By Augustina DAN-BRAIMAH
Access to finance and its related costs remains a major challenge for doing business in Africa, particularly for small businesses. This hinders the establishment of new businesses and the ability of existing businesses to upgrade or upscale.
In some cases, inadequate funding ultimately leads to an abrupt end or failure of business. One reason for this is that businesses mostly resort to traditional financing options without exploring alternative financing options that are now available.
This article highlights these options for the consideration of businesses, especially micro, small and medium enterprises (MSMEs).
Traditional Financing Options
Businesses in need of financing typically opt for traditional financing, which generally include two main funding options.
The first option is self-financing, which involves the business owner using personal funds or seeking funding from lending institutions such as banks or other financial institutions.
This option may sometimes include raising money (through equity or loan) in the capital market. However, self-financing is often limited or inaccessible, prompting the need to explore other funding sources.
The other option, obtaining loans from financial institutions is the mainly available option, traditionally. While this option is widely available, many businesses – particularly MSMEs in Africa including Ghana, are unable to access this funding due to the stringent credit requirements.
Typical credit approval requirements for businesses include:
- convincing evidence of a solid track record, being in existence for a considerable amount of time. This includes evidence of registration and incorporation, licensing and permits, and satisfaction of all legal requirements for the business.
- providing valuable collateral such as real estate, over and above the amount of the loan requested.
- proof of secured future receivables which will be directed through the account of the lender.
- good corporate governance system structured around personalities with proven track records at the helm of affairs, etc
Even where businesses manage to meet all the stringent requirements, they still grapple with high lending costs. Ghana currently averages an interest rate of 35% (as at July 19, 2024).[i]
The returns generated by these businesses are often unable to match such repayment obligations, further limiting their reliance on traditional financing options.
Alternative Financing Options
Alternative financing provides a viable option for entrepreneurs seeking to actualise their promising business ideas, businesses in need of additional funds to grow or upgrade, and financially distressed businesses seeking urgent funding to avoid closure. Alternative financing refers to financing other than the traditional financing options explained above.
In other words, alternative financing refers to financial channels, processes, and instruments that have emerged outside the traditional finance system, such as regulated banks and capital markets. MSMEs must, therefore, not restrict their options for sourcing funding to the traditional options but look to available alternative financing options. Some of these options are discussed below.
- Crowdfunding
Crowdfunding involves raising funds from groups of people, each contributing relatively small amounts, to support a project or business. This group can include family members, old school mates, church members, or the public. Although it may seem modern, as it has existed in African culture before traditional financing was popularised. In Ghana, this can be likened to concepts like as “susu”, “nnoboa” or “ntoboa”, which fostered saving culture and collective fund-raising for persons in distress.
Imagine you require capital of ¢50,000 to purchase motor bikes to start a delivery business. While securing a bank loan may be challenging, with a good business plan, you could potentially raise ¢100 each from fifty friends on your old school WhatsApp platform, which has over one hundred members to reach your funding goal.
Crowdfunding is typically facilitated through online platforms, but it does not necessarily have to be undertaken through these platforms. Its popularity has surged as a viable option for financing businesses.
Accordingly, as a proactive measure, the Bank of Ghana and the Securities and Exchange Commission (SEC) have issued policies and guidelines outlining the regulations for investment crowdfunding (equity and peer-to-peer lending/debt crowdfunding) and non-investment crowdfunding (donation and reward) in Ghana. These regulations must be adhered to for all formal crowdfunding activities.
- Grants for SMEs and Start-Ups
Everyone loves getting ‘free’ money, and grants are an excellent way to achieve just that. These grants, often offered by development finance institutions (DFIs), government programs and some not-for-profit agencies, are aimed at supporting vulnerable groups, boosting specific business sectors or promoting some business practices.
MSME-targeted grants may focus on businesses that engage vulnerable persons, operate in deprived communities as a source of livelihood for a particular community, or support women’s entrepreneurship.
Grants are typically awarded based on specific qualifications. Businesses seeking grants must meet the stated criteria. Applications for grants may be open periodically or around-the-year applications for consideration depending on the grant awarding agencies.
Some grant awarding agencies that MSMEs can consider in Ghana include AfDB[ii], Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ)[iii], MasterCard Foundation, the World Bank, specific government intervention programs administered by MDAs, and a number of foreign embassies in Ghana which have fund opportunities for innovations, agribusiness, renewable energy, women-led business.
- Debt-to-Equity Conversion
In a typical lender-borrower relationship, the borrower is expected to repay the principal amount with interest within the repayment period. For businesses burdened with significant debt that struggle to meet current repayment schedules, a common approach is to secure additional loans to repay maturing debt. An alternative financing option in this case, is to convert the debt into equity. This must be based on an agreement with the lender.
Converting from being a lender to a shareholder offers the advantage of receiving dividends when declared. This is a long-term commitment that may not suit every lender as they may not necessarily want to be a shareholder in perpetuity. Redeemable preference shares, which are redeemable at a future date, can be explored as an option in this arrangement.
Another consideration is mezzanine financing, a blend of debt and equity. In this arrangement, businesses have the option to convert owed debt into equity in case of default only after other senior lenders have been repaid. Mezzanine debt is particularly useful when a company has exhausted bank and asset-based loans but requires additional funds for various purposes like expanding operations, acquisitions, or facilitating the transfer of a business to family members or the management team.
- Private equity and M&As
One approach for business owners to consider is to open ownership interest by inviting other investors. This can be achieved through private equity participation or through mergers. Instead of aiming for full ownership of an unprofitable venture, consider enhancing your business through strategic partnerships with other equity participants or through mergers and acquisitions.
Private equity investors can be approached through private placements or by formally engaging with private equity or investment firms, who play matchmaking roles by introducing suitable investors – including high-net-worth individuals or investment firms.
A merger option can also be a viable strategy for upscaling or the growth of a business. For example, instead of seeking loans or new equity investors as a way of obtaining funds to open a branch in another region, you can propose a merger with a similar business operating in that region which may be seeking an opportunity to operate in your region. This type of arrangement can be mutually beneficial to both businesses without the financial strain, if appropriately implemented.
This collaborative approach can offer financial support and expertise, fostering growth and success. It is also an effective strategy for entering new markets. MSMEs could use leverage this approach to position themselves to take advantage of the African Continental Free Trade Area (AfCFTA), tapping into broader opportunities for expansion and integration.
- Venture Capital / Growth Equity / Angel Investors
This option is often considered the most common alternative financing option. Essentially, venture capitalists are seasoned business experts who invest external funds into startups and businesses in exchange for equity.
On the other hand, angel investors are affluent individuals who use their personal funds to invest in early-stage startup ventures, seeking equity or convertible debt in return. These investments can serve as seed capital for launching a business or as growth equity/expansion capital for more established companies in need of funds for substantial growth. In addition, venture capitalists and angel investors may also provide valuable guidance, mentorship and industry connections to help businesses succeed.
An effort in this regard is the establishment of the Venture Capital Trust Fund in Ghana, which is a government-backed venture capital aimed at investing in SMEs. There are other venture capital funds managed by private firms which businesses can access.
- Private Listing or Public Offerings
It has long been held that listing on financial markets is reserved for “matured” or “big” companies, and that such an option for raising capital was not available to MSMEs. This narrative is being changed by regulators in Africa, who have recognised the importance of providing alternative financing options for businesses. As a result, new avenues are being created to enable SMEs to access capital through the stock exchanges.
In Nigeria, the idea has been mooted for SMEs in the agro-allied sector to form cooperatives where smallholder farmers will be aggregated for easier access to funds and eventual listing on the Nigerian Stock Exchange (NSE).[iv] This approach may be extended to include other businesses and adopted.
In Ghana, the Ghana Alternative Market (GAX) is a parallel market operated by the Ghana Stock Exchange (GSE). It focuses on businesses with potential for growth and accommodates companies at various stages of development, including start-ups and existing enterprises, both small and medium.
To list on the GAX, a company must meet specific criteria. Incentives companies may enjoy from listing on the GAX include mandatory underwriting of the minimum offer directly or indirectly by the sponsor. Therefore, there will be no likely failures of Initial Public Offers.
Additionally, companies listing on the GAX gain access to a revolving fund to support the cost of raising capital and deferment of up-front fees. This may also apply for funds under the GAX-SME listing support fund to pay fully or partly for the cost of advisory services.
Conclusion
While traditional financing remains a widely embraced approach to business financing, businesses should explore alternative options as well. The main challenge facing MSMEs remains access to and the cost of credit. Alternative financing has proven to unlock remarkable opportunities for numerous entrepreneurs and foster the growth of small businesses.
Augustina is an Associate at AB & David Africa. She specialises in advising the firm’s numerous clients in finance, corporate and tax matters, and has particular interest in assisting SMEs. She coordinates the Banking & Finance Group and SME & Start Ups practice area for the AB & David Ghana office. Augustina’s practice also covers assisting businesses to access finance and upscale by taking advantage of AfCFTA market opportunities.
Email: [email protected]
[i] https://www.bog.gov.gh/economic-data/interest-rates/
[ii] https://www.afdb.org/en/news-and-events/press-releases/guinea-usd-14-million-loan-african-development-fund-will-support-industrial-development-and-resilience-smes-72224
[iii] https://thebftonline.com/2024/05/27/52-smes-to-benefit-from-agi-giz-afnext-grant-scheme-2/
[iv] https://guardian.ng/how-smes-can-access-funding-opportunities-list-on-nigerian-stock-exchange/
