A new crop of capital providers – call them “growth funds” – are emerging to meet the financing needs of post-revenue, growth-oriented businesses in Africa.
The fund managers, largely local and still mostly small in size, provide ventures with a flexible mixture of equity and debt without the onerous collateral requirements of banks and with the vital technical assistance that many enterprises need to fulfill their potential. Small and growing businesses on the continent face a nearly $330 billion annual financing gap, according to International Finance Corp.
Such capital providers represent an emerging asset class that is proving attractive to both African pension funds and local wealthy families and high-net worth individuals, according to the Collaborative for Frontier Finance’s “state of play” report on small business finance in Africa. Africa’s pensions manage around $700 billion in assets, growing by more than 15% per year.
Still, the capital providers face what the collaborative calls the “hourglass dilemma,” a choke point between the potentially large pools of capital available from institutional and development financiers and the smaller amounts such funds can absorb. That points to the need for new approaches to nurture such funds through what the report calls “the Valley of Perseverance.”
“These models are proving that smaller-sized funds can meet small businesses where they are, in ways that nobody else in the market can meet them,” CFF’s Drew von Glahn told ImpactAlpha. “The big challenge is how do you move big capital to little deals.”
The collaborative surveyed nearly 100 such capital providers, and found that most write checks of between $20,000 and $1 million, with loan tenures of about four years, on average. In contrast, banks expect repayment within about 2.5 years. Almost all of the growth funds provide pre-, and certainly post-financing, technical assistance to their portfolio companies, accelerating their growth and, not incidentally, reducing the risks for lenders and investors.
Most importantly, the growth funds rely on their local networks for deal sourcing and on their proximity and market knowledge to adapt their financing to the needs of local businesses. However, in working with what they have, growth funds are arguably more responsive in capital provision, going by the various structures they use. Over 60% of the funds are willing to offer shared revenue lending models or convertible notes.
Uganda’s Shona Capital, for example, provides non-collateralized loans to businesses in agriculture and healthcare. The investor factors an entrepreneur’s character in its risk assessment, alongside its own developed alternative credit assessment framework. Shona says its seen portfolio revenues shoot up by 1.5 times, within the first year of providing its capital.
Local pension funds
Funding from local investors, “provides a domestic solution to domestic capital challenges, and also bypasses the inherent risk of foreign exchange being managed by small businesses,” von Glahn said. Most, if not all, of the losses in private equity funds in Africa can be traced to currency fluctuations that have disrupted many economies in recent years.
“Local fund managers should not be managing foreign debt,” von Glahn said.
Uganda’s $6.5 billion National Social Security Fund, of NSSF, is convening an “All Africa Pension Summit” in Kampala next month to advance the discussion of small business financing (for background see, “Ugandan pension fund is creating new savers with investments in small business and agriculture,” part of ImpactAlpha’s Pathways to Growth series with CFF).
The CFF report highlights Mirepa Investment Advisors in Ghana, which raised almost all of its first fund from local capital providers and pension funds in Ghana. “No foreign investor. No external investor,” Mirepa’s Samuel Yeboah told ImpactAlpha earlier this year. “For us, that’s pretty significant. It demonstrates that we actually can mobilize capital locally.”
Secha Capital and Linea Capital, both in South Africa, have also attracted local institutional investors.
Wealthy families and high-net worth individuals are also stepping up to fund local capital providers. Nearly 30% of the growth funds interviewed have raised funding from both local and international HNWIs and family offices.
“This group represents the second-largest investor segment, reflecting their flexibility and willingness to be early backers of this emerging asset class,” the report says. Development finance institutions, in contrast, have been disappointing as a source of capital. “Moreover, their commitments are concentrated in only a handful of funds, leaving most of the market underserved.
Many “blended finance” solutions have underperformed, the report says, “due to overly complex structures, limited local context, and weak execution.”
Development lessons
The Collaborative for Frontier Finance has adopted the “growth funds” nomenclature to distinguish the capital providers from other small business funders. Older terms such as “small and growing businesses,” or SGBs, and “micro-, small- and medium enterprises,” or MSMEs, tended to underplay the investment potential of growing businesses in some of the world’s most dynamic markets, von Glahn said.
Kenya’s HEVA Fund, for example, provides debt funding to players in the creative economy, one of the industries African youth are turning to for their livelihoods. HEVA’s loans are pegged to an artist’s intellectual property, or revenues generated from copyrights and royalties. (for more background see, “Creative financing for the creative economy in Africa”). The fund has committed over $20 million to 100 enterprises, 70% of which are women and youth-owned.
Development finance institutions, or DFIs, continue to have a role to play in ushering the asset class to scale. Regional funds-of-funds are emerging to channel larger checks from DFIs and other institutional investors and redistribute them to local growth fund managers. In Ghana, Ci-Gaba is nearing a first close
“Our companies are small and can’t take certain kinds of capital,” Hamdiya Ismaila of Savannah Impact Advisory, which manages the Ci-Gaba Fund of Funds, told ImpactAlpha this summer. “Foreign capital comes and it is heavy. There’s the need to have aggregators who aggregate big pools and give it to these smaller funds to really invest in a pipeline for larger funds to come in.”
Von Glahn said the report suggests that catalytic capital from development finance institutions and other development funders may be more effectively deployed to defray the cost of business support and technical assistance for portfolio companies, rather than for credit-enhancement and other approaches to derisking fund investments.
“Your best risk mitigant is a successful enterprise,” he said.
A report this year from ISF Advisors found that concessional financing is often used to crowd in commercial capital by reducing risks and enhancing returns for senior investors, “rather than to pass along some benefits to the underlying investee.”
Another takeaway: Focus on local growth fund managers, rather than commercial banks that are more attuned to traditional asset-heavy companies than the new generation of tech-enabled, high-growth businesses that lack such collateral.
“Until banks start to do cash-flow based financing, they’ll never do small business financing in the way that matters,” von Glahn said.
