SMEs remain heavily dependent on domestic resources and bank debt for financing, limiting entry into new markets, long-term investment, expansion and innovation. Cross-analysis by two fund managers who overcome these obstacles for the benefit of African SMEs: J-P Fourni, from Metier, and Lucas Franck, from Ascent Capital.

Interviewed by the teams of Proparco, a subsidiary of the French Development Agency, J-P Fourie, Director and Head of Investor Relations at Metier, and Lucas Kranck, Founding Partner of Ascent, discuss the importance of equity for the scaling up of SMEs, and describe their activity to us from a practical point of view.*

Founded in 2004, Metier is one of Southern Africa's leading fund managers specializing in development capital for medium-sized enterprises and sustainable infrastructure. To date, Metier has raised three funds for a total of more than $600 million.
Updated on 09 October 2019 at 16:09

SMEs remain heavily dependent on domestic resources and bank debt for financing, limiting entry into new markets, long-term investment, expansion and innovation. Cross-analysis by two fund managers who overcome these obstacles for the benefit of African SMEs: J-P Fourni, from Metier, and Lucas Franck, from Ascent Capital.

Interviewed by the teams of Proparco, a subsidiary of the French Development Agency, J-P Fourie, Director and Head of Investor Relations at Metier, and Lucas Kranck, Founding Partner of Ascent, discuss the importance of equity for the scaling up of SMEs, and describe their activity to us from a practical point of view.*

Founded in 2004, Metier is one of Southern Africa's leading fund managers, specializing in development capital for medium-sized enterprises and sustainable infrastructure. To date, Metier has raised three funds for a total of more than $600 million.

READ [Tribune] For massive financing of SMEs
Ascent is a private equity fund manager that invests in companies in East Africa, including Kenya, Ethiopia and Uganda. He manages the Ascent Rift Valley Fund, an $80 million fund raised in 2014.

Proparco: Could you describe the market opportunity, as it appeared to you, for an SME strategy in your respective areas of intervention?

Lucas Kranck: We operate in economies where companies are rather in the initial phase of development and poorly organized in terms of governance and performance evaluation. We must help them to build themselves and de-risk them, thus unlocking value.

SMEs are usually family businesses where decision-making is centralized and informal. Most institutional investors are reluctant to take the risk of investing in SMEs and bringing them towards more formalization and professionalism. This is where Ascent develops its strategy, the bulk of whose value is derived from the development of internal systems and processes, enabling more fluid and dynamic decision-making as well as greater transparency.
J-P Fourie: The drivers of investment in sub-Saharan Africa are still population growth and urbanization; the emergence of the middle class; a growing workforce and better social conditions; ever-increasing investment in infrastructure; the demand for specific skills; BoP markets require essential goods and services.

Apart from the issue of formalization, other obstacles can be considered as opportunities. For example, inadequate infrastructure in Africa is a major impediment to the competitiveness of SMEs. That's why Metier has invested in energy efficiency, downstream transport and logistics, cold storage, etc.
Geographically, we see South Africa as the gateway to Southern Africa, as it plays a leading role in regional trade and investment.

What differentiates your strategy from that of other funds operating in the same market segment as you?

J-P. F: Metier has an active value creation strategy. The investment theses we implement aim to transform the activity of portfolio companies, in order to respond to regional themes. Our goal as a manager is to bring out market leaders or at least leaders in a niche positioning.

This can include organizational transformation (to prepare for scaling up); strengthening distribution networks; optimizing supply chains; vertical integration; optimizing production and storage capacities; developing own brands; etc. If necessary, we call on external management, consultants or specialists.
Platform strategies are particularly effective. They consist of consolidating several companies within the same sector, in order to increase their combined value. The objective is to achieve economies of scale (purchasing, wcr consolidation, pooling of distribution channels, etc.) and promote a phase of organic growth.

A relevant example is Metier's investment in Libstar, a manufacturer of ready meals since 2005. Subsequently, Libstar took majority stakes in more than twenty South African companies active in the production and distribution of consumer products, before Metier retired in 2014.

Metier saw the potential of South Africa, where the emergence of the middle class and changing household habits stimulated consumption, while urbanization favored the development of catering or health and wellness products. At the same time, brand owners outsourced their production function, while the private label market emerged.

L.K: We have offices in all our target countries whose local staff have strong ties to the community. This allows us to detect business opportunities before others, and inspire entrepreneurs with confidence and the fact that we know the markets where they operate.

Most of our employees are themselves former entrepreneurs, who have created and then managed companies. So they understand the challenges that Ascent's partners face, so a real connection is made in most cases. The promoter can discuss the company's activity with ascent staff, from a technical point of view of course, but also from an operational point of view. Ascent's local offices facilitate access to the team, when SMEs need support (which is common).

"REGULATION TENDS TO MAKE IT COSTLY FOR SMES TO OPERATE, UNLIKE INFORMAL BUSINESSES THAT IGNORE REGULATORY BARRIERS"

Most funds in Africa have ticket sizes that are too high for SMEs, which are therefore excluded from the market. Is operating below a certain threshold an opportunity for funds that are ready to tackle the SME segment? Or is the lack of companies of sufficient size and formalization a challenge?

L.K: On this missing link in the supply of capital, there are actually quite a few companies. Over the past five years, in our three target countries – Kenya, Uganda and Ethiopia – we have reviewed no less than 960 transactions – not counting those deemed too small to be analysed. The supply of equity in Africa exists, but rarely reaches the SME segment. This means that investments can still be made at reasonable levels of multiples, especially if one is willing to intervene in countries like Ethiopia and Uganda, or even in Kenya, outside Nairobi.

SMEs almost systematically cite difficulties in accessing finance as the main obstacle to their growth. Do you agree?

L.K: Indeed, the financing gap is probably the main obstacle to their growth. This is especially true in Ethiopia when it comes to obtaining foreign currency financing, which is necessary for the purchase of machinery and raw materials.

This is also true in Kenya, the most developed country in East Africa, where interest rate caps have severely limited banks' appetite for SME credit.  bank financing is available, but interest rates (above 20%) are impractical for most entrepreneurs.

J-P. F: Another major cause is the readiness of companies. Too often, we see the need for introspect on the part of promoters: on their business model, their staff, their market, or their strategy, before they can access financing.

"THE MAIN BARRIER TO INVESTMENT IN SMES IS THE LACK OF RELIABLE DATA"

Other reasons are put forward to explain the lack of formal SMEs: still high demand in Africa for basic goods, disincentive taxation, binding regulations, etc. Do these explanations hold water in practice?

L.K: It is true that regulation tends to make it costly for SMEs to operate, unlike informal companies that ignore regulatory barriers and large companies whose economies of scale allow for additional costs.

SMEs do not necessarily face insufficient demand for their goods, but rather intense competition, not only from local players, but also from imports (often without payment of customs duties). It is particularly difficult for local firms to compete with cheap imports, even though they have sometimes created demand and the market at local level.

In your opinion, what are the main obstacles to investment in SMEs? Human capital is often cited as a major concern...

L.K: Human resources are often a problem indeed, especially outside Kenya. For example, recruiting an experienced CFO in Ethiopia is an expensive and time-consuming exercise. Many countries (such as Tanzania) also limit the use of foreign labour.

But in my opinion, the main barrier to investment in SMEs is the lack of reliable data, whether it is the company's financial indicators or market data.

The cost of institutionalization is another important barrier. SMEs generally have a flexible modus operandi, which corresponds to their level of income and allows them to generate margins. But when a private equity fund enters the capital, operating costs tend to increase without a corresponding increase in turnover – at least in the first year or two. This can discourage both the promoter and the investment fund, as the company loses attractiveness compared to its initial situation. In addition, the time to return to profitability is often longer than expected.

J-P. F: The challenge is to bring the company to a sufficient size, in order to offset the cost of institutionalization and reap the benefits, such as facilitating acquisitions or new exit routes for investors.

The private equity industry in Africa has matured over the past decade, with a decrease in the number of first teams and an increase in the number of successor funds. However, larger funds have larger tickets, which may exacerbate the shortage of equity capital for SMEs. How can fund managers grow without giving up their SME approach?

L.K: This is a difficult balance that, in our opinion, has no simple solution. One way for fund managers to grow while maintaining the focus on SMEs is to create sector-specific funds. This makes it possible to deploy a platform strategy that does not require large tickets.

Another way is to dedicate part of the fund to venture capital-type operations. The idea would be to have one or two assets of this nature rather than an entire portfolio.

J-P. F: Metier has started raising sector funds in renewable energy and clean infrastructure. We agree that platforms provide access to markets where it is not otherwise possible – or relevant – to deploy significant capital in a single investment. A challenge that is often encountered outside the largest African economies.

Finally, the theory behind support for SMEs is that small and innovative enterprises (referred to as "gazelles") have a more than proportional impact on job creation. Are the companies you are targeting particularly effective in terms of net job creation?

J-P. F: Yes, they are! Metier's investments in SMEs created 2,657 jobs from 2015 to the end of 2018. The total number of staff is 6,800, 47 per cent of whom are women.

L.K: The eight Ascent portfolio companies created an additional 359 direct jobs in 2018. This figure is in addition to the 1,364 employees at the end of 2017. And that number doesn't include temporary employees or jobs created by suppliers.

J-P Fourie joined Metier in 2012, where he is in charge of investor relations. He began his career at the Johannesburg Stock Exchange (JSE) in 1998, where he was responsible for strategy from 2001 to 2006. In 2006, J-P was appointed CEO of the South African Venture Capital Association (SAVCA). He holds a degree in Economics from Rand Afrikaans University (University of Johannesburg).

Prior to founding Ascent, Lucas Krack spent five years at the Scandinavian law firm Snellman and twelve years in senior positions at Nokia – in China, Latin America and Africa, most recently as Managing Director for East Africa. Lucas has lived thirteen years in Africa, Ethiopia, Uganda and currently kenya. He holds a law degree from the University of Helsinki and an MBA from INSEAD.