Surprising breed of financiers giving SMEs jab in the arm

At the centre of the Africa renaissance narrative is a beehive of activities by high growth small and medium enterprises (SMEs) that are steered by aggressive and visionary entrepreneurs.

These are small and medium size businesses that are focused on their long-term sustainability in the market and scalability of their business models.

In addition, these are the same businesses creating employment for our youth and developing solutions to our local social challenges; hence contributing significantly to our economic development as a nation. Unfortunately, most of these businesses are cash trapped and cannot grow as fast as they should without external capital injection.

Their first obvious source of funding is their operating cash inflows. However, these are spent before they are earned. Most high growth SMEs are at a stage whereby they are increasing their internal operations at an accelerated rate in order to meet their growing customer demands.

This means that all their cash inflows in any particular month are always budgeted for the following month’s operating costs before they land into the business bank accounts.

Production costs, salaries and wages and other office overheads in most cases consume all the cash inflows the business generates at any given month. As one of our clients puts it, this has turned them into mere “clearing and forwarding agents” within the money circulation system in the economy.

Due to their thirst for more cash injection to keep operations running, most high growth SMEs find themselves running into the bank overdraft rat race. The cost of the overdrafts notwithstanding, this second option for funding business operations in high growth SMEs is not sustainable for two reasons.

First, there is always a limit as to how much the SME can borrow which in most cases is way below the business cash needs. Second, bank overdrafts are only suitable for short-term working capital needs, hence leaving the SMEs still struggling to get funding for their long-term capital expenditure needs.

Most banks have SME banking which should ideally be more SME friendly and help in providing long-term debt funding to high growth businesses. However, the experience for most of our SME clients has not been glamourous on that end.

Besides the collateral question which is a perennial thorn in the flesh of SMEs; the capping of interest rates further clouded hopes when banks turned their focus to government papers and corporate lending.

The result has been a shrinking stream of debt capital injected into SMEs; their large numbers and huge business potential for commercial banks notwithstanding.

With microfinance institutions (MFIs) having lower lending capacity, high growth SMEs are left with one more source of funding to inject life into their businesses and maintain accelerated growth rates.

Individual and institutional investors are the shining stars at the end of the dark financial tunnel that many high growth SMEs in Kenya have found themselves in.

By individual investors, I mean people with surplus income or savings that they can inject into a business as debt, equity or mezzanine capital.

Traditionally, this has been a slot left for high net worth individuals. However, we are witnessing more middle class individuals joining the bandwagon by investing seed capital into businesses they like. Though crawling, the growing number of individual investors in SMEs is demystifying the conventional angel investor misconceptions.

READ: SMEs shun banks, turn to family for start-up cash

Institutional investors, on the other hand, are organised companies that pool funds for the purposes of investing in businesses. In the typical SME finance world, these would be your traditional venture capital firms and registered investment companies.

However, the tide is changing and saccos and other community savings groups are starting to invest in high growth SMEs with proven scalable and sustainable business models.

The new breed of investors including middle class individuals, saccos and chamas have not however fully embraced investment in SMEs due to the perceived high risk and the long-term nature of the investments.

To build their confidence, an aggressive awareness creation and education on opportunities presented by investing in high growth SMEs should be carried out by relevant market intermediaries.