Venture Capital: Why has it not taken off as financing for SMEs?

Jan 06, 2022

The rate of start-up business failure in Africa remains high, triggering an enormous threat to entrepreneurship and sustainable development.

A section of Kikuubo in Kampala. The rate of start-up business failure in Africa remains high, triggering an enormous threat to entrepreneurship and sustainable development.

Nelson Mandela Muhoozi
Journalist @New Vision

Small and medium-sized enterprises (SMEs) in Uganda suffer from lack of finance for their survival and growth. This liquidity emergency, according to Ian Nvula, an expert in capital markets and founder of T.E Markets, has motivated struggling start-ups to find alternative financing sources different from conventional bank lending, writes Nelson Mandela Muhoozi.


 

According to Nvula, Venture capital financing is now a popular and viable financial mechanism to revive SME performance.

Although it is well-documented that SMEs are the teamsters of economic growth, stimulating national gross domestic product (GDP) and the principal employment sector in both industrialised and emerging economies, Nvula says the rate of start-up business failure in Africa remains high, triggering an enormous threat to entrepreneurship and sustainable development.

According to Nvula, the latter is attributable to lack of finance, the topmost stumbling block for start-up survival and development.

Eng. Kenneth Legesi of Ortus Africa says venture capital funding in Africa is generally still low, at 1% of global VC funding.

“Additionally, this funding is concentrated in the larger economies of Kenya, Nigeria, Egypt and South Africa”, Legesi adds.

“Uganda, compared to these ecosystems, has a more nascent ecosystem, with a smaller market to serve, which makes it less attractive to Venture Capitalists,” Legesi says.

According to Legesi, attracting more VC will take time. He says as the ecosystem matures, we need to be discovered and seen as the geography that has entrepreneurs who build world-class start-ups.

“We need to support the entrepreneurs through mentorship and entrepreneur support organisations or linkages to market so that we build up their value to attract more VC financing,” Legesi says.

In addition, he says Uganda needs more local capital, including capital anchored by the public sector and relevant laws e.g., 12J Act in South Africa and the Enterprise Investment Scheme/Seed Enterprise Investment Scheme in the UK, as this gives confidence, thereby attracting more foreign capital.

“For example, can our pension funds, retirement benefit schemes and local investment clubs collectively allocate just 1% of their portfolio to VC, from NSSF alone that is $40m,” Legesi suggests.

CHALLENGES

Dickson Ssembuya, the director for research and market development at the Capital Markets Authority (CMA), says corporate governance has been one of the key weaknesses that the private sector has faced while trying to access capital through the capital markets.

However, he said under the current CMA 10-year master plan that was launched recently, they are pushing for the proposal with other partners to develop what he calls ‘the Advisory Capital Markets Centre’ that will offer training for businesses on key aspects of corporate governance, record keeping, business strategy and plans and more – all geared towards helping beneficiaries to tap into the capital market to raise long term financing for expansion and related opportunities.

“Most of our businesses are not ready for external financing because they are not prepared to be transparent and strategise their management, which is the only way to prepare our SMEs for financing,” he said.

According to Ssembuya, businesses only look to their families to raise capital without considering the fact that the public can also support them through the capital markets.

BOOSTING VC FINANCING

Prof. Augustus Nuwagaba, a consultant on economic transformation, characterises VC in Uganda as small and underdeveloped, without much upstream private equity (PE) activity.

Nuwagaba says in order to boost SMEs, private equity would have been a good alternative.

However, he says the sector is still undeveloped and gives the sectors in which PE/VC firms can invest in as infrastructure, energy, construction, manufacturing, pharmaceuticals, health care services and health care products, retail, as well as financial services.

Nvula says: “There is tremendous growth of VC backed companies in sales turnover, profitability and return on assets matched to the non-VC-backed firms.”

“Last week, we launched the Africa Consolidated Exchange (ACEX) to allow Africans to trade mineral products, such as gold, agri-products, including coffee and local currencies. The exchange is

built by T.E Markets to allow people to buy and sell stocks, bonds, forex, cryptocurrency and get venture capital from all over the world from a one-stop trading platform,” he says.

He adds: “We have our own coin (XTEMCoin) that will be used as the main medium of exchange on the platform. There has been a lot of cryptolisation and massive adoption of crypo assets all

over the world and Africa is one of those. We know that crypto is here to stay. And with ACEX, we hope to put Africa on the map and help businesses get VC funding from across the globe.”

According to Nvula, T.E Markets’ first goal is to leverage on disruptive technology to solve the problem of access to finance not currently offered by other players in the African market.

“I have realised there is no one-stop-shop for trading agricultural commodities, especially those of African origin, stocks, indices, forex and cryptocurrencies.

ACEX will bridge this gap, with Africa’s first Consolidated Exchange

that will be synthetically indexed to almost all tradable instruments, including African commodities,” Nvula says.

For the VC market to flourish in Uganda and developing economies at large, Nvula says it is incumbent upon both the public and private sector structures to increase VC investment into the early-stage entrepreneur ventures with growth potential.

VC tickets in Uganda range from $250,000 to $1m, according to an Ernst and Young 2016 report explaining why Uganda’s VC market is grappling.

VC STIMULATES GROWTH

According to Organisation for Economic Co-operation and Development 2018, VC financing stimulates the growth of start-up firms and is a sustainable solution to their equity gap.

The VC4Africa 2015 report shows an increasing number of African businesses successfully growing their operations over time.

The research shows that 49% of the ventures start generating revenue in their first year of operation with 44% of the ventures successful in securing external capital investment.

The top investment categories are related to the technology, followed by agriculture, health, finance and energy.

WHY VC FINANCING?

According to the Uganda Investment Authority (UIA), micro SMEs are encouraged to opt for this means of equity financing, which is more long term than debt and is a better option because the well-equipped businesses are exposed to mezzanine financing options.

According to Asher Namanya, a techpreneur, Venture Capitalists (VC) usually stay low key in their contribution to making these companies successful.

Apart from the capital they provide, there is also a considerable amount of trust in the founders that translates into guidance, improvement for the business, exposure to relevant networks and greater knowledge for the start-up.

However, Namanya says it is not necessary for a business to raise external capital if it is cash flow positive, but capital always helps in growing faster. Prof. Augustus Nuwagaba, a consultant on economic transformation, says venture capital provides large amounts of funding, generates high returns and facilitates active involvement of the financiers where experienced professionals get involved in the business resulting in major improvements.

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