by Tom Scriven
For the last ten years, I’ve encountered both the promise and complexities of investing in African businesses. At RPCK Rastegar Panchal, I am legal counsel to firms tapping into the investment and social impact potential of local enterprises across the continent. Previously, I served as general counsel and remain a partner with RENEW LLC, which invests for impact in East Africa alongside a group of angel investors.
In these roles and through conversations with the growing network of investors in Africa, I have compiled an initial list of 7 takeaways that I hope others find helpful and add to with their own lessons. To understand these 7 lessons, some context for the environment in which they were learned is a useful place to start, so I begin there.
For international investors, small and mid-size enterprises (SMEs) in Africa offer ample opportunity for meaningful local impact and financial returns.
- SMEs make up a largely untapped segment throughout Africa, representing nearly 80% of businesses that are best positioned to serve fast-growing but often underserved consumer classes.
- Impact opportunities abound in Africa, as $1 invested in an SME generates an additional $13 in its community, with a particular urgency to address job loss and poverty brought on by COVID-19 and the pandemic’s disproportionate impact on women.
Africa’s SMEs can yield attractive returns for investors willing to tackle the regulatory, practical, and sometimes geopolitical challenges of business in Africa. However, despite the attention that SME investing has received, it remains not for the faint of heart. The following lessons are a few ways investors have navigated those challenges on a path to notable wins for their investments and the communities in which their portfolio companies operate.
Lesson 1: Don’t Overlook Simple Businesses. It can be tempting for foreign investors in African to pass over companies that are serving the continent’s fast-growing mass markets with low-tech or other conventional products and services. While more technologically advanced products, such as solar products or water filtration systems, offer efficiencies to users and higher margins to producers, they may not be appropriately priced for the local market, may be impractical for local environments or may not have gained traction. Even something that may not be perceived as an advanced technology, such as animal feed enhanced with usually costly supplements, may face adoption challenges. For example, farmers in places like Ethiopia historically have been reluctant to purchase feed, not having seen the benefits that often are realized only when accompanied by herd management practices. The lack of adequate distribution channels also presents a challenge to accelerated market traction in this and many other instances.
While opportunities exist to introduce advanced technologies that quickly leapfrog existing product offerings, such as we saw with mobile phones (Africans are expected to own 1 billion mobile phones by 2022), introduction typically must be accompanied by significant investments in supporting infrastructure and supply chains and in advertisement or other forms of market education. Meanwhile, investors have realized considerable returns on smaller investments in supply chain, efficiency and quality improvements in companies that serve a larger, more established market with more conventional products, such as consumer goods, retail stores, beverages, and healthcare.
Lesson 2: Aim for strong financial returns but require interim payments to achieve modest wins. Most private equity and venture capital investors anticipate a home run exit down the road. The near term is equally important, even more so in Africa’s capital markets where exits through strategic sales are rare and IPOs even less common. Given this reality, consider structuring investments to require interim payments. On a convertible loan, for example, require payments on the note, even if only a modest amount of interest. Revenue-based financing is another good option. Introducing an element of self-liquidation into investments through these or other structures offers the following benefits:
- The realization of returns along the way instead of depending on a single “home run” event at maturity.
- The entrepreneur gets in a habit of making payments, which increases your likelihood of receiving larger payments due later.
Lesson 3: Retain the ability to provide additional cash. Even though entrepreneurs may be reluctant to dilute their equity by receiving further investments, investors need to keep this option open. Where possible, include in your deal terms a right to inject additional capital if the company needs it.
Lesson 4: Realize that even impact-neutral companies can generate meaningful social impact through operational changes made post-investment. By all means, screen investment opportunities based on your impact criteria. But holding tightly to those criteria to the exclusion of entities that don’t initially meet them may significantly reduce your deal flow. Impact screening also may underestimate the impact that may be achieved through operational changes after you invest.
Let’s explore gender-lens investing as an example. In certain regions or cultures where women historically have not owned business or held leadership positions within them, investors may struggle to source companies where a woman is at the helm. Even where this is not the case, female entrepreneurs may be more cautious than their male counterparts to bring on private equity investors. In such cases, an investment criterion requiring majority female ownership or leadership of portfolio companies that may be appropriate for part of a portfolio or investments in certain geographies, when applied universally may impede a gender-lens investing strategy in its very aim to empower women.
So how do you advance women’s empowerment where sourcing qualifying deals is a challenge? Consider converting a business that doesn’t initially meet the impact criteria into something that does. In addition to investing in women-led and run companies, explore opportunities to work with companies owned and run by men who commit to hire more women, to equip them to take on management roles and to issue equity compensation to women to bring them onto the company’s cap table. In so doing, you unlock new opportunities to achieve desired gains for women post-investment.
Lesson 5: Leverage the strength of partners. This lesson feels like a bit of a softball for anyone investing in Africa. Still, the portion relating to sociopolitical scenarios that are so different from our own is worth noting. Forming supportive relationships with the following partners you can turn to when needed is key to successful SME investing:
- Banks – to secure loans, access foreign currency, and repatriate investment proceeds.
- Government officials – to obtain permits, build support for legislative or regulatory change, and have a trustworthy place to turn if you encounter corruption.
- The SME’s community – to attract talent, avoid local backlash against foreigners, or have willing hands available to lend a hand (for example, when rains wash out the only road to a factory you’ve financed).
Lesson 6: Exit with foresight and grace. Anticipate sticky spots that could derail an exit and take steps to smooth them. Your plan for a disposition of your investment should encompass regulatory concerns, repatriation of funds, and the expectations of the founders and other shareholders.
- Ease the path for others to invest in the company. One suggestion that is unique to SME investing in frontier markets is to introduce a holding company in a jurisdiction familiar to investors (e.g., Delaware or Mauritius).
- Build a history of returns, even modest ones (see Lesson 2).
- Your ability to exit often depends on the health of your relationship with the founders and often their extended families. Ensuring that you all are on same page regarding the timing of an anticipated exit is key. Even with an attractive deal on the table, when the time comes, entrepreneurs may not want to exit a company they founded. They may also be hesitant to introduce foreigners into their community. Plan for this possibility before investing, build it into the legal documents and then revisit the plan frequently. The plan may include, for example, carving out an ongoing role for the founder in the company following a sale.
Lesson 7: Reduce risks through blended finance. The transaction costs of SME investing in Africa make most deals economically unfavorable for investors – especially locally owned companies. These costs mainly derive from deal-related issues (readiness of a company to engage with investors), complexities that arise from bureaucratic government processes, and added risks that SMEs face, often due to limited collateral and a lack of access to adequate capital (trade finance is a notable example worth calling out).
Increasingly, philanthropic and government funds with a focus on international development are providing blended finance to support impact investments. This blended finance has taken a variety of forms, including first loss vehicles, other guarantee facilities, design funding, technical assistance grants, and below-market co-investments. RENEW has designed several blended finance projects in support of its investments in East Africa and reports that a dollar of blended financing provided to an investment firm, on average, leads to $7 in follow-on private capital, suggesting that there is significant opportunity for blended finance to unlock additional sources of capital for SME investments.
Invitation to Continue a Conversation
Do these lessons ring true? Are they consistent with your experience? Do you have lessons of your own you can share – potentially for a follow-up post featuring the collective responses? If so, feel free to reach out at email@example.com or on Linkedin. By sharing the lessons we have learned journeying down the winding and, at times, bumpy road of SME investing in Africa, we can continue realizing the investment and impact potential this path offers.
About Tom Scriven
Tom is Senior Counsel in RPCK’s Denver office where he advises early and growth stage companies, investment firms, fund managers and foundations. He is a seasoned transactional and regulatory attorney and former General Counsel and managing partner of an impact investment firm operating in Africa, chair of boards of directors and an angel investor.
 The past performance of any investor is no guarantee that that investor or others will realize similar performance in the future.