Ignored SME sector
One of the challenges that local markets continue to face is the sidelining of their small and medium enterprises. “Because the financial framework in East Africa is still in its nascent stage, a lot of organisations, especially large and middle-sized SMEs and small corporates, prefer to grow the business organically because they don’t have the in-house capacity to take advantage of private equity or debt financing,” says Muammar Ismaily, Head of Research at Genghis Capital.
“PE has to become part of the fund-raising tool, part of the capital markets. Right now it is a very private affair. It’s more of a push service, and the middle man is normally the corporate finance departments in banks,” says Ismaily. And, since corporate finance departments focus on large corporates, SMEs are being left out of the equation.
Ismaily explains how the PE requirement for audited financial statements, corporate governance, and a board of directors could lock out small businesses. The average SME would have to spend a lot of money to reach a stage where a PE firm would even consider it seriously. While the launch of the Growth Enterprise Market Segment at the Nairobi Securities Exchange offers an opportunity for smaller companies to raise capital, it does not equal the advantages of a PE investment where company affairs can be kept discreet and value additions are made to business strategy and leadership.
The Deloitte Africa Assets study suggests future deals will concentrate more on SMEs. Some projects have already commenced. Venture capitalists, in particular, have tried to meet the needs of younger businesses by providing seed capital to companies that have not reached a stage of maturity to attract PE funds.
The $300m Mkoba fund launched by Tanzanian President Jakaya Kikwete in May also intends to close the financing gap by targeting the needs of SMEs who are hungry for capital. Some of the local VC firms attracting interest include Ashish Thakkar’s Mara Launchpad in Uganda and Heshan de Silva’s DSG in Kenya, both of which offer incubation and investment guidance to young entrepreneurs. The Savannah Fund and 88mph have also made a name for themselves.
A concern is that the limited partners for many of the funds continue to be development-focused organisations. Regulatory challenges have also prevented East African institutions from becoming limited partners. So, even though East Africa’s financial markets are opening up to private equity, the rest of the economy seems to be lagging behind. But the possibility of high returns on investments coupled with expectations of rising consumer spending are expected to fuel increased levels of PE activity in 2014.