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What Financing for the Private Sector in Africa? The Role of Impact Investing?

The private sector is a driver of growth. However, African firms, regardless their size, suffer from a lack of financing, especially in areas where traditional financing solutions are insufficient. Could…

Companies – large, medium, small – are one of the main sources of economic growth, as they actively participate in job creation, generate income and contribute positively to social and environmental well-being. However, the private sector in Africa faces significant financing gap, especially in areas where traditional financing solutions as banking credit are lacking. This is where impact investing emerges as a promising alternative, particularly for companies having important externalities for their communities.

Impact investing, an unknown financing solution

Impact investing is seen as a recent alternative to finance the private sector, particularly for firms and projects that generate substantial extra-financial benefits for their communities. Impact investing vehicles have grown by double digits (14%) in five years (2017-2022) in Africa, but it still remains a less developed segment compared to other forms of financing. There is a real enthusiasm around this financial innovation, particularly from donors and governments. Despite this interest, this recent financing solution remains largely unknown. In a recent study, the FERDI, through its Impact Investing Chair, aims to improve the understanding of this industry in Africa by publishing an analytical mapping of impact investing on the African continent.

Specificities and role in development financing

Impact investing mobilizes financial traditional tools such as debt or equity. Its specificity lies in directing its funds towards firms and projects that generate high extra-financial impacts, whether economic (e.g., creation of jobs, direct and indirect ones), social (e.g., improvement of healthcare services), or environmental (e.g., providing renewable energy solutions). It also targets investees that cannot qualify for traditional financing channels, such as bank loans, due to their unfavorable risk-return balance.

Impact investors play a crucial role in bridging the financing gap for many companies in Africa. They take the risk of investing in these latter at various stages of their development, despite a potential lower return than market rates. The trade-off for this reduced profitability and increased risk is that the provided investments will generate significant community impacts. This financing helps entrepreneurs launch their projects, develop their products, strengthen their market strategies, and become self-sufficient on a long-term run. A notable example is the Laiterie du Berger (LDB), a Senegalese dairy company that has been supported financially by the impact investor I&P. With over 700,000 euros invested over several years, I&P supported LDB from its early stages, despite modest initial profits – impact investors often use patient capital. Other impact investors subsequently provided financial support for its development. Today, LDB employs more than a thousand people and contributes to improving the agricultural value chain, nutrition, incomes, and Senegal’s GDP – demonstrating the importance of impact investing and its actors in development financing.

Some data on impact investors in Africa

On the African continent, impact generation goals are often based on the ability to achieve the Sustainable Development Goals (SDGs), and contribute to the national development plans of the countries in which they invest, which may not be the case elsewhere. Therefore, investees’ economic activities are often tightly linked to one or most of the seventeen SDGs.

Moreover, given their dual objective – impact and financial return – impact investors seek to finance sectors that allow them to attain scalability and an acceptable financial return. This is why their investments in Africa are concentrated in agriculture, finance, and energy. These three sectors meet this dual constraint. They are among the fastest-growing sectors on the continent and also employ the most workforces.

For instance, the agricultural sector is crucial both economically, by employing more than half of the active population in Africa (51.71% of jobs on the continent are in agriculture, World Development Indicator); socially, due to rural poverty; and environmentally as agriculture is both a recipient and a solution to environmental challenges (climate change, biodiversity, pollution).

Nevertheless, the mapping conducted by the FERDI’s Impact Investing Chair shows that the majority of investment funds operating in Africa are headquartered outside the continent, mainly in North America and Europe. African impact funds represent barely more than 16% of the activity of funds operating on the continent, with a notable concentration in a few english-speaking countries such as Nigeria, Kenya, and South Africa. These countries are also where most of the investees are located.

The landscape of impact investing in Africa is also dominated by medium-sized funds (from 1 to 250 million USD), which constitute 54.5% of identified impact investors on the continent. However, 80% of the assets under management mobilized in Africa, amounting to 108 billion USD, are managed by a few mega-funds (over 1,000 million USD) – representing 7% of investors, with only three out of eighteen headquartered in Africa (in Nigeria and Mauritius), the rest being mostly European.

Impact investing challenges in Africa

Impact investing in Africa faces several challenges.

Firstly, the disconnection between the nationality of the funds and the country and companies they invest in is a source of challenges for investors on the African continent. Investing in the local currency of the investees’ market or in the investors’ currency presents a dilemma, often leading to a “currency mismatch.” Currency market shocks can be a blocking factor for fund allocation and can be an argument for withdrawal by capital providers and local financial institutions.

The difficulty in measuring and demonstrating the real net impact of these investments is also a major challenge for this sector in Africa. Indeed, its economic impacts are higher than what data can show – as in the case of LDB.

However, it is indeed essential for impact investors to demonstrate their community impacts to build their legitimacy and credibility among capital allocators, who are mainly foundations and development finance institutions (DFIs). The lack of qualified personnel and the high cost of evaluation systems partly explain that difficulty to prove their credibility to these entities to support their fundraising efforts. The administrative burden linked to fundraising is also one of the reasons for the decline in the creation of new funds since the beginning of the century. This human resource issue is explained by the competitive labor market. Impact investors face competition from competitors like DFIs and development agencies that offer higher salary ranges, making it challenging for them to meet these standards.

Another challenge is the difficulty of exit due to the limited size of the local impact investing ecosystem. Few investors, whether international or national, are interested in buying their shares. The sale of these shares can thus be prolonged beyond the initially defined maturity, serving as a deterrent for impact investors themselves.

To conclude, in order to fully realize the potential of impact investing, it is essential to increase the financing of local actors by simplifying procedures and innovating to attract institutional investors. Supporting its development by implementing mechanisms to improve the risk-return balance, notably through the development of specific instruments and secondary markets, would leverage the emergence of this sector. Finally, it is important to improve the quality of funds and their impact measurement methodologies by supporting teams, sharing best practices, and implementing dedicated incentives. The FERDI Impact Investment Chair addresses these issues in its current research agenda.

By : Léon Florian and Rabary Sitraka

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Resilience and adaptation in times of insecurity: Mali’s renewal will come from the private sector (2/2)

Recent crises and the resulting structural vulnerabilities have considerably diminished the capacity of Sahelian countries, already historically very weak, to attract investment. For instance, after an all-time high of 860 million USD in 2019 (5% of GDP), foreign direct investment to Mali (net inflows) has fallen drastically to just 252 million in 2022 (1.3% of GDP).

Despite the low priority given to private sector development in fragile security contexts, it plays a central role during and after conflict situations. Experience has shown that the private sector remains active even in times of conflict, and can adapt to overcome systemic shocks.

In this interview, Malian entrepreneur Mohamed Keita, Director and Co-Founder of Zira Capital, a company created in 2022 and dedicated to financing and supporting start-ups and SMEs in Mali, shares his fund-raising experience and argues for the need to continue supporting the private sector despite a difficult security and socio-political context.

Entreprenante Afrique: What is the current state of entrepreneurship in Mali?

Mohamed Keita: Over the past ten years or so, the Malian economy has been affected by the combined effects of the security crisis and political and institutional crises. We are keeping a close eye on how the situation evolves, and our wish as entrepreneurs is of course to quickly return to a stable business environment.

But despite this difficult context, despite the challenges, we observe that entrepreneurs are still succeeding at creating opportunities locally. They develop projects and goods that satisfy local needs. They create and maintain jobs that support thousands of households, and stimulate other aspects of economic activity in the process.

Malian companies are exceptionally resilient, but they need strategic partners to support them, both financially and extra-financially. This is why, together with other players (BNDA, Investisseurs & Partenaires and a number of private individuals), we have launched Zira Capital to support these small local businesses through financing mechanisms and tools tailored to their development projects.

Raising funds to support entrepreneurship in such a high-risk country is no easy task, how did you address the financial backers?

M. K.: The model of Zira Capital, a fund co-created by or with local players to provide equity financing for local businesses, is a model that has already been set up and is beginning to prove its efficiency in other African countries, in other countries in the Sahel zone, such as Burkina Faso or Niger. However, it’s a completely new concept in the Malian entrepreneurial ecosystem.

The initiative was well received, and generated enthusiasm among Malian entrepreneurs. Even before the official creation of the management company, we had built up a pipeline of quality projects. We had built up a database of high-potential companies in a variety of sectors, all of which are linked to the fundamental needs of the Malian economy: agri-food, which accounts for 45% of GDP and employs 80% of the population, but also energy, essential services, health and education.

Our main argument for convincing people of the need to create our financing facility was this pipeline of quality entrepreneurs, rooted in the country and whose needs had been clearly identified.

Investing in a country like Mali obviously involves taking on a certain degree of risk. But mechanisms can be put in place to mitigate them. During the fundraising process, which lasted several years, we faced several challenges. We had identified a number of potential partners, including subsidiaries of multinationals with whom discussions had reached a more or less advanced stage, but whose enthusiasm gradually subsided in view of the changing political situation. This is understandable when a certain degree of investment security can no longer be guaranteed.

But fortunately for us, the vast majority of investors identified at the outset of the project maintained their confidence in our project, and supported us through our first closing in 2022.

“Investing in a country like Mali obviously involves taking on a certain degree of risk. But mechanisms can be put in place to mitigate them”

The Sahel countries have received significant public aid from the international community in recent years, with mixed results. Should we rethink the mechanisms of public aid? Does SME investment represent a more impactful alternative?

M. K.: In 2021, Mali received USD 1.42 billion in official development assistance. This represents an important resource for the country in general. I wouldn’t say that aid is inappropriate, but that it needs to be channeled more towards local actors, in particular private companies. Some historical approaches to public aid have shown their limits. And we need to deploy innovative mechanisms and more substantial resources to enable public private finance institutions (DFIs) to be more present, faster, and more effective.

I am among those who firmly believe that the development of our countries, particularly fragile states like Mali, relies on the growth of a network of small and medium-sized enterprises.”. An effective way of doing so would be to bet on making more resources available to these companies, especially resources they have difficulty mobilizing locally.

“I firmly believe that the development of our countries, particularly fragile states like Mali, relies on the growth of a network of small and medium-sized enterprises.”

What’s important to note is that Mali’s entrepreneurial fabric is vibrant. There’s a tremendous amount of effervescence, and more and more people are starting up. Rather young people, who bring new solutions, who despite the context, develop services with quality, manage to launch projects. And I think this adds a note of hope to the country’s overall picture, which is rather complicated, with a security crisis that has lasted for ten years or so, and political instability. For my part, I’m among those who are betting that Mali’s renewal will come largely from the private sector.

Further reading: in our “Resilience and Adaptation” series, discover Maïmouna Baillet’s article, “the battle of Niger’s women entrepreneurs”

By : Mohamed Keita

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3 essential paths for the development agenda of the next 30 years

On May 22, 2023, an exciting day of debate was organized by the Architecture Chair in International Development Finance and the Impact Chair of the FERDI. The event brought together…

On May 22, 2023, an exciting day of debate was organized by the Architecture Chair in International Development Finance and the Impact Chair of the FERDI. The event brought together some twenty African and international researchers, investors, entrepreneurs, and heads of development institutions. What can we learn from this work?

The current debate on the architecture of international financing is bringing the role of the private sector and private financing in development back to the spotlight.

Whichever approach is taken, if we are to meet the challenges of the coming decades, the rate of investment needs to increase. This is particularly the case in poor and fragile countries, which are the focus of everyone’s attention for two reasons: on the one hand, their demographic growth, with its implications for education, health, regional amenities, mobility and the response to social challenges; and on the other, climate change, with in particular the challenge of adaptation. Of course, public investment will be essential. So will public development aid. But private investment must also grow, and so must private financing.

There are at least three different subjects.

First, it is necessary for governments of poor and fragile countries to obtain more financing from banks and markets, in a sound and responsible manner. The current period is witnessing a growing risk of over-indebtedness, particularly in Africa. Returning to this issue is essential. The establishment of a common, global debt coordination mechanism is the central issue, as is the strengthening of the IMF’s surveillance capacity. The G20 “common framework” is the first step in this politically complex process.

To meet the challenges of the coming decades, the rate of investment needs to increase.

Furthermore, more direct foreign investment in these countries is required. The needs in terms of infrastructure are a priority: the domestic private sector, both productive and financial, is rarely on a par with the complexity and size of operations, even if it can make progress. The main challenge lies within the countries themselves: we need better national policies and more projects. That’s why the most appropriate recommendations involve ways of improving the first category, by making them more welcoming to private investors, and strengthening the capacities of administrations in the second category. Development institutions could become more proactive in assisting project development. International investors also need to be reassured about sovereign risk, by improving access to guarantee instruments (such as MIGA, the Multilateral Investment Guarantee Agency) and enabling public private sector financing institutions (DFIs) to be faster, more efficient partners.

Finally, strengthening the entrepreneurial emergence and growth of SMEs in these poor and fragile countries must be a top priority. Whatever support and guarantees might be offered to large international companies or institutional investors, these countries are too small and too complex to be of any interest to them other than marginally. So, in contrast to infrastructure, we must position ourselves at the level of the local private sector. This sector is incomplete, fragile and very small.

It is possible to strengthen the entrepreneurial dynamic in poor countries. Twenty years of experience and pilot projects have produced some convincing results, in a context where the will to embrace entrepreneurship is huge. There’s no shortage of projects here!

Today’s agenda is one of scaling up.

So today’s agenda is one of scaling up. First and foremost, we need to support start-ups by strengthening our acceleration, incubation and pre-investment structures. Next, in as many countries as possible, private funds or private investment companies should be set up to provide long-term capital and capacity-building for small businesses in the process of being structured. Finally, regional funds are needed to finance the expansion and capital strengthening of companies that are becoming too large to be financed at national level, but cannot yet access, for example, commercial investment funds. At every level, technological and managerial capacity-building is essential.

There are, however, two important points about the agenda that are too often underestimated.

National savings are still too low to finance this capital investment effort. Moreover, as we have already said, international savings cannot really be mobilized easily in their direction. We therefore need public funding, both national and international, to reinforce domestic private investment. This is why the mobilization of the DFIs, as well as public aid agencies, is essential.

Also, even if private companies that are financed are highly profitable, and bring considerable societal value, investors operating in this field can rarely achieve levels of return corresponding to market expectations. Indeed, it’s difficult to value small African companies, for example, at levels equivalent to those of their European peers. Investments in these small companies are also affected by high management costs, tax burdens and foreign exchange losses, not to mention a claims experience which, while not very high, does take its toll on earnings. Public investors must therefore accept low financial returns, which are justified by the very high fiscal and social returns. If they want to attract private investors, they must also agree to provide guarantees or other return-enhancing elements.

It’s an agenda with a budgetary cost.

It’s an agenda with a budgetary cost. But this cost, as various studies have shown, is modest in relation to GDP and the societal gains generated. The DFIs, for instance, must have the capacity to support this effort. Until now, this has not been their mandate. It must become one, and their business model must enable them to support it. It’s up to their public shareholders – the governments of the OECD and China – to act in this way. Aid agencies also need to accept the idea of committing public funds to the productive sector. For some of them, this is a major ideological and sometimes know-how barrier to overcome. We need to invest in the conceptual framework and the economic and impact justification to reassure and convince them.

There are very few large and medium-sized companies in Africa. Most of the major African companies of 2050 are not yet born. Accelerating their birth, reducing their losses during their growth period, making their expansion faster, safer and more environmentally and socially sustainable: this is the major development agenda for poor and vulnerable countries over the next thirty years.

It will create the mass of jobs needed to absorb the huge demographic wave ahead of us, which is both a challenge and an opportunity. This is how we will create the financial markets of tomorrow, and how major international investors will turn to these countries, which are still poor, and tomorrow, even less fragile, if this agenda succeeds.

International society needs to gain in coherence

A final word. International society needs to gain in coherence. If big business and the world’s financial markets are to connect with developing countries, the right hand of OECD countries that wants to help them must act in the same direction as their left hand, which governs the financial markets. However, the accumulation of rules on anti-money laundering, anti-terrorism, banking risk management, ethics and the environment is beginning to raise questions. As positive and unquestionable as they may be in their inspiration, they lead to a level of compliance risk that today turns too many leading international companies away from developing countries, and particularly the poorest ones. It is essential to return to a more coherent approach and find the right modalities and compromises between the desire to make financial markets healthier and more stable, on the one hand, and to promote investment in the world’s most fragile zones, on the other.

This article is inspired by the working paper: → → Millions for billions: Accelerating African entrepreneurial emergence for accelerated, sustainable and job-rich growth, a publication by Jean-Michel Severino, part of the work of FERDI’s International Architecture of Development Financing Chair, and which argues for the need to strongly accelerate public involvement in favor of entrepreneurial emergence in poor and fragile countries.

By : Severino Jean-Michel

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