Dynamics of business funding

Tania Ngima

Over the past few months, I have been keenly watching the financial services industry, specifically the investment space.

To a large extent, this due to the fact that every time I speak to players on one side of the industry, usually private equity, the consensus is that there is a lot of money and not enough viable businesses to invest in. The opposite end of the spectrum however, tells a different, even paradoxical story.

Entrepreneurs in the SME space recount horror stories of looking for funding, whether for equity or debt, and not even the numerous competitions and challenges can plug the financing gap that exists.

An example I like to give that illustrates the desperation experienced by enterprises in the small sector when seeking funding comes from years ago, when the technology industry was still nascent.

Given that we are so in tune with Silicon Valley, we were lying awake dreaming up applications that would rival WhatsApp’s $19 billion acquisitions by Facebook.

While investment has always been hard to come by, every year it increases in leaps and bounds. And while all experts advise entrepreneurs to seek highly experienced legal counsel when they have an offer for funding, not many of them heed the call.

This is in part because experienced legal counsel is expensive and in part because they think they know what’s best for their businesses, forgetting they are no match for the legalese and maze of clauses contained in contracts.

Long story short and protracted proceedings later, the entrepreneur almost lost his business to the same investors who put their money into the venture.

This scenario has played out a couple of times and in as much as we ask SME founders to be selective about who they sell a stake in the business to, I am not sure that is realistic in a space that is dominated by a hundred businesses competing for the same investments and other entrepreneurs who are willing to give up a bigger stake for a song.

In 2015, the Economist warned that too much money was ‘pouring into too few funds, chasing the few big deals on offer’ while the IFC at the same time estimated that up to ‘84 per cent of SMEs in Africa are either underserved or unserved in terms of capital’.

In late 2016, an article in the Financial Times estimated that out of the new funds raised in 2015, nearly 70 per cent was accounted for by three of the largest funds - Helios, Development Partners International (DPI) and Abraaj.

This past week I was invited to a number of pre-Sankalp events which were focused on the investing aspect of entrepreneurship and most importantly, the missing middle. The missing middle is a phrase that is used to refer to the ‘lack of investable capital targeted at funding SMEs’.

For Africa the concerns around limited access to capital are especially relevant due to the relationship between a thriving SME base and substantial economic and social growth in the developing world.

The range of discussions unpacked a number of assumptions that industry players have observed to be less and less germane to the African continent and in this particular instance to Kenya.

The first was that surrounding the providers and the users of capital. We often refer to increasing the attractiveness and preparedness of SMEs to investors.

That these businesses require the structures and frameworks that will allow them to reach scale and efficiencies is not in doubt.

However, the dynamic we forget to address is that of investors also needing preparedness for investing and operating in developing environments.

This especially applies if they originate from regions with different fundamentals with regards to the speed of growth of small businesses, how easy it is to find the right local skills and how realistic the time from say, proof of concept to a viable product is.

The second assumption was that because the capital raising process is so strenuous for enterprises, it was considered as the most difficult aspect of running a business.

However, what tends to happen in businesses especially in the start-up or growth stages is that the small teams or founders tend to split their time between capital raising, which can take anything from six to nine months, and business continuity.

When the funding round is closed though, if enough time has not been taken into evaluating whether the current model of operations allows for growth and if the business is not set up for expansion from an internal perspective, throwing money at problems is a recipe for disaster.

One of the examples given was the need for hiring as a resolution to a firm’s growing pains. Going from a five to a ten-person firm in a relatively short period of time can create more problems and slow growth as opposed to the speed expected in scaling up and high performing teams.

Increasingly, the need for post-finance support was cited as important for enterprises of any size, but even more for smaller firms that need significant support in achieving the scale and stability that they need.