Adding Value to SMEs Through

Venture Capital
Michael Olorunninwo
August 2013

Outline

Introduction Industry Focus

Venture Capital Advantage
Challenges Faced by VCs in the Emerging Markets

Introduction
Missing Middle of SME Financing

Industry Focus Venture Capital

Venture Capital (VC) is a branch of Private Equity (PE)
strategically focused on providing early stage financing
to start-up and small businesses i.e. SMEs
While PE firms provide risk capital to large, established
businesses with proven markets, and growth potentials
VCs focus on SMEs with perceived long term growth
potentials
Similar to mainstream PEs, VCs also bring on board
managerial and technical expertise, and have a say in
strategic decisions
Most start-ups usually commence operations as SMEs,
requiring patient, risk capital often between $25,000

Western Africa - Real GDP growth (%)

and $2 million
Based on research evidence, emerging markets offer
great investment opportunity for VCs, most especially
in sub-Saharan West Africa

10.0
8.0
6.0

7.8

7.9
5.9

5.3

5.6

5.8

6.9
5.5

6.2

6.9

6.4

4.0
2.0
0.0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Financial Times, World Bank, CFED, Africa Economic Outlook

3

SMEs in the Emerging Markets

Key Growth Drivers
Rising income levels and growth of
consuming class
Annual consumption to rise to $30
trillion by 2025, up by >100% from
2010
Impressive Growth in Emerging
Market companies
Emerging markets to significantly
outperform developed markets
Average GDP growth of 4 to 7% p.a.

Double-digit growth of mobile

phone, internet, e-commerce usage
(internet penetration rising faster)
More stable politics, propelling &
driving economic reforms
High proportion of active
population, about 40-60%

Increased entrepreneurial flair,

huge informal sector

Key Challenges
Unfriendly business environment:
poor infrastructure, inconsistent
government policies, inadequate
economic incentives, poor legal
framework, high public sector corruption
Poor funding: low access to flexible,
risk capital, high interest rates (~23%),
unreasonable collateral requirements,
poor relationship with banks
Low managerial skills: dearth of
skilled business managers, inadequate
knowledge of business practices, poor
succession and corporate governance,
high cost of consulting fees
Low access to modern technology:
probably due to high costs (access to
finance), dependence on importation,
lack of training
Potential areas for VC value-add
areas

Source: CBN, Bain Insights, McKinsey Global Institute.

4

Why a targeted growth effort for SMEs?

Reason to Invest in SMEs?
However, SMEs presents unmatched
opportunities in the emerging market due to:
Huge Potential for Growth: GDP is growing
at ~6%+, increasing consumer population,

Differences in SME contribution to

GDP for low-income and highincome countries, show that growth
in SMEs is likely to come from the
informal sector

government reforms, more stable politics

Potential for Social, Environmental &
Economic Impact: crucial contributor to job
creation and economic growth
Lower Capital Requirements: i.e. investors
can spread risk across investment portfolios

Potential to Contribute to Poverty

Alleviation & Achieve Productivity Gains
through infusion of new technologies and
business practices

As the world look to Emerging Markets for growth,

the evident financing gap could potentially
undermine global prosperity, with negative
consequences for innovation, economic growth,
and global macro-economic resilience

Access to New (underserved) or Growing

Markets
Opportunities Abound in virtually every
sector (agriculture, e-commerce, technology,
manufacturing, retail, etc.)

Source: CBN, USAID, World Bank

5

VC Investments targeted at Emerging Markets

Venture Capital Advantage
VC improves access to funding - a major hindrance to
emerging market SME opportunities and perform other
roles, such as:

Venture Capital Value Map

Deal Sourcing

Evaluation

Bringing on strategies/plans to seek new markets,

innovate, train management teams, improve business
processes, make acquisitions, strengthen financial
controls and operating systems

Hand-holding management through strategy

execution to create active value-adding partnerships,

Investment
Management

Exit Management

often required by businesses

Providing managerial talent, assisting investee

Structuring

businesses to produce better returns

Ensuring efficiencies in resource (i.e. finance and
management time) allocation to opportunities with
potential for economic success and societal impact
Interestingly, in the last 5 years, PE returns have been on
the rise in the emerging markets (App. V)

Key area with tremendous VC value-add

potential

Source: Capricorn Capital Partners, Bain Insights

6

Why VC Value Model is Essential for Growth

Provide well developed

networks, in-depth sectorial
knowledge, proactive targets

Play hands-on role

during due
diligence

Focus on strategy
alignment

Deal Sourcing

Evaluation

Corporate governance:
strengthen financial controls, risk

management
Structuring

Manage relationship with other

funding parties: with banks

Grow businesses in size &

profitability such that exits
via, trade sale, listing, other
investors, become possible

Build management team, and

Investment
Management

incentivise growth

Develop growth strategies and

provide implementation support

Exit Management

Initiate value-driven mergers

and acquisitions
Manage growth for sustainability

Challenges Facing VCs in the Emerging Markets (SSA)1

Investing in the emerging markets comes with various challenges. VCs must have

capabilities or strategies to overcome these challenges:

Finding good investments

Determined by calibre of management
team. Need for effective due diligence

Riskier investment profiles

Require accurate understanding of local
markets, regulatory environment, etc.

Availability of limited leverage

Need for strong relationships with other
funding institutions e.g. banks, etc.

Challenges of survival and growth

Need for VCs to have strong operational
capability to assist with growth

Apathy towards equity dilution

Need for market reputation,
communicating benefits of VC

1. Sub-Saharan Africa
8

Appendices

Appendix I: Gaps in SME Finance

Total Value of Gap in SME Finance

16.0%

14.4% 14%

14.0%

Turnover Growth (%)

(world average p.a.)

12.0%
10.0%

3 year

5 year

8.0%
6.0%

5.2%4.9%

5.1% 5%

Medium Caps

Large Caps

4.0%
2.0%
0.0%
Small Caps

Source: OECD, World Bank, Capricorn Capital Partners

10

Appendix II: Limited Sources of Sustainable Funding

for SMEs
Percentage of SMEs reporting access to finance
and cost of debt as a challenge (Nigeria)

70%

Percentage of SMEs reporting access to

finance and cost of debt as a challenge
(Selected Countries)

90%
80%

60%

70%

50%

60%

40%

50%

30%

40%
30%

20%

20%

10%

10%

0%

0%
Total

Small

Difficulty of Access

Medium

Nigeria

Large

Brasil

S. Africa

Difficulty of Access

Cost of Debt

Sources of Financing (selected countries)

Indonesia

Nigeria

Brazil

China

India

Indonesia

Kenya

S. Africa

70%

44%

13%

47%

38%

73%

66%

1%

30%

27%

32%

16%

7%

17%

25%

15%

2%

9%

4%

17%

12%

Family & Friends

4%

5%

8%

9%

20%

3%

1%

New Equity/Debt

0%

4%

12%

2%

2%

0%

1%

Others

0%

2%

38%

1%

20%

0%

3%

Retained Earnings
Banks and Other FIs
Credits from Suppliers & Customers

India

China

Cost of Debt

Majority of emerging
market SMEs reported
limited access to
sources of finance.

Source: CBN, ICA

11

Appendix III: Access to Finance as Major Constraint

Businesses in high income

countries, regardless of size,
generally have better access
to finance

Location of businesses
defines huge disparity in
access to funding.
Source: IFC, World Bank

12

Appendix IV: Growth in the Emerging Markets

Consumption in the emerging
markets expected to increase by
>100% in the next 15 years.

Growth in emerging market

companies surpasses those of
developed markets by
>100%
Source: Bain Insights

13

Appendix V: Emerging Market PE Returns on the Rise

18

Comparative Net End-to-End Returns as at 2011

16

Comparative Net End-to-End Returns as at 2011

30

14

25

12
10

20

15

10

0
-2

35

3 Years

5 Years

10 Years

15 Years

3 Years

-4

Emerging Market VC & PE Index

MSCI EM Index

S&P 500 Index

5 Years

US Private Equity Market

W. Europe PE Index

Emerging Markets VC & PE Index

Current PE Sector Exposures

Energy

Financials

Consumer
2

PE/VC provides better access to growth sectors

(consumer markets, info tech, industries) explaining
the difference in performance

Energy

Energy
Financials

Financials

Consumer
Healthcare

Returns on EM PE have exceeded those on US PE over

10 years and both US & EU PE over 5 & 3 years
Industrials

15 Years

US Venture Capital Market

Emerging Market PE Index has out-performed market

indices over the past 3 and 5 year horizon

10 Years

Consumer

Industrials

Industrials

Info Tech

Info Tech

Materials

Info Tech

Telecoms
Other

Emerging Market Private Equity

MSCI Emerging Markets

Source: IFC, Cambridge Associates

14

Appendix VI: The Opportunity keeps getting bigger

Within the 10-year horizon from 2000 to 2010, PE has expanded to

more countries in the emerging markets. West Africa represents a
growing investment destination for PE, with Senegal, Cote dIvoire,
and Ghana, now joining Nigeria, on the West African PE map.

Developed Markets

Emerging Markets with PE Opportunity

Source: IFC

15

Appendix VII: Country Overview Nigeria

PEST Analysis

Overview
Economic growth has averaged about 7.4% annually over the past
decade and remained robust in 2011 at 6.9%, driven by the nonoil sector (i.e. telecommunications, construction, wholesale and
retail trade, hotel and restaurant services, manufacturing and
agriculture).

Political

Economic

Relatively stable political

climate following
peaceful elections.

GDP growth is expected to be

sustained

Government is expected to reach its target inflation of under 10%

in 2013. Inflation rate fell 10.2% in 2011; but climbed to 12%
following removal of subsidies on petroleum products.

The economic growth has not cut poverty nor created necessary
jobs. About two thirds of the population live on less than US$1 per
day and unemployment rate in 2011 was 23.9%, up from 21.1%
in 2010. Unemployment in the 15-24 age group was 37.7%, and
for 25-44 years, 22.4%.

Violence in the North by

extremist groups is
greatest source of
concerns

Informal economy account for a large proportion of employment.

Selected Economic Indicators

2010

2011

2012

2013

Real GDP growth

7.8

6.7

6.9

6.6

Real GDP per capita growth

5.3

4.1

4.4

4.1

13.7

10.2

10.1

8.4

CPI inflation
12.0

10.0
8.0
6.0
4.0
2.0
0.0

Corruption levels remain

high, undermining recent
economic reforms

Real GDP growth (%)

Western Africa - Real GDP
growth (%)
Africa - Real GDP growth
(%)

Source: World Bank Database, Economist Intelligence Unit, Africa Economic Outlook

Private and informal sector

employs 80% of the
economy
Access to and high cost of
finance remain a major
constraint to growth
Another challenge to growth
is dilapidated state of
infrastructure and overdependence on oil revenue
by government.

Social

Technological

Social indicators on
health and education
remain weak. The 2011
UN Human Development
Report ranked Nigeria
156th out of 187
countries.

Increasingly successful
telecoms sector, increase in
mobile telephony and
internet usage
Reforms in financial sector
point towards the embrace of
technology to drive growth

Major Sectors (contribution to GDP)

Agriculture: 35%; Mining and Quarrying: 34%; Wholesale &
Retail: 16%;Finance, Retail Estate & Business Services:
6.3%; Manufacturing: 2%

Appendix VIII: Country Overview Ghana

PEST Analysis

Overview

Ghana made progress in consolidating the gains made in the

management of its macro-economy. Inflation dropped to 8.7 %
and the fiscal deficit fell to 4.3 % of gross domestic product
(GDP).

Middle-income status and oil receipts have provided the country

with the fiscal space to seek non-concessional sources of finance.

Country continues to enjoy a more open society, with a vibrant

media and strong public dialogue, which point to the
consolidation of democratic rule.

These have enabled Ghana to outperform most countries in West

Africa and in the continent on measures of civil liberty, political
rights and political stability.

Selected Economic Indicators

2010

2011

2012

2013

Real GDP growth

7.7

13.7

8.3

7.7

Real GDP per capita growth

5.4

11.3

5.4

10.8

8.7

8.2

7.7

CPI inflation
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0

Real GDP growth (%)

Western Africa - Real GDP
growth (%)
Africa - Real GDP growth
(%)

Source: World Bank Database, Economist Intelligence Unit, Africa Economic Outlook

Political

Economic

The organisation of district

level elections came under
pressure due to 2010
altering of the local
Government Act.

Government has been

undertaking policy and regulatory
reforms for conducive enterprise
development.

Smooth transition following

recent death of incumbent
president received global
applause.
Use of biometric registration
in 2012 elections is expected
to further check
irregularities.

Ranked twice as top 10 global

reformer by World Bank's Doing
Business Report.
Private sector increasingly being
considered as significant financial
& delivery partner for
infrastructure.
Oil production to boost economy.

Social

Technological

Rapid population growth rate

contribute to poverty and
underdevelopment

Mobile telecoms is seeing

significant growth. Currently
among the top 10 projected to
rule Africas ICT sector

Major Sectors (contribution to GDP)

Agriculture: 30%; Wholesale & Retail: 12%; Transport &
Communications: 12%; Finance, Retail Estate & Business
Services: 10%; Manufacturing: 7%

Appendix IX: Country Overview Senegal

PEST Analysis

Overview

GDP grew by 4% in 2011 and this rhythm is expected to continue

during the coming years, with forecasts of growth around 4.2%
and 4.7% in 2012 and 2013 respectively.

Growth is driven mainly by private consumption, which itself is

sustained by transfers from emigrant Senegalese working
abroad, and by the industrial and service sectors.

The elections were a major challenge to the country's

democracy, given rise to disagreements over validity of the
candidacy of outgoing president. However, the positive conduct
of the presidential election allayed fears of instability.

Unemployment remains a crucial problem, especially for young

adult whose employment rate is 25% below that of adults.

Selected Economic Indicators

9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0

2010

2011

2012

2013

Real GDP growth

4.1

4.2

4.7

Real GDP per capita growth

1.4

1.3

1.6

2.1

CPI inflation

1.2

2.6

1.9

Real GDP growth (%)

Western Africa - Real GDP
growth (%)
Africa - Real GDP growth
(%)

Source: World Bank Database, Economist Intelligence Unit, Africa Economic Outlook

Political

Economic

Relatively stable political

climate following
peaceful elections.

GDP growth is expected to

accelerate driven by
ambitious infrastructure
investment funded by
Eurobond.

Still underlying an threat

is intermittent
intensification of violence
from the 30-year
insurgency by separatist
rebels.

Countrys flourishing
relations with China and gulf
states is expected to boost
FDI inflows.
There is no need for rapid
investment in various sectors
to support growth trends

Social

Technological

42% of the population

live in urban centres,
given its current
urbanisation rate of
3.3%, half of the
population will be reside
in urban centres by
2015.

Presence of good fixed line

telephone system, although
nearly two-thirds all fixedline connections are in the
capital, Dakar, where a callcenter industry is emerging

Major Sectors (contribution to GDP)

Wholesale & Retail: 20%; Agriculture: 17%; Transport &
Communications: 12%; Manufacturing: 14%; Finance, Real
Estate & Business Services: 13%

Appendix X: Country Overview Cote dIvoire

PEST Analysis

Overview

GDP growth contracted by 5.9% in 2011, the economy was hard

hit by the negative effects of post-electoral crisis.

Substantial growth rates forecast (8.6% and 5.5% respectively,

for 2012 and 2013) depend upon peace being consolidated and
productive capacities being restored.

Need for accelerating the reforms set out in the Extended Credit
Facility (ECF) 2012-14 which aim to improve governance and the
business environment and boost performance in the financial,
energy and coffee-cocoa sectors.

The mismatch between training and employment and the

weakness of the job prospecting system comprise obstacles to
the promotion of youth employment and hampering efforts to
reduce poverty.

Selected Economic Indicators

2010

2011

2012

2013

Real GDP growth

2.4

-5.9

8.6

5.5

Real GDP per capita growth

0.4

-8.1

6.4

5.5

CPI inflation

1.7

4.9

3.6

3.1

10.0
8.0
6.0

Real GDP growth (%)

4.0
2.0

Western Africa - Real GDP

growth (%)

0.0
-2.0

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Political

Economic

Institutional normalisation,
strengthening of
democratic process and
progress towards
reunification and
reconciliation is
encouraging

Hard hit by conflict,

government introduced
reforms and tax breaks to help
the private sector

Pleas for reconciliation

and peace will need to be
reinforced by dialogue

Institution of public sector

reforms is expected to drive
economy towards
normalisation

Social

Technological

Youth unemployment is a
challenge, recently
estimated at 40%.

Technology use is drastically

improving and represents a
major growth sector in the
economy.

Government is now
implementing a poverty
reduction programme

Country witnessed
improvement on Doing
Business Rankings

Africa - Real GDP growth (%)

-4.0

Major Sectors (contribution to GDP)

-6.0

Agriculture: 31%; Wholesale & Retail: 14%;

Manufacturing: 13%; Finance, Retail Estate & Business
Services: 11%; Government Services: 9%;

-8.0

Source: World Bank Database, Economist Intelligence Unit, Africa Economic Outlook

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