Why SMEs

The context: Africa today

Africa is enjoying a period of rapid growth. Our economies are developing faster than anywhere in the world, our population is set to double by 2050 and we have a growing middle class.

However, despite these positive signs of growth, poverty is still a serious issue with over half of the population living on under $1.5 a day and unemployment rates remaining high.

Without new job creation, a sense of inequality will abound, economic development will stall and the continent could face widespread civil unrest.

 

The role of SMEs

It is well-known that small to medium sized businesses (SMEs) are the engine of social and economic growth in Africa. SMEs are the driving force of a country’s GDP, wealth and Government tax revenues which can be used to fund public services like hospitals and schools, and infrastructural reform to improve our roads and power supply. In fact, every $1 invested in an SME generates an additional $10 in the local community.

SMEs are also the primary source of new job creation. In high income countries, small businesses provide 60% of employment opportunities compared to less than 20% in developing countries. Helping Africa’s entrepreneurs to build successful SMEs is therefore essential for the long-term and sustainable economic development of Africa.

 

SME growth capital

However, to grow their SMEs, entrepreneurs need access to financial capital – and this is where the problem lies. Most African banks will not provide loans to SMEs due to the high-risks associated with starting a business in Africa and the lack of fixed assets (e.g. formally registered land) to offset the high risks. If an entrepreneur does manage to receive a bank loan, they will often struggle to meet the rigid deadlines and to pay back the sometimes cripplingly high rates of returns.

 

Private equity is the answer to this problem. Providing both growth capital (finance) and value-add expertise to build successful businesses, private equity is the best solution for entrepreneurs seeking to expand their businesses.

 

 

The challenge of SME investing in Africa

The problem is that SME investing in Africa is notoriously difficult. Existing African SME private equity funds lack investment track records, so they struggle to secure backing from international investors. They also lack the depth of resources and experience needed to overcome the considerable financial, operational and strategic challenges of investing in SMEs in Africa, where entrepreneurs often lack management capacity and experience.

 

So successful SME investors need to be able to support their portfolio companies and add value to their operations. This takes resources, however in this part of the private equity market, funds are small by definition therefore management fees are low. As a result, the traditional model for private equity does not work for African SMEs because precisely in the part of the market where fund managers need to have more resources to support portfolio companies, fee levels can usually only support small teams with limited experience.

Furthermore, if African SME private equity funds do succeed in overcoming the many challenges to developing experience and a track record, they immediately raise larger funds and focus on bigger transactions, so their expertise is lost to the SME sector. As a result, international development finance investors are often faced with sub-scale, first time fund managers which lack track record and are high risk.

 

Jacana was developed as the solution to this problem. To find out how click here.