Data from the World Banks shows in developing countries, small and medium enterprises (SMEs) make up 90% of the private sector and as such, they are critical to the employment of the wider population in these countries. SMEs contribute more than 40% to GDP and are less likely to obtain bank loans than larger firms. Instead, they rely on internal funds, or cash from friends and family to start up their businesses.
Why Invest in female led businesses?
Statistically speaking, women are critical to running businesses.
“Research shows that female leadership can impact business performance and overall growth. In a survey of more than 350 start-ups, Mass Challenge and BCG found that women-run businesses deliver higher revenues, equating to more than twice as much per dollar invested.” (Forbes Business Council, 2021)
Unfortunately, impediments to the growth of SMEs affect the rate at which businesses in Africa grow and there are even more challenges faced by women running businesses. Some common challenges are as:
1. No Collateral: SMEs do not have the balance sheet, or the asset base required to back commercial lending facilities from the bank if they choose debt to finance their businesses. SMEs have a high probability of business failure, so bank/funders need collateral to securitize the credit facility.
2. High Cost of Borrowing: Commercial bank lending rates and micro lending institutional rates tend to be extremely high and debt service obligations by SMEs tend to eat into very high portions of their already very limited revenue. It makes it unsustainable for the SME to borrow.
3. Moral Hazard: Business owners tend to use funds for other things and not their intended purposes. Character of the entrepreneur comes into question when funds are diverted, this affects the of the perception that the business owner creates in the eyes of the funder. The use of cash in the business is a key determinant of the successful outcome of an application for funding.
4. Limited variety of financial options in the market: Before the pandemic, SMEs were overlooked. Business Strategy of Commercial Banks is skewed towards large corporates and not SMEs due to their high-risk profile. Due to the pandemic, SMEs have mushroomed everywhere due to high rates of unemployment, so they create businesses to sustain themselves. Financial institutions around the world seem to have acknowledged this fact and are now beginning to alter their business strategies to increase their exposure to SMEs. Before the pandemic, SMEs were overlooked. SMEs are unaware of the opportunities that exist under the venture capital or private equity space.
5. Unconscious Bias by financial institutions/investors: Africa: the Big deal, a VC/PE data analytics hub, reports that in 2021 only 7% of US$4.3 billion of start-up funds went to women led or owned businesses in Africa. This is because some investors or financial institutions have an automatic gender bias when considering businesses led by women. After running three investor ready cohorts, there are three main factors that wCap has observed that may be contributing towards this:
i) The inability of some female entrepreneurs to articulate themselves in a clear and confident way: This affects the delivery of the presentation and pitching process. How the entrepreneur articulates themselves to investors or funders affects the overall perception that they have of the entrepreneur. Most times, they do not know the ‘language that the funders speak’ and they do not have a firm grip on their business model. This creates an ‘automatic biased view’ for staff in the funding institutions. As a result, a very small portion of funding goes to women led businesses.
ii) Inadequate financial knowledge: Understanding the link between money and finance, SMEs need to increase their knowledge and level of understanding to be able to manage their businesses more effectively. It is also crucial to how the entrepreneur articulates themselves to investors. Poor quality project proposals and business plans are submitted to financial institutions because there are skills gaps within the business (low business acumen), especially for family-owned businesses. Limited resources lead to business models that are not correctly aligned causing strategic problems with the business.
iii) Poor financial reporting standards: SMEs tend have poor reporting standards, no management accounts, or financial statements. Investors/financial institutions need these documents to monitor the historical performance of the business prior to deploying funds. SMEs tend to have extremely poor banking practices so there are high cash leakages which affects the credibility of the business, and the tracking of business expenses becomes difficult when cash generated is unbanked. It makes it difficult for financial institutions or investors to see how cash is managed in the business. Manual bookkeeping practices exposes the businesses to human error. Because reporting is not properly done, it affects the cash flow projections included in a business proposal that the SME submits to the bank. Most SMEs have an accounting skills gap because they cannot afford to have them inhouse, so they tend to outsource the function. SMEs need to ensure they get fully qualified individuals to do their books.
6. Inadequate governance: Governance, Core fundamentals in business are not correct, crucial to the performance of the business. Crucial in accountability to shareholders and key stakeholders. Helps entrepreneurs and employees understand the business strategy your business has, these stem from the overall goals of the board, shareholders, and other key stakeholders. It provides a framework or structure to the business for operational purposes. Our experience is most SMEs do not comply with regulatory requirements. If they want to scale the need to ensure they have fully registered their businesses, they are tax compliant and the meet the basic. Most SMEs do not have a board of directors or an advisory board to help with oversight and guidance on how to navigate the business strategically. They hold the CEO/entrepreneur accountable for the performance of the business. Funders pay close attention to governance, structure, and compliance issues as they form the base for the sustainable growth of the business.
7. No Risk Mitigation Measures: SMEs do not usually assess risk, therefore they are not able to manage risks effectively. This is a hug red flag for investors.
8. Inadequate business structures and business processes: inadequate structure affects the fundamentals of your business; funders do not like to see this. Most SMEs do not have the right management structure, organisational structure and to fully achieve the SMEs business strategy or value proposition.
In conclusion, it is evident that business owners must make the effort to address the fundamental flaws that exist in all aspects of their businesses prior to being considered for investment funds. Aside from having the requisite human capacity, what is of particular importance is financial reporting, governance and compliance and business acumen. Funders must also take responsibility for the some of the challenges they impose on small businesses by adjusting their requirements and skewing their strategies and financial products to align with the needs of small businesses, especially those led or owned by women.
This article is a summary of a discussion held on 21st January 2022 between Incubator Nest Hub and wCap on ‘The Challenges WSMEs Face When Raising Capital’.
The full conversation can be viewed here: https://www.facebook.com/incubatornest/videos/1344162322708805