All over the world, small and medium-sized enterprises or SMEs are the driving force behind the economy, supporting employment and sustaining communities. However, when it comes to access to capital and financing for growth, they are often overlooked in favor of larger companies that are considered a better investment bet. The situation is acute in emerging markets, and in particular in Africa.
African SMEs account for up to 70% of employment and 40% of GDP across the continent. However, only one in five of these companies has access to financing through local banks. Meanwhile, private equity funds can often be too large to meet the needs of smaller companies. Moreover, they are often provided by funds and investors with international, rather than local, viewpoints and goals. As the world faces the threat of another global economic downturn, there is a risk of a new crisis for small businesses already struggling to attract funding.
The Covid-19 pandemic marked a turning point for governments and investors. He highlighted the growing disparity in opportunity and wealth between developed economies and emerging markets. It spurred debate and action around rebuilding fairer economies that benefit all people and the planet. That’s why the UK G7 presidency commissioned us to lead its impact taskforce last year. One of its main objectives was to focus on key leverage points to increase the flow of capital towards investments that can have positive benefits for society and the environment, especially in emerging markets that are in danger of becoming back off
To implement the recommendations made by the G7 Impact Task Force, the Global Steering Group on Impact Investment, we joined forces with the World Economic Forum, the Collaborative for Frontier Finance and other partners. Our goal is to improve financing for SMEs in countries such as Ghana, Zambia and South Africa. Together, we have explored ways to channel more investment into this critical segment to help build more resilient economies that can provide more people with better livelihoods.
It may come as a surprise, but there is ample untapped capital in African markets. Private pension funds in Ghana control about two-thirds of the country’s $5.5 billion in pension assets and are growing at a rate of about 30% annually. But while the industry is allowed to allocate up to 15% of assets to alternatives, data from the Ghana National Pension Fund Authority shows that only 0.03% is actually invested in private assets. Even in South Africa, where pension funds invested $8.9 billion in private equity and venture capital by 2021, many funds are well below the permitted limits. More than the availability of capital, the problem has been the lack of the right types of local financing structures that can meet the needs of SMEs.
There is no single approach, but a range of options depending on the needs of each country. However, the goal is the same: to encourage domestic institutions to invest more in small and growing companies, while attracting more international investors with a growing appetite for impact investing.
More than the availability of capital, the problem has been the lack of local financing structures that can meet the needs of SMEs.
In Ghana, our local partners have begun structuring a fund of funds model that can attract investment from domestic institutional investors as well as international development finance institutions and impact investors. This fund will then invest with local capital providers (or, in other words, with an impact on venture capital and private equity funds), who in turn will finance the SMEs in the volumes they need, usually between 50,000 and the $500,000 that many larger funds lose. This investment could be debt, equity or mezzanine financing, as long as it has impact objectives at its core. Critically, local capital providers will be led by local talent with an intimate understanding of local markets, rather than international investors with a more helicopter view.
In countries like Zambia, where SMEs are smaller and financing options less developed, the government is pursuing a credit guarantee scheme. For pension funds whose primary consideration is capital protection, these structures can de-risk their investment while allowing capital providers to channel money into SMEs through loans and other debt. Investors with a greater appetite for risk can underwrite the guarantee, providing investors with impact returns and companies with capital to grow. The credit guarantee scheme that our partners are currently developing with the Central Bank of Zambia will initially target the country’s smallholder farmers, who produce 80% of the national food supply. Enabling them to improve their resilience through adequate financing will in turn have a positive impact on food security and poverty reduction.
Skills and talent required
As always, there are challenges in developing new forms of financing for SMEs. Fund of funds (and other schemes) structures need to be considered to incentivize managers and provide risk reduction mechanisms to attract new types of local and international investors. Also, there is a limited number of people with the experience and knowledge to set up and run these impact investment vehicles in Africa and other emerging markets.
Pioneering efforts in Ghana and Zambia are examples of how other countries can empower smaller businesses
But that is changing. The growing supply of capital in the SME space in Africa will fuel innovation, catalyze the creation of new investment structures and stimulate the development of skills and talent. If we want more resilient economies, where people have better livelihoods, we need to focus more on SMEs and creating ecosystems that help them thrive and contribute to the Sustainable Development Goals.
Pioneering efforts in Ghana and Zambia are examples of how other countries in Africa, as well as Asia and Latin America, can empower smaller businesses. They show how local investors and managers can unlock essential investments for small businesses and, in doing so, secure even more impact investments from international investors.
To create fair economies and fair societies in emerging markets, we must focus on small businesses at their heart. It’s time to get involved.
Explore this topic further at Joining forces: growing impact in Africa and beyond, a side event co-organized by GSG at the Finance in Common summit, in Abidjan, Côte d’Ivoire, on 18 October. In addition, the second part of the GSG Impact Summit series will take place on September 22 online, on the topic of boosting capital flows to emerging markets, with a panel discussion on increasing investment in SMEs.
Detailed findings on how Funds of Funds vehicles can help improve SME financing can be read here.
- Krisztina Tora is Chief Market Development Officer of the Global Steering Group for Impact Investing.
Header image: View of Accra, Ghana (photo by Muntaka Chasant, CC BY-SA 4.0)
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