A UN forecast suggests that by 2050, the world will have an extra 2.2 billion people and over half will come from Africa
Forty-nine
countries have signed up so far this year to join the African
Continental Free Trade Area, which is the latest contribution to a
perennial debate: how to create more jobs on the African continent.
The
need to remove all possible impediments to job creation is a very real
one. Recent UN forecasts suggest that by 2050, the world will have an
extra 2.2 billion people and over half (1.3 billion) will come from
Africa. That’s 1.3 billion more people to be fed, housed, educated and
trained with skills that will lead to jobs in tomorrow’s economy.
Similarly,
the IMF predicts that by 2035 the number of Africans joining the
working age population will exceed that of the rest of the world
combined. This population explosion is either a demographic dividend or
millstone, depending on one’s optimism about Africa’s future economic
growth.
The debate about job creation and growth in Africa often
focuses on trade barriers or the huge investments required in
infrastructure and power – typically multi-million dollar projects –
that are correctly seen as pre-requisites for Africa to fulfil its
potential. The role of private equity (PE) also garners much attention,
and perceptions about foreign direct investment in Africa can often be
dominated by what PE is doing and where.
These factors are all
relevant, but too little analysis is done on investment in
small-to-medium enterprises – those day-to-day businesses that are the
backbone of any economy.
A 2017 World Bank Report noted that SMEs
total more than 95% of registered firms worldwide. The ratio for Africa
is no different. You can have all the free trade areas and
infrastructure you like, but successful economies need successful SMEs.
Unfortunately,
SMEs can be seen as risky propositions by commercial lenders in Africa.
Banks compete for mass market savings and have extended mobile banking,
but this is not matched by dynamism in lending to SMEs. Where lending
does occur, it is often at crippling interest rates of up to 20%.
PE
has invested heavily in Africa, but this form of investment tends to
overlook SMEs due to stringent qualifying criteria related to enterprise
track records and the near-term pressure on PE to profitably exit from
investments.
As ubiquitous as SMEs are, and as talented as their
management teams can be, they are inevitably more inclined to the
nuances of doing business in the local African context, which doesn’t
necessarily gel with the requirements of an overseas PE financier,
focused on a five-year exit plan. There is a natural disconnect.
It
could be argued that a policy of flexible and patient capital is
required towards African SMEs. This does not mean an interminable delay
in a return on investment to investors, rather that foreign investors
need to take a long-term view of the African country and SMEs they
select to invest in, and a long-term view of the people they work with
and the issues they face.
Investors should take into account
factors such as first-mover advantage, existing competition and
government incentives. Historical performance in other business areas
can also indicate potential. If an opportunity makes good business sense
but company leadership is weak, a financier could decide to strengthen
the management team.
Patience also means investors take time to
understand the environment their SME operates in and the challenges
faced, such as infrastructure deficiency and precarious power supply.
SME management may be resourceful in handling the challenges of a local
environment, but they may not necessarily be in the mould of Western
European or American MBA management skills.
Whatever form
patience and flexibility takes, it has to happen. Releasing the
potential of African SMEs is crucial to creating jobs for those 1.3
billion new entrants to the African economy and for the continent’s
population rise to be positive, instead of ruinous.
If local
banks and the international PE model aren’t sufficient, there is a huge
opportunity for enlightened Middle Eastern investors to fill the void.
This may require some careful hand-holding for those entering previously
uncharted regions or new fund structures that are more SME-focused than
the average international PE fund.
The hand-holding in this
context will involve building trust which has been cited as an issue
holding back Middle Eastern investors from exploring SME opportunities
in Sub-Saharan Africa. It will not happen overnight and will require
patience, perseverance and goodwill from either side.
To date,
capital invested by Gulf countries in Africa has been gradually
increasing, mostly driven by the region’s geographical proximity to East
Africa. Time will tell how significantly Middle Eastern investors with a
flexible and patient view take the plunge, or, whether African domestic
lenders will relax their lending practices. But investment in African
SMEs must surely happen.
The opportunity is too exciting, and the alternative too calamitous, for it not to.
