In 2012, I made the decision to move back home to Ghana. I had no idea what I would get up to but I knew it had to involve supporting entrepreneurs.
I spent the first couple of months meeting start-ups, local enterprises and those that support them; from bee keepers to ICT providers and retailers to micro-finance institutions (MFIs). It was a fun few weeks, not to mention incredibly enlightening, as I wanted to understand what the bottlenecks these businesses face and what I could do to help.
Before I get into the issues, I would like to briefly mention the merits of these small and medium enterprises (SMEs). In developed countries, they employ over 90% of working the population, generate a large bulk of tax for governments, are resilient and nimble during downturns and have in-depth knowledge about their markets. There is no doubt that SMEs are big drivers of social and economic growth. This is in stark contrast to developing sub-Saharan Africa where the majority of livelihoods earned are through the informal economy and public sectors as well as the large corporates/multinationals.
What makes the presence and growth of SMEs in these territories so anaemic?
There are a number of hurdles SMEs face: from basic business skills to the right support through the services sector such as audit, tax etc. But the biggest is access to finance and that is where I focused my effort as most of them rely on raising money from friends and family.
My first inclination was to setup a venture capital fund. I spent a few weeks working through the SME financial requirements (deal size, tenure etc) and then the fund requirements (assets to break even, fee structure, tenure). It became quickly apparent that in a typical investment fund structure, venture capital is just not sustainable. This is why: being quite cost-conservative, break even sits at $50m to source deals across sub-Saharan Africa (few institutions will take country risk), if investors are locked up for 10 years (which is the higher-end of the scale) and it takes you 6 months to do due diligence (this is the time it takes for a corporate in a developed country, it will be even longer for an SME in Africa) – to make investments for the first half of the fund’s lifespan and exit in the second half, that implies around 10 investments. That’s $5m an investment, too big for an SME looking to raise $5,000-$250,000. Plus these businesses are mostly family run and they do not want to give up control by selling ownership.
So if it is not equity, what about good old fashioned debt? I went on a mission to find out who lends to SMEs and discovered that neither micro finance institutions (MFIs) nor commercial banks truly do.
Let us start with commercial banks, whose balance sheets are growing at over 40% a year (the banked rate in Ghana is only 41% despite being one of the highest in sub-Saharan Africa). They are geared to lend to corporates and don’t have the need or risk appetite to downscale their strategy. And from an operational perspective it is difficult to do so, requiring large investments and training when there is easier money to be made.
On to the MFIs. There are 750 such institutions in Ghana (I am including credit unions, rural banks and most of the savings & loans companies). The majority of which don’t have the financial muscle nor the skill to lend beyond their client base. Their funding model depends on selling high interest time deposits and the collection and distribution of loans through large work forces that inflate their cost base by up to 50% compared to commercial banks. As a result they lend at high interest rates (up to 110% in some cases) to become profitable. Now a business can only afford these rates if the loan size is small (say borrowing $50 to buy tomatoes to sell them at a high mark-up) or a larger amount for a short period (working capital/cash-flow loans).
What SMEs are crying for are affordable long-term loans. Growth capital. Neither the existing commercial banks nor the MFIs can address their need.
So who can they depend upon?
Given the lack of support from the financial sector, public and non-profit initiatives (and others in between) have had to step in to fill the gap.
On one end of the scale, the non-profits, endowments and foundations from Gates and MasterCard serve a strong purpose. I was recently asked to judge a panel at the MEST UNICEF Hackathon. MEST is a foundation that was setup to train university graduates in Ghana on how to code, develop a business plan and pitch to investors – ultimately to become tech entrepreneurs (they are a great organisation so please look them up). They joined forces with UNICEF and organised a three-day hackathon: 125 applicants were presented with 6 issues as diverse as improving birth registrations to knowing your rights and told to come up with solutions to solve them. The results were fun (a mash-up between Dragon’s Den and American Idol) and the winner took a generous cash prize as seed money to build their app alongside UNICEF’s support. A win-win situation.
These organisations play an important role. They give out grants and provide funding to high-risk initiatives that solve problems in the developing world. Problems that may not have a direct monetary link but help alleviate poverty, promote development and improve the livelihood of many. But going beyond their expertise – grant giving to SMEs – proves detrimental. Not to jump on to the “Dead Aid” brigade but unless businesses are held accountable (i.e. are asked to pay back any funding), the issuer cannot guarantee the funding is being used for income generation. This form of support is unsustainable.
On the other end of the scale is local government and their organisations. Their initiatives stem from the right place but are executed in an uncommercial fashion. A fund to support SMEs through grants (you already know my views) to lines of credit that are pushed through commercial banks (at non-commercial terms) that don’t take into account their operations.
Finally, there are intermediary organisations such as Developmental Financial Institutions (DFIs) like the IFC that have been partially mandated to support SMEs. These organisations provide a range of services, from investing in funds to wholesale funding as well as equity and debt investments. They have a thorough understanding of the key problems they need to solve but given their employees’ lack of private sector work experience (being part of a commercial bank, investment fund etc), are often unable to understand the local commercial solutions. They are slow, bureaucratic and take no risk. Of course there are exceptions but this is the general view.
Having spent two years on the private sector side of SME financing it is clear that the solution is complicated and requires the input of all the non-profit, private and public institutions I have mentioned. To support SMEs in developing countries, an efficient ecosystem needs to be built.
Governments need to step away from lending and provide the right infrastructure and policies. A multi-pronged approach is needed – improving the ease of doing business, incentivising informal businesses to formalise and encouraging investors to take risk.
I always discuss how important the speed of registering a company is, the pronounced amount of red-tape and lack of proper IT infrastructure is a hindrance to doing business in Africa. These issues need to be rectified. Any barriers to doing business will encourage potential SMEs (who, like the majority in this world will take the easy path) to stay informal or end up being employees at a corporate or public body. Furthermore, there needs to be legitimate reasons for businesses to formalise. Right now, if a micro-entrepreneur were to register their business, they would end up paying taxes and get nothing else in return (no access to credit, no service facilities, nothing). In short, their income would go down. So why not provide them with decent policies like a tax break, a simple legal framework to follow, access to educational seminars on business management as well as governance and auditing?
What of the grant-giving institutions? Experts in their fields exploring new avenues to solve their problems and I applaud them for taking the risk and having the vision to do so. However examples like the MEST UNICEF Hackathon are far and few between. These organisations need to throw more muscle behind such initiatives and realise that their main goal is to withdraw from the countries they operate in once their mission is over. Their projects are finite.
And then the DFIs who play an important role in supporting existing businesses, like the commercial banks or private equity funds, to push their agenda. Their roles are crucial however access to equity is not the answer to supporting SMEs (there are over 45,000 in Ghana) and providing banks with lines of credit will not work (after all it hasn’t in the past so why should it now?). I urge and plead for these organisations to take risk. And to move, fast. Only when this ecosystem is in place will SME growth follow. And this doesn’t just apply to Ghana, it applies to most countries in developing sub-Saharan Africa.
In the meantime it is up to new initiatives to emerge that can satisfy a large portfolio of SMEs because with if this status quo continues: throwing resources at the current “solutions” expecting different results, then Einstein’s definition of insanity certainly holds true.