The Government of Ghana has admitted that the country is going through some economic challenges. Even though the political actors do not agree on the cause of the challenges, they agree on the fact that there are economic challenges. One evidence of the economic challenges is the international and domestic debt restructuring that the Government acting through the Ministry of Finance is undertaking. With the domestic debt restructuring, the Government has implemented the domestic debt exchange (DDE). One unintended consequence of the debt restructuring activities by the Government is declining investor confidence in the debt market, especially in the acquisition of government debt instruments. These negative or adverse economic effects may also have some advantages. One such advantage is that they present solutions to the fundamental challenges of businesses in Ghana in terms of access to funding for the business and the cost of funding. Since investors are reluctant to invest in Government instruments, funds are available looking for investment opportunities. Private sector businesses must take advantage of this to attract such investments. This article explains how private-sector businesses must position themselves to attract such funds.
Challenges of Assessing and Cost of Funding
Private businesses need capital to operate and expand. The capital is injected either as equity or debt. In other instances, companies capitalise their profits. Access to funding and the cost of funding have been the twin problem bedevilling the start and growth of businesses in Ghana. A simple online search lists these twin issues as major issues affecting businesses and entrepreneurs in Ghana. Whilst there may be many reasons accounting for this, one major reason is the fact that government competes for scarce funds available, especially from investors on the domestic market. In such competition, investment in government instruments is generally the winner.
Preference for government instruments and securities
Investors have traditionally preferred government instruments or securities. The general assumption has been that investing in government instruments or securities is less risky than investing in private businesses. This has accounted for instances where even financial institutions (banks and non-banking financial institutions) invest a considerable part of their funds in government instruments and securities. As it is always said, the government is crowding out private access to capital. It is assumed that the risk of government default on its debt obligations to investors is very low. It is not that often that there is a default of sovereign debt obligations in comparison to the default of corporate entities to satisfy their debt obligations.
However, the economic challenges leading to government debt restructuring are debunking these assumptions. Investors are therefore reluctant to invest in government securities and instruments. The under-subscription to the recent debt instrument issued by the government in the domestic market is clear evidence of this position. Even instruments issued on behalf of government corporates (Cocoa Bill) have also been undersubscribed, leading to the government’s inability to pay maturing debts, hence rolling over the maturing debts in circumstances that can be construed as default.
These circumstances signify dwindling investor confidence in investing in government instruments and securities. Undoubtedly, government instruments can now be considered high-risk instruments as there is the possibility of default by the government or delay in honouring its maturing debt obligations. This, it is suggested, is an advantage to private businesses looking for funds. Investors now hold funds looking for investment opportunities. Banks, non-banking financial institutions, and institutional and private investors will now be reassessing their investment strategies in terms of the risks of investing in government instruments and securities.
The increasing risks of investing in government instruments or securities will mean investors will look to diversify their investment portfolio into what they traditionally considered riskier than the government instruments and securities. Investors will therefore consider the option of investing in instruments issued by private businesses by looking out for equity and debt options for private businesses. However, for such businesses to attract investors, they must consider restructuring their equity and debt instruments to be attractive to investors. In addition, there must be mechanisms that reduce risks that account for the hesitation of investors to traditionally invest in such businesses.
As indicated, businesses traditionally require investment in the form of equity and debt. In equity investment, shares are issued to investors in return for consideration – cash or non-cash considerations. Such equity investors are deemed “owners” of the business. The returns on the investment are an increase in the price of the shares and dividend distribution when the company makes profits.
Alternatively, the investors invest in a business by acquiring debt instruments. The investor becomes a lender who grants a loan to the company with clear terms on interest and repayment. The return on the investment is the interest payable on the principal by the company, who is the borrower.
For the corporate entities to attract funds that previously would have been invested in government instruments, it is suggested that private businesses must efficiently structure their equity and debt instruments to attract such investors and back such instruments with suitable mechanisms to minimise risks of the investors.
Structuring corporate instruments to attract investors
Most government instruments are fixed terms instruments with fixed returns. That is the number one attraction to investors. The certainty of knowing what to expect periodically as the coupon payment and the expectation of a definite date for the payment of the principal. In order to attract such investors, private businesses need to structure both equity and debt instrument to mimic these requirements.
Traditionally, corporate entities make applications to banks and non-banking financial institutions for loans. The lenders essentially dictate the terms. A change in this approach will be for corporate entities to properly structure their debt instruments to attract investor-lenders to be interested in acquiring such instruments. These may take the form of corporate entities issuing corporate bonds or a series of loans on terms dictated by the corporate entities. Nothing stops a corporate entity from structuring its debt instrument similarly to government treasury bills or bonds. This type of structuring need not be limited to public companies since private companies can issue such instruments through private placements. Well-structured and thought-through terms on which a corporate entity requests a loan is likely to attract a positive response than just an application for a loan, especially if it is not from a bank. This calls for a properly written business plan or information memorandum on the business which clearly explains the sources of the receivables to be used for the repayments.
In relation to equity instruments, corporate entities should create different classes of shares that allow for payment of pre-determined fixed dividends with obligations on the company to acquire the shares back on pre-determined dates. This is permitted under our laws in the form of redeemable preference shares as to dividends. As a way of giving further assurances to investors, the dividends are made cumulative dividends by default under the law unless expressly otherwise indicated in the constitution of the company. The law allows for different rights and interests to be attached to different classes of shares. Private businesses need to understand what attracts investors to government bonds and seek to attach such rights and interests to the share instruments being issued to attract such investors.
The government domestic debt exchange reveals that many individual bondholders hold government debt instruments. This means corporate entities must not only position to attract institutional investors. Entrepreneurs must move from where they approach family, friends and potential business partners asking for funds without clearly structured instruments or terms on what they are offering. Such an approach must be based on clearly structured financial instruments or securities offered for funds from family, friends and other potential investors.
In addition to having well-structured instruments, corporate entities must establish their creditworthiness by putting in place mechanisms that give the investors (both equity and debt) comfort in acquiring the instruments on offer. These will include having a properly structured contract that reduces risks of not obtaining receivables that are to be used for the repayment, establishing escrow, waterfalls or debt service accounts that ensure the clear process of settling the liabilities and providing security as a fallback measure for lenders to recover their debts. In addition, having good corporate governance systems boost the confidence of the investors.
Whilst we all dwell on domestic debt exchange and international debt restructuring and its negative effects, businesses need to look beyond that and fashion out how they are able to not only survive but also strive in the midst of the economic challenges. This requires tapping into funds hitherto that may be invested into government securities. However, for businesses to attract such funds, they must change their approach to raising funds by taking the lead in the process.
As it is said, success is where opportunity meets preparedness. Businesses and entrepreneurs must be prepared first by properly structuring the financial instruments on offer to attract investors who are reluctant to invest in government instruments.
[i] *Ferdinand D Adadzi is a Partner, with the Corporate & Finance Practice Group of AB & David Africa. He is based in the Accra office and works with the firm’s Africa Finance Team which looks at the finance sector across sub-Saharan Africa. He has advised a number of entrepreneurs/start-ups on their set-up, raising funding and partnership arrangements from the idea stage to the implementation and scaling up of such businesses. Ferdinand also lectures at the GIMPA Faculty Law in corporate law. He recently published a book titled “Modern Principles of Company Law in Ghana”.
Email/Telephone No.: [email protected] / +233242262180
 *Ferdinand D Adadzi is a Partner, with the Corporate & Finance Practice Group of AB & David Africa. He is based in the Accra office and works with the firm’s Africa Finance Team which looks at the finance sector across sub-Saharan Africa. He has advised a number of entrepreneurs/start-ups on their set-up, raising funding and partnership arrangements from the idea stage to the implementation and scaling up of such businesses. Ferdinand also lectures at the GIMPA Faculty Law in corporate law. He recently published a book titled “Modern Principles of Company Law in Ghana”.
Email/Telephone No.: [email protected] / +233242262180