The Definition of Insanity: Why Repeating the Same Approach to Enterprise Support is Failing Africa’s SMEs

15 October, 2018

 

 

Original Source: Next Billion

Africa’s economic growth is driven by small and medium enterprises (SMEs). Yet these businesses face a myriad of challenges, the most pressing often being financing. Despite the fact that small businesses are the backbone of the East African economy, 72 percent of all startup funding went into only three companies in the region in the span of two recent years. And 84 percent of SMEs in Africa indicate access to capital as their main challenge, representing a financing gap of US $140-170 billion.

This challenge is driven from both a demand and supply perspective. On the demand side, early-stage entrepreneurs, more often than not, create business models that are neither bankable nor investible – and most are unaware of the type of commercial funding options available in the market. On the supply side, investors, banks and financing institutions are very risk averse, and often expect a potential investee company to have significant traction and be post-revenue stage before providing capital. In fact, the most common sources of funding for SMEs are from family and personal savings (45 percent) and private equity (19 percent). Once these are exhausted, entrepreneurs face the challenge of tapping capital from other avenues. Furthermore, the process of fundraising in the region takes longer (usually 6-9 months or more in our experience) compared to other mature markets, which is tiring for entrepreneurs and often takes away valuable time and energy from operating the business.

Solutions for the missing middle

In trying to mitigate this challenge, in 2015 Intellecap seeded the first angel investor network in East Africa, Intellecap Impact Investment Network (I3N), to support pre-venture capital companies and close the missing middle gap. I3N has adopted an approach of co-investments, especially with local investors who often have a better understanding of the market. This not only catalyzes these investments into local companies, it also helps eliminate in-group bias. Currently the network has over 45 angels, and it has directly facilitated deals with an accumulated value of US $1.2 million, and indirectly facilitated deals worth over US $29 million. Intellecap’s role involves offering investment readiness support to these companies to create a viable potential pipeline for investors, and providing transaction support to actually close investments.

One company we supported through this program is Ikirezi, a Rwandan enterprise that partners with smallholder farmers to grow and process essential oil crops and extract oils that are then sold in the flavor and fragrance industries. Ikirezi’s founder, Nicholas Hitimana, applied to I3N in his efforts to raise capital for his company. His main challenge had been the cost of credit, which is generally high, at an average bank lending rate of 17 percent. In fact, before applying to our network, he had received a term sheet from an investor that had such unfavorable terms (over 19 percent, post-hedging) that it actually would have been cheaper for him to secure a loan from the bank – so he turned down the offer. Not to be deterred, Hitimana is still looking for a better investment option, targeting an accumulated amount of US $300,000. He is currently having conversations with investors in the I3N network, and undergoing due diligence.

Early-stage capital isn't enough

While most entrepreneurs cite the lack of financing as their core issue, they also lack access to the right networks and advisory support. At Intellecap, we feel that enterprises need not only access to capital, but also advisory knowledge and networks for them to be able to succeed – one without the other simply throws things out of balance. There are 2.5 million early-stage entrepreneurs in East Africa who survive the first year and require incubation support, whereas only 600 enterprises can be incubated in a year by the region’s existing incubator industry. And this situation is not unique to Africa: It is also evident in countries with more developed startup ecosystems, including India and the U.S.

Much like the supply and demand mismatch of early-stage financing, the challenge for enterprises accessing incubation is attributable to a mismatch in enterprise demand and incubation supply, as well as an inability by some entrepreneurs to articulate their businesses. What’s more, most incubation and accelerator programmes in Africa are based in urban towns, thereby inadvertently locking out enterprises operating in rural areas that are unable to relocate to the city to receive incubation services.

To address this gap, Intellecap (with the support of GiZ and DFID) conceptualized and launched StartupWave, an “all-in-one” online business pre-incubation and incubation support service to help entrepreneurs in East Africa become business and incubation-ready. The platform combines services such as business model refinement, mentoring support, and access to funding opportunities and business service providers, ultimately facilitating introductions to incubators and accelerators. Currently there are very few players that focus on offering these kinds of pre-incubation services, which increases the risk of mediocre or overly similar companies populating the pipeline for incubators and accelerators. Since launching in mid-2017, over 700 entrepreneurs from across East Africa have joined StartupWave.

The impact of incubation support

One such enterprise is Taimba, a Kenya-based social enterprise that helps smallholder farmers access markets. Through their business-to-business mobile cashless platform, Taimba is trying to streamline and simplify the agriculture value chain by eliminating the unnecessary wastage and bottlenecks inherent in the system. Dominique Kavuisya co-founded Taimba with his wife, both of whom had been running the company as a side business for two years. Dominique finally decided to take the plunge and work on the business full time, and decided he needed to join an accelerator programme to take his business to the next level in terms of scale, partnerships and revenue. He signed up on StartupWave in March 2017 and received a business model review, mentoring, and support with pitching and collateral – as well as linkages to accelerators.

Taimba was one of the six startups that pitched at the inaugural Pitch2Incub8rs session at the 5th Sankalp Africa Summit in Nairobi last March. The pitch session gave entrepreneurs a platform to be heard, to receive feedback, and to connect with the global Sankalp community. Since signing up for StartupWave, Dominique has also participated in the MakeITAfrica accelerator programme by GiZ, and has won pitching contests like Food+City and Disrupt Africa Live Pitch. He is currently being evaluated by several investors for a potential equity investment.

It’s often said that the definition of insanity is doing the same thing over and over again and expecting different results. It’s clear that simply recycling previous approaches won’t be sufficient to solve the challenges of financing Africa’s SMEs. Through I3N and StartupWave, we are exploring fresh ideas for accessing networks, raising capital and generating knowledge – the building blocks for all successful enterprises. If you’re an entrepreneur who’d like to learn more about our approach, or an investor interested in any of the enterprises mentioned in this article, please contact us.

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