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Small and medium-sized enterprises (SME’s) are the backbone of most economies in Africa. Innovative and creative entrepreneurial approaches are needed to help African SMEs adapt to global standards and realize their economic impact. SMEs in Africa face different social, ethical and environmental challenges, opportunities and dilemmas than their counterparts in Europe or the US.

Their problems are shaped by economic factors (e.g. poverty, debt, industrialization, trade flows), political factors (e.g. level of democracy, corruption, legislation, institutional capacity), social factors (e.g. cultural context, urbanization, ethnicity, basic services, public health, HIV/AIDS), and ecological factors (e.g. drought, desertification, deforestation, resource scarcity, pollution).

SME Challenges & Opportunities

Labor costs may be low but often not enough to offset the high costs of transport, raw materials, utilities, and other inputs. African businesses therefore find it difficult to compete in export markets, particularly in markets outside the region, and to compete against imports of a range of goods from other developing regions.

Moreover, many African companies, especially SMEs, lack reliable financial data that allows financial organizations to scrutinize the health and prospects of the company. Most SMEs in Africa also lack assets that can act as collateral and mitigate the risk involved. As a result, capital in Africa remains too expensive for most entrepreneurs looking to build a sustainable enterprise.

Africa faces the challenge to provide better economic opportunities to its citizens, through sustained growth led by the private sector and to alleviate the poverty that has long plagued the region. A strong private entrepreneurial sector plays a vital role in this respect, in particular the small and medium-sized enterprises (SMEs) that provide many Africans employment, income and hope for a better future. As the Shell Foundation says:

“SMEs contribute around two thirds of national income and provide the foundation for a stable middle class in many countries. They help form strong communities and are a powerful force for poverty reduction. Indeed, SMEs play a significant role in building economic stability and sustainability for the future.”

SMEs Need Financial Resources

Paul Collier, in his book The Bottom Billion: Why the Poorest Countries are Failing and What Can Be Done About It, he argues that the bottom billion needs private capital and says:

“clearly there are brave people within these societies who are struggling to achieve change. It is important to us that these people win their struggle, but the odds are currently stacked against them.

He goes on to explain the numerous challenges ahead, but introduces a valuable line of thinking that builds the case for supporting local entrepreneurs seeking to implement solutions that are designed for a local context, the needs of a billion consumers rising as a middle class.

Andrew Mwenda, the chief editor of the Independent Magazine in Uganda, argues we need to replace “Poverty Reduction” with “Wealth Creation.”

The focus needs to be taken off of symptoms (food, medicine and peace keepers) and in the effort to start addressing the real underlining problems i.e. the ability to generate an income, a trading opportunity and the ability to find a well paying job. His argument is clear; wealth is a function of income.

The focus should be placed instead on entrepreneurs as agents of wealth creation. Entrepreneurs make up about 4% of the population and 16% of the population then follows as ‘entrepreneurial imitators.’ Any development efforts should thus be focused on these individuals and the areas of the economy where there are opportunities to productively grow. An emphasis should be placed on private investment and on the institutions and tools that can empower these individuals to do business.

Traditional Financing Options Fall Short

In order to promote the development of the private sector access to finance is crucial. This can take many different forms form bank loans to overdraft facilities. Unfortunately, Africa is still seen as a risky and expensive place to do business. Indeed, transactions costs are often higher than elsewhere. Speaking to entrepreneurs actively working to set up their business I find that getting a loan from a bank in Africa is like getting a root canal. They always take more than expected and the process is painful at best. As reported in Uganda’s the New Vision:

“Data shows that the lending rates remained high over the past year, standing at over 20% but consistent with trends over the past five years. Despite a slight decrease over the financial year from a peak of 21.8% in August 2009 to 19.6% in January 2010, lending rates remain high by international standards and significantly higher than in any of the other four East African Community partner states, where the average is about 15%.” East Africa is not alone and entrepreneurs face these rates or worse across the continent.

And don’t think its only the small business who struggle, I remember interviewing Mo Ibrahim, the founder of Celtel, and hearing about the challenges he had getting funding for a telecom proposition that was already in the black and operating in thirteen countries, otherwise the lucrative foundations for what is now Zain (recently acquired by Bharti).

Amazing to learn that a company that eventually made 100 people millionaires the day it was sold, had just of a hard time finding the financial support and business trust needed to make it happen. Of course few would turn him away if he called this afternoon, but where was the support when he started out and how many other entrepreneurs on the continent are in this situation today?

The Case for Venture Capital

Venture Capital can be characterized as long-term, risk equity finance in new firms where the primary reward is capital gain.

Complementary to existing lending facilities and micro-finance programs, there is a growing need for Private Equity and Venture Capital, to fuel the development of the private sector in Africa. Equity investments can be instrumental in helping small enterprises grow into medium-sized enterprises and semi-formal into formal businesses. An important role in this respect can be played by Venture Capital (VC) Funds.

VC funding can support business opportunities through investment relations with private companies in the South and the North, introduce new business concepts and offer mentorship and guidance many entrepreneurs need to tackle tough challenges they will face along the way. Hence the VC impact on the business environment can be significant.

Looking to support the continent’s aspiring entrepreneurs there is reason to believe we need a lot more of it. VC4Africa is one way we canhelp bridge the gap between need and solution. Looking at a map like this we can see there is still a long way to go.