporate funding, lease / receivables financing or stock options. Some entrepreneurs in South Africa claim that their businesses are funded using multiple credit cards because most banks are reluctant to provide a loan to businesses but are willing to increase limits on the entrepreneurs’ credit cards — expensive, but easy.

The majority of respondents are in agreement that the cost of funding is too expensive — the report found that in some cases, banks require 150% of the borrowed amount in collateral. An alternative, government lending, could be more attractive was it not for bureaucracy and nepotism reported by some respondents.

Venture capital still emerging

The report concludes that venture capital in Africa is still an emergent phenomenon and the majority of survey respondents (67%) agree. Entrepreneurs are forced to pursue bank loans which simply are not tailored for startups. Banks see startup investments as high risk, low reward and like to quote statistics that show 9 out of ten startups fail within the first five years of operation.

Illustrating a profitable business model is critical to boosting VC activity in Africa says the report. Entrepreneurs need to focus on being rigorous business planners and demonstrating their understanding of a particular sector to investors. Entrepreneurs must “know something about everything, and everything about something,” says the founder of First Rand Group in South Africa, Paul Harris.

The report warns however, that finance is not the determining cause of a venture’s success or failure. “Rather, the entrepreneur’s ability to adapt to market changes and cope with uncertainty, as well as their level of tenacity, are greater determinants of a business’ success.” Entrepreneurs also forget about market access. Without multiple product channels, revenues and profits likely stall, and this lack of growth makes funders reticent to invest.

When looking for funding it’s important to get matched with the correct funding provider and to be proactive. A mismatch might occur where a financier is looking for historical data when the venture is fledgling. Entrepreneurs must identify the availability of capital sources and the suitability of capital given their company’s stage of growth. They must also be able to assess their funding requirements and identify those funders that are most likely to fund them. The report advises that misperceptions and misunderstandings can be mitigated by enhanced communication.

Lack of exit opportunities

The report identifies a lack of viable exit opportunities, which leads to a disincentive for funders to make investments — funders can’t recoup their investments. 48% of Ghanaian respondents report that it is uncommon for business owners to use buyouts to sell their firms. Respondents in Ethiopia (42%), Tanzania (41%), Nigeria (38%) and Kenya (37%) share the same concern. The regulations for exiting businesses are also considered rigid, and there is little awareness about the fact that large multinational corporations or private equity funds can sometimes be compelling buy-out options.

Importance of networking

The report raises a fascinating point about how the size and power of an entrepreneur’s network shapes innovation. A larger, more powerful network, with a larger funding pool will allow for bigger ideas and lessen the chances of a startup stagnating.

The research calls for the formalising of seed and angel investing networks. It singles out successful examples, such as the Mo Ibrahim Foundation and the Tony Elumelu Foundation.

Solutions

To mitigate some of the challenges, the study proposes solutions for startups in different growth stages.

Early-stage enterprise financing in Africa

- Reduce bureaucracy for early-stage companies to access government funding in order to provide ‘softer’ sources of financing for less-experienced entrepreneurs.

- Expand or initiate local angel investing ecosystems to ensure the availability of the most appropriate type of funding for start-ups, especially for entrepreneurs who lack the network of friends and family that traditionally play this role.

- Provide tax and other incentives to formal, as well as informal (e.g., family and friends), angel investors to make it easier for people who have extra cash to invest in startup businesses and reduce their risk.

- Provide tax and other incentives for large clients of early-stage ventures to provide supplier credit to incentivise and reduce the risks suppliers take when providing generous payment terms and/or stock to new ventures.

Mid-sized enterprise financing in Africa

- Leverage indirect personal sources of funding, such as pension funds to fund SMEs, so that more resources are available to fund more-established enterprises where the risks are lower.

- Expand or initiate local venture capital investing ecosystems to ensure that the most appropriate source of funding is available for companies at the mid-level stage of development.

- Use local banking systems to disburse donor or government lines of credit to SMEs to reduce prohibitive interest rates and collateral requirements.

- Provide incentives and support to mid-sized SMEs to practise sound financial management and maintain adequate records, including audited statements.

Later-stage enterprise financing in Africa

- Create capital-raising engagement programmes with leaders of well-established private African enterprises to inform entrepreneurs about the benefits of private equity funding, as well as the benefits of listing at local stock exchanges.

- Create continent-wide ‘regional champions’ programmes to facilitate access to capital (both debt and equity) for independently vetted pan-African companies that are expanding across the continent.

- Educate entrepreneurs about possible sources of funding outside banking systems.

- Train and assist early-stage entrepreneurs in the intricacies of capital-raising.

- Train the local financial community to evaluate investment opportunities on the basis of future prospects rather than historical cash flows.

As always we welcome you to share your own experiences, insights, reactions in the comments below!

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