Nearly every business is looking for financing. There is always a need to expand the production capacity in various aspects. A huge disconnect however exists between the enterprises and the financial institutions. Businesses are looking for financing but investors indicate they are not finding appropriate businesses to put their money into. This then begs the question: what has caused this disconnect and how can the gap between the demand and supply sides of investment be bridged?
A study conducted in 2009 revealed that there is a disproportionate impact on job creation and economic development in growth companies. They have minimal contribution to economic growth and therefore even the magnitude of job creation does not reflect the level the company is in. This has been attributed to the slow expansion of the companies which in many cases is due to the lack of finances to push the companies from what is called the valley of death, a stage where the company requires financing to expand when it has successfully developed a product and managed to venture into the market. The hurdle then becomes financing to increase efficiency and production capacity.
Challenges Affecting Investor Readiness
Scholars over time have documented various challenges that have affected investor readiness. In many regions in Africa, most if not all businesses are family-owned. It is either directors of the company are members of the family or the seed financing for the company was from the family. It then becomes a challenge when the company reaches a stage where it needs to raise finances because of the fear of bringing in new people into a family business. They then become skeptical towards investors. On the other hand, investors tend to shy away from businesses that are majorly controlled by a family.
There is also an overreliance on grants by startups and this makes them shy away from commercial funding. Startups, particularly in Africa, have attracted massive grant funds to build their businesses. The grants have been useful in the early stages but are limiting at the growth stage of a business. Once a business has received heavy funding from grants then it becomes a challenge for them to be open to commercial funding.
Poor documentation is another main challenge that hinders investment. Startups in most cases will not have proper records of their financials, production, human resource etc. For an investor, the historical data of the company is very important when they are making an investment decision. Investors’ confidence in putting their money in such a venture is dented when records are not provided.
Related article: Private Equity and Mezzanine Financing: Is it the answer to Kenya’s SME financing challenge
There is also lack of understanding of the types of funding available and what is suitable for a specific business, which creates a lack of appreciation of the types of funding in the market. Needless to say, various types of funds exist including equity and debt among others. It is fundamental for the businesses to have an understanding of what the market is offering and also be clear on what they are seeking.
Some Considerations Investors Make When Looking for What to Finance
There is a general process that investors walk through when they are seeking to invest in a company. An enterprise needs to prepare a data room and allow an investor in order for them to get much information on the company. This is done to make the interaction between the investor and the investee easier. Below are some piece of information an investor could be looking out for:
- The organizational structure which means the human resource capacity and any gaps that may exist. No investor will want to put in money to a “one man’s show”. It is important to have technical capacity to run the business or even have plans to fill in the gaps.
- Corporate governance structures. Who are the advisors of the company and what level of control do they have?
- An assessment of the product. What are the opportunities for the product in the market, the market size, the competition for the product?
- The customer profile: who are the potential customers for the product? Investors also consider their willingness and ability to purchase the product as well as the market share of the product in relation to existing competition.
- The growth of the company. From inception, how the company has grown and what any future growth projections. This means an assessment of the financial model and the business model. It also means looking at the drivers of growth risks that may hinder growth.
- What is the investment ask and to what specifically will the money be directed?
- The legal due diligence that confirms the documentation of the company as registered under the law. A consideration is therefore made on the shareholding, permits where applicable, any court cases, etc.
It is important to note that the list above may not be exhaustive and thus may differ in some instances. While preparing for an investment process, it is fundamental for a Small and Medium Sized Enterprise (SME) to have an advisor who is able to offer an independent view of the offer they receive from the investor. This is a role that KCIC has been able to play effectively for its clients.
By Sarah Makena