May 28, 2021

The Role of Private Equity and Venture Capital in Spurring the Growth of SMEs

Juliet Hinga

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SMEs play a critical role in most global economies, particularly in developing countries. In Africa, SMEs are among the leading drivers of growth, innovation, and employment. SMEs in Kenya represent more than 80 percent of businesses and employ up to 75 percent of the active working population.

According to the World Bank (2017) report, SMEs represent about 90 percent of businesses and account for more than 50 percent of employment globally. The World Bank estimates 600 million jobs will be needed by 2030 to absorb the growing global workforce. This makes SME development and growth a high-priority development item for many governments globally (Beck, Dermiguc-Kunt & Levine, 2015).

One of the main factors constraining the growth of SMEs in Kenya and Africa as a whole is access to finance which remains one of the most cited obstacles facing SMEs to grow their businesses in emerging economies.

Private Equity (PE) and Venture Capital (VC) have become a mainstay source of cash for entrepreneurs and investment options for return-seeking institutions and individuals. This article seeks to shed light on PE and VC as financing options for established businesses, SMEs, and start-ups.

In East Africa, there are over 60 private equity and venture capital funds focused on investing in East African businesses. The total investment allocation from private equity and venture capital in Kenya stands at more than 100 billion shillings.

Over the years, this asset class has contributed immensely to the growth of local brands in Kenya; Family Bank Kenya, Quick Mart, Nairobi Women’s Hospital, Java House Africa, Brookhouse, and UAP Old Mutual, and many others.

Speaking during a webinar session at Strathmore University Business School, David Owino, managing Partner, Ascent Capital Advisors & Chairman of the East Africa Venture Capital Association (EAVCA) highlighted the main differences between private equity and venture capital investments. “Private Equity is capital invested in a company or a business entity that is well established and has a proven growth track record. Venture Capital is funding given to start-ups or other young businesses that show potential for long-term growth,” he noted.

The webinar session dubbed ‘The Role of Private Equity and Venture Capital in Spurring the Growth of SMEs in Kenya’, was aimed at enlightening participants on how Private Equity Capital and Venture Capital firms can spur the growth of SMEs in the country.

David further highlighted four reasons why entrepreneurs and businesses bring in PE & VC firms to invest in their businesses.

  • When a business is drowning in debt and the only way to salvage it is a bailout.
  • When you run a fast-growing business and you need money to invest into the business to expand
  • When you want to realize the value of your business.
  • When an entrepreneur is looking to create a sustainable business that will outlive them. In this case, PE comes in to help the entrepreneur institutionalize his business while creating a governance framework that separates the business from the owners.

Since private equity investment agreements are only for a specified period, the entrepreneur needs to understand the fine print of the agreement. “Ensure you get a lawyer, and not just any lawyer, preferably a commercial lawyer who can effectively explain the terms of the agreement,” David advised. This will go a long way in preventing misunderstandings in the future and at the point of exit.

Some of the challenges that arise many of the times are the entrepreneur feeling that the investors want too much control, investors not delivering on the promises made and differing expectations at the point of exit in terms of timing, how a sale should be executed among others. To avoid such issues, the investors and the entrepreneurs must have a clear understanding of the terms and conditions of the partnership. If these issues are not ironed out at the start, the private equity investment will be sure to fail.

Most investors understand how to evaluate and make investments in traditional asset classes such as equities, bonds, and cash. However, in the recent past, there has been significant downward pressure on returns from these asset classes with the risks involved also soaring. This has necessitated individuals, asset managers, insurance companies, pension funds, and investment groups to take a keener look at alternative asset classes to diversify risks and bolster returns.

The Private Equity and Venture Capital Programme is geared towards one of the alternative asset classes like private equity, loosely defined to cover angel, venture, and private equity investing. It aims to provide the participants with the necessary skills to evaluate, value, structure, negotiate, invest in and manage investments within this asset class. Learn more about the Private Equity and Venture Capital Programme.

References:

  1. Beck, T., Demirguc-Kunt,A., & Levine, R. (2015). SMEs Growth and Poverty: Cross-Country Evidence. Journal of Economic Growth, 10

Article by Juliet Hinga 

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