Scaling up Africa SMEs & financing: Solution in search of problem?

By Ferdinand D. ADADZI     

At the Crystal Ball Africa 2025, held by AB & David Africa on 23rd January 2025, under the theme “From Challenges to Opportunities,” many insightful discussions took place.

One focused on the ability of Small and Medium-scale Enterprises (SMEs) to become industry giants and create African billionaires. One major challenge in attaining that goal is securing finance to upscale. This article discusses suggestions and key takeaways.

The SME landscape in Africa

SMEs anchor the economies of many African countries. In certain regions, SMEs account for between 80% and 90% of businesses and contribute between 35% and 45% of GDP. In addition, SMEs provide up to 80% of employment opportunities in many African countries.

SMEs also drive entrepreneurship, innovation, and value addition in terms of products and services for the growing middle class. In many jurisdictions, SMEs with export-oriented business models are becoming foreign exchange earners for the economies.

From the above, the discussion of the growth, development, prosperity and general economic development of Africa cannot be complete without a special focus on SMEs. Whilst governments have to take the lead in dealing with key developmental issues in Africa, SMEs have critical roles to play and are vital for the economic development of the continent.

The growth of SMEs has a direct correlation, at the least, to the economic development of the respective countries where the SMEs are located. In that respect, scaling up the SMEs will directly benefit the entrepreneurs, societies within which they operate, the country and Africa as a whole.

However, SMEs in Africa face several challenges that hinder their growth. A survey of MSMEs shows that 65% reported deterioration in 2024 compared to 2023. 41% cited high inflation, and 39% cited political uncertainties.

The survey also revealed that 40% of MSMEs had laid off staff and 40% of SMEs who applied for loans had their applications rejected.[ii]

The challenges SMEs face include lack of or limited access to funding, regulatory constraints, inflation and economic instability, digital and technology barriers, informal sector dominance, market expansion and trade barriers, and operational challenges.

Among all these challenges, lack of or limited access to funding ranks high as the barrier to expanding or scaling up SMEs in Africa.

Solution in search of problem

While lack of or limited access to funding remains a challenge, a session moderated by the writer proposed the following solutions to the problem.

• Formalize: even for South Africa, which is one of the advanced economies on the continent, 72% of its MSMEs operate informally. It is problematic for an informal entity to seek to access formal funding. Formalizing a business does not mean incorporating a company. Any business type can be formalized simply by having proper records, including contracts with business partners. Investors and lenders need to know the state of the business to invest or lend money. A verbal presentation with no evidence will not attract any investment. For those that are registered entities – partnerships, companies, registered sole proprietorships, ensure compliance with the relevant regulatory compliance since lack of compliance is a red flag. The main point is to formalize to be investor-ready.
• Proper value sale: most SMEs in Africa are sitting on hidden wealth or untapped resources regarding their value proposition when seeking to attract investors. The SMEs undervalue their assets, limiting their value proposition to tangible assets. The core assets in modern business have shifted from tangible assets like buildings, vehicles, equipment, etc. The trend is that there is more value in intangible assets – intellectual property rights, customer lists and relationships, brand equity, business processes and culture, licenses and regulatory approvals, human capital and resources, digital and online assets, supplier networks, etc. Valuation of assets of SMEs to attract investors or secure lending often ignores these thereby overlooking the values they can leverage to attract funding. Proper valuation is, therefore, essential.
• Funding type: The stage of the business must determine the type of funding source. Businesses go through various stages: concept or idea stage, startup phase, growth stage, maturity stage, expansion stage, etc. Each stage requires targeting funding from the right source. Businesses at the concept or startup stage may find it difficult to secure funds through borrowing from financial institutions or listing on the stock exchange. However, such businesses can attract equity investments from angel investors and venture capitalists. Match the stage of the business to the right funding source.
• Skin in the game: to attract investors, business owners, especially SMEs, must demonstrate commitment to the business. In many negotiations, investors have indicated, “we are not giving our money to an abstract entity but to you”, even though the company is technically and legally separate from the owner. Investors, therefore, want to see the owners of SMEs take some substantial risk to demonstrate their confidence in their business. Business owners must demonstrate commitment by having substantial interest, looking to profit rather than salary as returns, transfer of personal IP rights to the legal entity, commitment to remain in the business for a considerable period, etc. Passion alone for the business is not enough. The owner must put some skin in the game by taking substantial risks. An owner cannot just make himself an employee with a guaranteed salary when potential investors are not guaranteed returns on investment. You must demonstrate the assumption of substantial risks.
• Partnership: An often overlooked option for obtaining funding is through partnership. An illustration will be helpful. You run a private school and require an additional building to accommodate increased enrolment. The landlord next door has an empty building with a high price tag, and you are seeking a loan with a high interest rate for which you are not even able to meet the requirements to secure. A good option is to propose a business partnership to the landlord to achieve your ultimate aim of expanding your business. Partnerships in their various forms – equity partnership, strategic partnership, profit-sharing, joint ventures, vendor or supplier partnership, collaborations, etc. – offer means by which additional resources are secured for businesses. Remember, it is better to own 10% of a ‘big’ business than 100% of a ‘small’ business.
• Funding requirement: Each specific funding source or type has requirements imposed by the funders. To obtain funding from a particular source, you must satisfy the funding requirements. With financiers’ increased focus on sustainability and ESG criteria, SMEs should have a strategy to meet these requirements. With the increase in the availability of green financing and other sustainable financial products, SMEs can increase their chances of securing such funding by aligning their management and operations to suit these financing criteria. A similar case can be made for the availability of pension funds looking for investment in many African countries, which requires SMEs to structure their security offerings to fit the investment goals of these pension funds.
• Engage experts: An interesting comment from many entrepreneurs is that they are ready but cannot find the financiers or interested investors. A fashion designer, a farmer, an app developer, etc., is not expected to go around looking for financiers. Financiers are not secured at conferences. Formalizing your business to be investor-ready, proper valuation to have a good value proposition to attract investors, identifying suitable funding sources, ensuring compliance with funding requirements, etc., require work that experts must undertake. SMEs seeking funding must engage the right experts.

Conclusion

Given the myriad of challenges they face, the above is not an exhaustive list of all the things SMEs in Africa must do. However, the above takeaways are significant in addressing the significant barriers seen in the SME landscape in Africa, particularly those related to raising funds to scale up.

[i] Ferdinand D. Adadzi is a Partner, with the Corporate & Finance Practice Group of AB & David Africa. He is based in the Accra office and works with the firm’s Africa Finance Team, which looks at the finance sector across sub-Saharan Africa. He has advised a number of entrepreneurs/start-ups on their set-up, raising funding and partnership arrangements from the idea stage to the implementation and scaling up of such businesses. Ferdinand also lectures on corporate law at the GIMPA Faculty Law. He recently published a book titled “Modern Principles of Company Law in Ghana (Revised Ed)”.

Email/Telephone No.: [email protected] / 0242262180

[ii] https://www.geopoll.com/blog/africa-msme-pulse-2024/#:~:text=Yet, 31.2% of MSMEs have,to capital (43.64%) persist.

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