Exploring the role of private equity in driving growth for African SMEs

INTRODUCTION

‘SMEs are the major contributors to African economies’ This remarkable statement was made by Ifeyinwa Ugochukwu at the 2020 International Youth Day with Tony Elumelu Foundation. Martha T.M. Phiri also stated that SMEs have a really big job to play in Africa.[1] Small and Medium Enterprises (SMEs) are pivotal in many economies, especially in developing countries. According to the World Bank, they constitute the majority of businesses globally and significantly contribute to job creation and the advancement of the global economy. SMEs make up roughly 90% of businesses and over half of the global workforce. In emerging economies, formal SMEs can contribute up to 40% of the national income (GDP).[2] The majority of economic activity in Africa is attributed to small and medium-sized businesses (SMEs). Therefore, fostering a robust financial environment in Africa is closely intertwined with creating conditions that support the expansion of SMEs.[3]

Investing in Africa through private equity is a strategy where private equity funds are used to invest in companies and businesses based in Africa. This approach is gaining popularity as investors seek to leverage the potential of Africa’s swiftly expanding economies. Private equity funds have been operational in Africa for several years, with a significant focus on sectors like consumer goods, healthcare, and technology.[4] According to Ngaalah Chuphi, ‘Private Equity in Africa is primarily used to support growth, whereas in the developed world, it may have more of a financial structuring bias.[5]

 

THE LANDSCAPE OF AFRICAN SMEs

There is no one-size-fits-all definition of SMEs; the criteria can vary depending on the perspective or standards applied. The commonly employed definitions typically rely on quantitative measures, emphasizing factors such as the number of employees, assets, size, and revenue.[6] SMEs encompass a spectrum of businesses, ranging from tiny micro-firms operated by one or two individuals with minimal or stagnant growth, to rapidly expanding medium-sized enterprises generating significant revenue, with many employing up to 250 staff members.[7]

Small and medium-sized enterprises (SMEs) play a vital role in fostering inclusive socio-economic development and growth in Africa. Their contributions are significant as they create employment opportunities, generate income and wealth, and contribute to poverty alleviation efforts.[8] SMEs are the foundation of African economies, encompassing a wide array of businesses across different sectors such as agriculture, manufacturing, services, and technology. They contribute substantially to GDP, employment, and poverty reduction [9]

SMEs serve as the bridge connecting basic industries to complex, highly developed large-scale industries, thereby serving as a launchpad for Africa’s development. These industries play a crucial role in facilitating development by supplying inputs and services to larger industries while simultaneously offering goods and services directly to consumers. This ongoing role of SMEs continues to drive sustainable growth and economic development across African nations.[10]

 

 

CHALLENGES FACED BY SMES IN AFRICA

Despite the crucial role played by SMEs in various African economies, they encounter various challenges that can hinder their ability to contribute effectively to economic development. Some of these obstacles are:

• Access to Financing: SMEs encounter challenges in accessing funding. This poses a significant problem because without adequate working capital, companies are unable to invest and expand.[11] The presence of high-interest rates also deters SMEs from seeking financing altogether. This absence of affordable funding significantly hinders the growth of SMEs in Africa.[12] This problem has been escalated in Nigeria due to the recent increase of the Monetary Policy Rate in an attempt to mitigate inflation in the country.
• Lack of Infrastructure: Numerous SMEs in Africa face challenges in accessing dependable electricity, internet connectivity, and essential infrastructure. This impedes their ability to expand their customer base, access markets, and scale their operations. Often, SMEs resort to costly alternatives like generators, private transportation, etc. leading to higher operating expenses. The absence of sufficient digital infrastructure further hinders their competitiveness in the global market.[13] These additional operational costs make it harder for SMEs to stay afloat. This problem has been prevalent in Nigeria due to the removal of fuel subsidy and the increase of electricity tariffs.
• Lack of Information and Knowledge: SMEs lack a consistent and reliable information source and market database, which are essential for their success. The inability of SMEs to access information has been identified as one of the primary obstacles hindering their growth and development in Africa.[14]
• Poor Information Management and Record Keeping: Inadequate management of information and poor record-keeping practices are critical issues affecting SMEs in Africa. Scholars argue that for SMEs to function effectively, they must adopt efficient management strategies, maintain accurate and current records, and diligently document all aspects of their business operations, encompassing documents, finances, and data storage.[15] The absence of financial records, audited statements, or dependable financial projections can impede the ability of SMEs to obtain financing.[16]
• Regulatory Constraints: Navigating intricate and constantly changing regulatory frameworks is a common challenge for SMEs. Complying with various laws and regulations concerning taxation, employment, data protection, and environmental standards can be particularly demanding, especially for smaller businesses that may lack specialized expertise or dedicated compliance departments.[17]

 

THE ROLE OF PRIVATE EQUITY IN SUPPORTING AFRICAN SMEs

Private equity refers to ownership or interests in entities that are not publicly listed or traded. It represents a form of investment capital provided by firms that acquire stakes in private companies.[18] Private equity firms are investment entities that pool funds from high-net-worth individuals and institutional investors. These firms use these funds to acquire ownership shares in privately held companies, aiming to improve their performance and eventually exit their investments with a profit.[19] These firms generally invest in non-publicly traded entities and offer financial support for activities like growth, expansion, and acquisitions.[20]

Finance serves as a vital catalyst for establishing new businesses and enables existing ones to seize growth opportunities, create jobs locally, and subsequently contribute to supporting other businesses.[21] The availability of private equity financing opportunities has the potential to alleviate financial constraints for businesses, leading to potential benefits for employment and firm growth.[22] SMEs frequently face heightened susceptibility to economic fluctuations and struggle to withstand stock market changes. Private equity offers a solution by assisting these businesses in navigating such volatility, potentially resulting in higher profits. The primary objective of private equity is to enhance a company’s value, ultimately translating into greater profits for its owners.[23]

Private equity funds have emerged as an effective channel for both public and private sector investors to access African markets. In recent years, numerous prominent specialized players have entered the scene, and several large fund managers have launched Africa-focused funds.[24] Amidst various crisis in recent years such as the looming global recession, disruptions in supply chains, and surging energy prices, investment in Africa is still ongoing. These challenges have prompted fears of a prolonged period of high inflation and sluggish economic growth. However, for private equity investors, tough times can present opportunities to access value. While not immune to market difficulties, the private equity sector has shown the ability to weather storms and even thrive.[25]

Numerous opportunities remain available, particularly for entities open to adopting a comprehensive, long-term strategy. The potential for stabilizing interest rates and strengthening currencies across the continent may contribute to a more optimistic outlook. Additionally, there are indications that countries aiming to attract investment are prioritizing enhanced investor confidence through the adoption of elevated corporate governance standards.[26]

THE ROLE OF PRIVATE EQUITY FIRMS

Private equity firms are made up of proficient investment professionals, including financial analysts, investment analysts, industry specialists, and seasoned managers. Their responsibilities encompass evaluating potential investment opportunities, conducting thorough due diligence, and making strategic decisions to maximize returns.[27] Some of the important roles performed by private equity firms include:

• Private equity firms fulfill a crucial role in the economy by offering patient capital to businesses requiring financial support. They contribute to economic stability by extending financing to businesses that might otherwise struggle to secure funds. Additionally, these firms aid in job creation by providing financing to companies seeking expansion opportunities.[28]
• Private equity firms actively engage with the companies they invest in, collaborating closely with management teams to pinpoint operational inefficiencies, growth prospects, and possible cost-saving initiatives. Through leveraging their expertise and resources, their goal is to elevate the overall performance and value of the companies within their portfolio.[29]
• Private equity firms also conduct due diligence on a business in order to assess the business. This due diligence involves an examination of certain things like the strategy of the business, the business’ financial health, industry and market, etc.[30]
• Private equity firms influence the strategic path of the companies within their portfolio. They often provide direction regarding mergers and acquisitions, market growth strategies, product enhancements, and other key initiatives aimed at boosting value.[31]
• Private equity firms actively engage in continuous monitoring and provide ongoing assistance to the companies within their portfolio.[32]

 

CONCLUSION

SMEs in Africa are seen as crucial for driving economic growth and development because they provide jobs, generate income and wealth, and help reduce poverty. Despite their importance, these businesses encounter various obstacles that can limit their ability to contribute fully to the economy. One significant challenge discussed in this article is their limited access to financial resources. Private Equity presents a viable method for SMEs to secure funding, promoting their growth and expansion.

Crimson Oak offers private equity services, by offering the capital, expertise, and support required to achieve our clients’ growth objectives.

[1] ’22 Quotes From the International Youth Day with TEF’ (12 August, 2020, The Tony Elumelu Foundation) < https://www.tonyelumelufoundation.org/news/22-quotes-from-the-international-youth-day-with-tef > accessed 25^th April 2024.

[2] ‘Small and Medium Enterprises (SMEs) Finance’ (16 October, 2019, World Bank) < https://www.worldbank.org/en/topic/smefinance > accessed 25^th April 2024.

[3] Linda Onyinyechukwu, ‘Top 5 Challenges of SMEs in Africa’ (5 November, 2021, Sme360) < https://www.sme360.ng/2021/11/05/top-5-challenges-of-smes-in-africa/ > accessed 25^th April 2024.

[4] ‘Private Equity Investing in Africa’ (AFSIC) < https://www.afsic.net/private-equity-investing-in-africa/#:~:text=Private%20equity%20investing%20in%20Africa%20is%20an%20investment%20strategy%20that,of%20Africa’s%20rapidly%20growing%20economies. > accessed 25^th April 2024.

[5] ‘A growth engine: Trends and outcomes of private equity in Africa’ (March 2017, Hello Investment) < https://www.heliosinvestment.com/uploads/files/A-growth-engine-Trends-and-outcomes-of-private-equity-in-Africa.pdf > accessed 25^th April 2024.

[6] Samuel Muiruri Muriithi, ‘African Small and Medium Enterprises (SMES) Contributions, Challenges and Solutions’ (ID Publications) < https://www.idpublications.org/wp-content/uploads/2017/01/Full-Paper-AFRICAN-SMALL-AND-MEDIUM-ENTERPRISES-SMES-CONTRIBUTIONS-CHALLENGES.pdf > accessed 25^th April 2024.

[7] Ibid.

[8] ‘Unlocking the Potential of Africa’s SME’s Using Emerging Technologies in Africa’ (1 August, 2022, Nepad) < https://www.nepad.org/blog/unlocking-potential-of-africas-smes-using-emerging-technologies-africa > accessed 25^th April 2024.

[9] ‘Empowering Africa’s Economic Growth: The Role of MSMES’ (17 January, 2024, Tony Elumelu Foundation) < https://www.tonyelumelufoundation.org/articles/empowering-africas-economic-growth-the-role-of-msmes > accessed 25^th April 2024.

[10] Samuel Muiruri Muriithi, ‘African Small and Medium Enterprises (SMES) Contributions, Challenges and Solutions’ (ID Publications) < https://www.idpublications.org/wp-content/uploads/2017/01/Full-Paper-AFRICAN-SMALL-AND-MEDIUM-ENTERPRISES-SMES-CONTRIBUTIONS-CHALLENGES.pdf > accessed 25^th April 2024.

[11] Daniel F. Runde et al. ‘Supporting Small and Medium Enterprises in Sub-Saharan Africa through Blended Finance’ (7 July, 2021, CSIS) < https://csis.org/analysis/supporting-small-and-medium-enterprises-sub-saharan-africa-through-blended-finance > accessed 25^th April 2024.

[12] Linda Onyinyechukwu, ‘Top 5 Challenges of SMEs in Africa’ (5 November, 2021, Sme360) < https://www.sme360.ng/2021/11/05/top-5-challenges-of-smes-in-africa/ > accessed 25^th April 2024.

[13] Stride ERP, ‘Overcoming Obstacles to SMES’ Growth in Africa The Need For Investment and Innovation’ (27 March, 2023, LinkedIn) < https://www.linkedin.com/pulse/overcoming-obstacles-smes-growth-africa-need-investment-innovation#:~:text=Regulatory%20barriers%2C%20including%20excessive%20bureaucracy,can%20limit%20their%20growth%20potential. > accessed 25^th April 2024.

[14] Abdul Kanu, ‘An Investigation into the Challenges to SMEs Development in Africa’ (1 January, 2022, IJECM) < https://ijecm.co.uk/wp-content/uploads/2022/01/1013.pdf > accessed 25^th April 2024.

[15] Samuel Emezie, ‘Prospects and Challenges of SMEs in 21^st Century Africa’ (Core) < https://core.ac.uk/download/pdf/161421553.pdf > accessed 26^th April 2024.

[16] ‘Challenges faced by SMEs in Raising Capital’ (12 June, 2023, LinkedIn) < https://www.linkedin.com/pulse/challenges-faced-smes-raising-capital-cm-sme-club > accessed 26^th April 2024.

[17] Ibid.

[18] Troy Segal, ‘Understanding Private Equity (PE)’ (9 February, 2024, Investopedia) < https://www.investopedia.com/articles/financial-careers/09/private-equity.asp#:~:text=Private%20equity%20is%20ownership%20or,delist%20them%20from%20stock%20exchanges. > accessed 26^th April 2024.

[19] ‘Private equity Firms in Nigeria’ (AFSIC) < https://www.afsic.net/private-equity-firms-in-nigeria/#:~:text=Private%20equity%20firms%20in%20Nigeria%20invest%20across%20various%20sectors%20of,various%20stages%20of%20their%20development. > accessed 26^th April 2024.

[20] ‘Private Equity Firms in Africa – Private Equity Firms Investing in Agriculture etc.’ (AFSIC) < https://www.afsic.net/private-equity-firms-in-africa/ > accessed 26^th April 2024.

[21] Victoria Duff, ‘Importance of Finance & Its Role Within Business’ (12 February, 2019, Chron) < https://smallbusiness.chron.com/importance-finance-its-role-within-business-1513.html > accessed 26^th April 2024.

[22] Lawrence Ngalim and Asli Togan Egrican, ‘Private Equity Industry in Africa: Firm Survival and Growth’ (30 January, 2023, SSRN) < https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4340228 > accessed 29^th April 2024.

[23] ‘Everything You Need To Know About Private Equity’s Financing For SMEs’ (15 March 2024, Fater Capital) < https://fastercapital.com/content/Everything-you-need-to-know-about-private-equity-financing-for-SMEs.html#:~:text=Small%20businesses%20are%20often%20more,can%20lead%20to%20increased%20profits. > accessed 26^th April 2024.

[24] ‘Private Equity Investment in Africa In Support of Inclusive and Green Growth’ (AFDB) < https://www.afdb.org/fileadmin/uploads/afdb/Documents/Generic-Documents/Private%20Equity%20Investment%20in%20Africa%20-%20In%20Support%20of%20Inclusive%20and%20Green%20Growth.pdf > accessed 26^th April 2024.

[25] ‘Africa: Resilience in the Private Equity Market’ (16 May, 2023, InsightPlus) < https://insightplus.bakermckenzie.com/bm/private-equity/africa-resilience-in-the-private-equity-market#:~:text=This%20is%20confirmed%20in%20a,in%20the%20last%20five%20years. > accessed 30^th April 2024.

[26] Simon Page, ‘Private Equity Investment Could Hold the Key to Accelerating African Growth’ (12 February 2024, Hawksford) < https://www.hawksford.com/insights-and-guides/private-equity-investment-key-to-african-growth#:~:text=However%2C%20a%20burgeoning%20working%20age,digitalisation%2C%20service%20provision%20and%20infrastructure. > accessed 30^th April 2024.

[27] Invexic, ‘Understanding the Role of Private Equity Firms’ (21 August, 2023, LinkedIn) < https://www.linkedin.com/pulse/understanding-role-private-equity-firms-invexic > accessed 30^th April 2024.

[28] ‘What are Private Equity Firms and Why are They So Important’ (20 March, 2024, Faster Capital) < https://fastercapital.com/content/What-are-private-equity-firms–and-why-are-they-so-important.html#What-is-the-role-of-private-equity-firms-in-the-economy- accessed 30^th April 2024.

[29] Invexic, ‘Understanding the Role of Private Equity Firms’ (21 August, 2023, LinkedIn) < https://www.linkedin.com/pulse/understanding-role-private-equity-firms-invexic > accessed 30^th April 2024.

[30] ‘What are Private Equity Firms and How do They Work?’ (4 February, 2023, Indeed) < https://www.indeed.com/career-advice/career-development/what-are-private-equity-firms > accessed 30^th April 2024.

[31] Invexic, ‘Understanding the Role of Private Equity Firms’ (21 August, 2023, LinkedIn) < https://www.linkedin.com/pulse/understanding-role-private-equity-firms-invexic > accessed 30^th April 2024.

[32] Halyna Herasym and Edilberto L. Segura, ‘Th Role and Benefits of Private Equity in Emerging Market Economies’ (4 April, 2006, Bleyzer Foundation) < https://bleyzerfoundation.org/files/tbf_reports/Private%20Equity%20in%20Emerging%20Markets%202006.pdf > accessed 30^th April 2024.