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How to create an enabling environment for funding early-stage businesses


A number of factors complicate investing in early-stage enterprises

SA’s latest labour force survey shows that the country's unemployment rate has increased to 27.5%. That means more than 6-million South Africans are looking for work.


With the economy in recession, this is likely to affect access to basic services such as education, health and energy.

Addressing this problem has been a government priority for years, yet unemployment has been rising steadily for the best part of the last decade. From a low of 21.5% in 2009, the trend has been consistently upward.

President Cyril Ramaphosa has shown his commitment, with initiatives such as October’s jobs summit and the investment conference, aimed at attracting more capital into the economy. There is no question that SA needs more investment, but only time will tell whether the conference paid enough attention to one of the areas where it will have the most impact: early-stage finance in support of the entrepreneurs and enterprises shaping SA’s small, medium and micro-enterprises (SMME) sector.

The success of early-stage businesses in an economy is closely linked to its ability to create jobs. A 2015 report by the Kauffman Foundation found that new businesses accounted for virtually all new job creation in the US.

“Policymakers often think of small business as the employment engine of the economy,” noted the authors of the report, Jason Wiens and Chris Jackson. “But when it comes to job-creating power, it is not the size of the business that matters as much as it is the age.”

There have been similar findings in SA. Finfind’s inaugural SA SMME Access to Finance Report released earlier in 2018 found that high-growth SMMEs generated 86% of new jobs in the country. In the same report, however, Finfind notes that there is a credit funding gap in the SMME sector of between R86bn and R346bn. The biggest shortfall is in funding for start-ups and micro-businesses.

While access to early-stage finance is a global problem, it is a particularly acute issue in SA. There are very few organisations providing funding in this space, albeit often for good reasons; investing in early-stage businesses is high-risk given their high failure rates, and it is expensive as the same level of due diligence is often required for potentially much less reward.

A number of additional factors complicate investing in early-stage enterprises. New enterprises often have limited collateral with which to secure loans from banks or other traditional financial companies. In addition, their financial documentation is often inadequate for doing a thorough due diligence check. These issues are exacerbated among entrepreneurs who are operating outside the formal economy, where investors can struggle to evaluate the creditworthiness.

In addition, a large number of entrepreneurs in SA lack access to a key source of funding in more developed markets, known as “friends, family and fools” — a network of individuals with excess capital, willing to take a chance on someone they know.

For an investment conference to truly have an impact on job creation in SA, these are the fundamental issues that have to be discussed; how do we create a more enabling environment for the funding of early-stage businesses?

This can be done in a number of ways, by reducing risk to investors, by providing access to business development support to entrepreneurs to reduce failure rates, and by incentivising investors and intermediaries to invest in high impact sectors or geographies.

It also means looking at innovative ways of structuring financing so that private funders do not have to carry 100% of the risk. The developing trend towards blended finance models, where grant or donor funding can be combined with private investment, has huge potential in this respect.

A good example of such a model in SA is the partnership between the Asisa ESD Fund and USAid’s Partnering to Accelerate Entrepreneurship (Pace) initiative.

Grant funding from USAid provided Edge Growth with upfront capital, which could be used to source, support and deploy capital to enterprises. Asisa ESD Fund is able to offer tailored business development support to investees, building their internal capacity and making them scalable and sustainable, while decreasing the risk that they will default on their loans.

Alternative ways of assessing risk to investors are also being explored. If entrepreneurs don’t have formal credit ratings, there are ways to use artificial intelligence and big data to evaluate their behaviour in other ways to determine how likely they are to repay a loan. Local financial technology company Jumo is a thought leader in using behavioural science in the design of low-cost financial services. Alongside its peers such as Yoco, Lulalend, and Nominani, these organisations are examples of how data driven intelligence is being used to mitigate the risk of early stage investing.

The regulatory hurdles early-stage businesses face also impact on their attractiveness to investors. The ease of doing business, intellectual property regulation, exchange controls and taxation are among a number of issues that have to be addressed to give start-ups a greater likelihood of success, and therefore a better chance of securing finance.

All of these issues are even more significant for impact enterprises that specifically focus not just on generating profits, but also on creating a positive social or environmental impact. It is often harder for them to secure early-stage investment, yet the role they can play in developing SA is even greater since they are not just creating employment but also driving positive social impact and change.

All of these incremental changes are promising, but can be amplified if we shift the system. To this end, the Bertha Centre initiated the establishment of an Impact Investing National Task Force focused on driving more capital into businesses operating in high-impact sectors such as water, renewable energy, sanitation and agriculture.

This is a cross-sectoral initiative with high-level representation. The taskforce supports policy development, capital mobilisation and education, among others, and is a self-governed, national initiative under a global umbrella and is the first of its kind in Africa.

It is imperative that we share the lessons and successes of these initiatives. The taskforce, the investment conference and all the other good work are calls to action for more investment into early-stage enterprises desperately needed to grow the economy and, critically, create jobs. The success of early-stage businesses in an economy is closely linked to its ability to create jobs.



Disclaimer - The views expressed here are not necessarily those of the BEE CHAMBER

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