For SMEs and startups, accessing the right funding at the right time is crucial for long-term success, and nowhere is this more important than in Africa, where SMEs provide around 80% of jobs. Within Sub-Saharan Africa, there are approximately 44 million such businesses, and in Uganda, Ethiopia and Kenya, up to 90% of the population work for SMEs.
Enabling SMEs to access region and continent-wide export markets is a key plank in the development of the African Continental Free Trade Area. Yet according to the World Bank, SMEs in emerging markets face a funding gap of close to US$4.5 trillion. Consultants McKinsey note that in South Africa, although around 98.5% of all commercial enterprises are SMEs, a study found that only 6% had accessed government funding and just 9% had benefited from bank and other private sector financing.
Close to 70% of SME funding applications are rejected in the first screening rounds
So what do SMEs need to do to attract the financing they need? Making the right funding choice and developing a comprehensive pitch are key elements. According to a global survey, close to 70% of SME funding applications are rejected in the first screening rounds because they fail to effectively communicate aspects of their business model or their financial performance and projections, or to demonstrate skills and knowledge. This article offers pointers for landing the right funding to fuel growth, plus tips for perfecting the pitch.
Private capital options
With commercial banking finance focused primarily on larger enterprises, private capital is a preferable form of funding for SMEs, not least because it does not usually require the collateral and the regular repayments of interest associated with the servicing of funding through bank debt. There are a number of options available, depending on the SME’s stage of development. These are primarily angel investors, venture capitalists (VCs) and private equity (PE) providers (see box).
Most commonly, capital is advanced for an equity stake. The investor’s aim is to grow the value of the equity stake during the investment period such that, upon exiting, there will have been significant capital growth, thus providing a positive investment return. However, because of the high risk of failure associated with early-stage ventures, angel investors, VCs and PE providers seek higher returns than they would ordinarily get from other investment platforms such as the stock market or bonds.
Before you start exploring your finance options, it’s important to be clear about which stage of development your SME is at. Most businesses will go through multiple rounds of investment throughout their growth and development before reaching the maturity stage, commonly referred to as series A to D funding rounds.
If an SME is in the early stages of development, angel investors are often a good option as they usually do not require collateral. Typically, they will help SMEs in product/service development and proof-of-concept work, as well as offering business management support.
There is a set of qualifying criteria to be met for each development stage
By contrast, SMEs that are ready to move beyond the start-up stage may benefit from VC support, which can include scaling-up capital; inventory/raw materials financing; debtors’ financing; and capital equipment acquisition. VCs often also support business model refinement.
Meanwhile, SMEs that are moving beyond the growth and expansion stages towards maturity may be best supported by PE providers, which, like VCs, can offer scaling-up capital. In addition, PE providers can provide mass production/distribution financing, guidance on improving corporate governance and initial public offering support.
For an SME to attract an investor, there is usually a set of qualifying criteria that should be met for each development stage as well as the funder’s own requirements. Early-stage investors – typically angel investors – will scrutinise the SME’s background, the attractiveness of the market, and the characteristics of the product or service.
Sources of private capital
Angel investors are high-net-worth individuals who invest their own money in early-stage ventures.
Venture capitalists (VCs) operate within a more formal structure, providing money invested by other entities and individuals in a company or fund.
Private equity providers operate within a similar structure to VCs but focus on more established businesses looking at listing on a public stock market or expanding on a larger scale than VCs can support.
Crowdfunding leverages the wide reach of the internet to invite users to fund entrepreneurial ventures, but has yet to gain much traction in emerging markets. These platforms do not pool funds but focus on matching prospective investors/funders to specific ventures.
Whatever the source of finance, to avoid rejection SMEs must present a rock-solid case to potential investors. Mastering the ability to pitch will boost their chances of success. Here are 10 areas a pitch should include:
- What problem(s) are you solving, and who are your target customers?
- What products and/or services will you offer?
- What is the market opportunity and how big is it?
- What is your business model? How do you create value for your customers and shareholders? Is the model scalable?
- What is your current financial position? What are your future financial projections? What are the associated assumptions?
- Do you have a team with the skills and experience to deliver on this opportunity or to run the venture?
- How will the required funding further develop and grow the venture?
- Will you require any other funding or support in the future?
- What critical challenges or risks – from regulatory and legal to disruptive technologies – are you likely to face?
- What are the venture’s environmental, social and governance objectives, and how compliant is it with the associated regulatory requirements?
Ultimately, the key to SME financing success is to know what you need and when you need it, and then prepare a strong case that potential funders cannot ignore. If you can do that, you’re well on your way to seeing your entrepreneurial dreams come true.