The difficulties for SMEs in Africa and the rest of the world in accessing finance have been well documented. The causes are equally well known: First, traditional bank financing (secured or cash-flow based) is often not available due to the lack of adequate collateral or the opaque modus operandi of many SMEs as well as access barriers due to the often rural base of SMEs. Furthermore, African financial markets are not sufficiently well developed to facilitate traditional private equity (PE) financing of SMEs. If those constraints can be overcome, Private Equity can offer a much needed stimulus to SME finance. Private Equity targets established high-end small to medium sized companies and are believed to offer trickle down effects to a much larger sector of the economy and create employment.
Importance of equity for SME growth: Tanzania’s Precision Air
The Tanzanian airline Precision Air is an example of how finance is essential for an SME to grow. Owner Shirima started his small business in 1987 with two planes and aerial sprayers serving large farms. Trade and investment liberalization contributed to a significant development of tourism in the United Republic of Tanzania. However, many of the key sites for tourists were far from the international arrival points, generally the airport in Dar es Salaam. Thus, Shirima’s aim was to provide tourists with a suitable means of transport, to easily reach popular destinations.
Shirima, a former executive at the “defunct” East African Airways, knew that building Tanzania’s first privately owned airline would require substantial outside capital. Therefore, he approached the Africa Project Development Facility (APDF), which after a thorough feasibility study confirmed the viability of the project and found potential investors. Thus, Precisionair could raise US$333,000 in equity financing from the Tanzania Venture Capital Fund (TVCF). Since then, the company has expanded considerably with more funding from the African Development Bank. Today, Precision Air has several aircrafts and created more than 600 jobs. Precision Air has contributed remarkably to Tanzania’s recent tourism boom through its regular scheduled air services that enable tourists to reach key attractions. The company provides affordable and reliable domestic transport for the local business community. Moreover, Precision Air invests in its own personnel and has so far trained four pilots, 12 technicians and sent 5 management staff for MBA’s abroad.
Precision air used to be a very good example of successful private equity injections for growth. Latest reports about a government bailout and financial troubles show that a conducive operating environment and good management are equally important, as a lack of government support and infrastructure hinder many other SMEs considerably. Thus, the questions is: how much benefits will the majority of SMEs reap from private equity initiatives?
How many benefits will SMEs get from Private Equity
- Target group
As mentioned above, private equity, is constrained by operational deficiencies of SME’s such as lack of capacity and a weak governance strucutre. A typical private equity firm usually requires controlling positions in a company it invests. Yet, most small businesspeople are both owner and operator and company boards as well as communications structures are oftentimes barely in place. The majority of the SMEs in Africa would not qualify, which bears the question how strong the target group is to have a competitive process.
- Relationship of capital to growth
The assumption that a capital injection for the medium sized businesses would produce a significant trickle down effect for a larger crop of the population is questionable. Former World Bank economist and Nobel Price Winner Joseph Stieglitz convincingly demonstrated in his book “The Price of Inequality” how macro-economic models and policies targeted at societies’ poorest elements frequently miss the mark.
- Private Equity perception
Several SMEs in Nigeria, for example fear that private equity would open up a funnel for corruption, where politically connected companies would benefit and remote companies miss out. Private Equity investments due to the control aspect mentioned above would quite possible be restricted to accessible large urban areas as rural SMEs do not have the necessary infrastructure. This in turn can exacerbate already worrying trends of urbanisation and would not alleviate the rural poverty problem.
However, as the case study of Precision Air demonstrates private equity can inject needed private investment and monies into an economy and help SMEs to scale up. Private equity can be a valuable instrument to complement existing initiatives such as microfinance and SME loans by large banks. Two aspects, however, are key:
Transparency and ensuring a holistic approach
To counter the issue of public perception mentioned above and to avoid any allegations of corruption, investment allocation should be in a transparent and competitive process with a public competitive bidding process.
Private Equity investments must be part of a coordinated policy and strategy in every country that addresses the issue of skills development so that those most in need are ready to reap the benefits of growth.