11 November 2012

Africa: SMEs Form New Growth Frontier


The role of the development finance institutions is under debate. As the countries they serve increasingly become engines of global growth, with the capacity, resources and entrepreneurial talent to make their own economic destinies, so the emphasis on including the local market private sector in development finance projects has increased.

This is not to say that the requirement for development finance has decreased, poverty in Africa is still a serious issue, with the last Africa Progress Report stating that almost half of the continent's population earns less than 1.25 dollars a day, but merely that the focus for its input has shifted.

The UK's development finance institution, CDC, has recently announced its intention to focus its new investment strategy on building businesses and creating jobs in Africa and Asia. Once again, supporting the local private sector is the focus.

That is a necessary strategy. With a population set to double by 2050, yet no clear sign of where the jobs to support this demographic growth will come from, Africa is facing the risk of stalled economic development and widespread civil unrest unless swift action is taken.

Small & Medium Enterprises (SMEs) are the driving forces of a country's gross domestic product (GDP), wealth and government tax revenues, which in turn fund public services and infrastructural reform critical for socio-economic growth. In fact, every one dollar invested in an SME generates an additional 10 dollars in the local community.

SMEs are also the primary sources of new job creation. In high-income countries, small businesses provide 60pc of employment opportunities compared to less than 20pc in developing countries. There is a huge opportunity, and acute need, for this percentage to grow.

Private equity investment, with its appetite for greater risk than the banks combined with its management expertise, is a sound solution for enabling private sector development inAfrica. It is one vehicle that equity providers can appropriate to target job creation via SME growth.

However, SME investing in Africa is notoriously difficult, due in part to a lack of investment track record, and depth of resources and experience among many African SME private equity funds.

The traditional model for private equity does not work for African SMEs because precisely in the part of the market where fund managers need additional resources to support portfolio companies, fee levels can only accommodate small teams with limited experience. If African SME private equity funds do succeed in overcoming the many challenges to developing experience and a track record, historically, they have, then, tended to raise larger funds and focus on larger transactions, so their expertise is lost to the SME sector.

What is required is the development of a new model for private equity investment, with the structure, skills and experience to successfully invest in SMEs on a pan-African and long-term basis. By combining African professionals who understand their local markets and can provide close support to portfolio companies, with highly experienced international private equity veterans who commit their time and expertise on a pro-bono basis, on-the-ground teams can be bolstered with high-level private equity professionals whose management fees they could never afford.

This unique blend of knowledge and expertise is the only way believed to make SME private equity investment in Africa successful and sustainable in the long-term.

Recognition of the evolving global economic landscape combined with innovative solutions to support African SME and private sector growth are essential to ensure that the demographic dividend is catered for with new and sustainable jobs. With the right support, from the development finance institutions, private equity managers, the local governments and the African private sector itself, economic growth in Africa will continue.

Simon Merchant is CEO of Jacana Partners, a Pan-African private equity company investing in SMEs. This commentary first appeared on This Is Africa.

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