Role of capital markets in empowering SMEs

Thursday December 6 2018


This is a continuation of where we ended last week. As we indicated, limited capacity among SMEs in the successful and sustainable running of businesses has led to diminishing trust among stakeholders who could potentially provide much needed equity capital, leading to such stakeholders rejecting financing options for SMEs.

Some of the key capacity gaps that SMEs face, which hinder their access to financing, especially equity finance, include:

Fear of control loss: one major concern that SMEs have regarding equity financing is the loss of control. Many SMEs are unwilling to accept external investment and bring in new partners, as they fear relinquishing control of their company.

What we normally hear from SMEs owners, is that entrepreneurs would rather own 100 per cent of one than 10 per cent of a hundred.

Additional observations, recent times, show that this culture is starting to change, albeit slowly, as SMEs are becoming exposed to the success stories of peer companies that have benefited from external financing, both at the regional and international level.

Good governance for growth: many SMEs are unaware of the importance of strong governance for business sustainability and growth, and hence their lack of access to expertise that could improve their management structures and practices. In many cases, company board of directors are lacking altogether, with no substitute structures in place to provide sound input, hold management accountable, oversee independent audit or remuneration decisions, or perform other traditional board functions. However, institutions such the DSE, CMSA, Institute of Directors in Tanzania Government-sponsored bodies and development financial institutions, i.e. the International Finance Corporation (IFC), sometimes help train and advise SMEs on the importance of following best governance practice.

Lack of transparency: many SMEs do not have mechanisms that safeguard operating and financing processes and preserve the integrity and transparency of their operations in order to ensure that deserving SMEs receive their fair share of financing. The preference by many enterprises to pay a lesser share of their tax obligations could be one of the reasons for lesser embrace of transparency.

Financial reporting: some SMEs do not have credible audited financial information to provide to potential investors. Entrepreneurs often lack the resources to prepare accurate records, or access to an external service provider that can produce better records on their behalf.

As a result, many SMEs continue to struggle to produce accurate, useful financial information without increased access to financial education and awareness of the value of this information.

Sustaining growth: lacking a strategic vision and strategic plans for how to grow the business in a sustainable manner is also preventing many small companies from scaling up. Even when a temporary revenue boost presents itself, it is almost never sustainable. A growth strategy plan is often not present, restricting long-term success.

Retaining talent growth: SMEs often underestimate the importance of managing talent by seeking to attract, develop and retain individuals who are valuable to the company. This ultimately restricts the company’s performance.

Initial public offering (IPO): there is a general lack of familiarity with the IPO process, from access to finance, to listing requirements, to the benefits of being a public company in term of easy access of future financing from a broader base of existing and potential investors.

Many SMEs regard IPO process as unachievable or too complicated, to the extent that many SMEs would not seriously consider accessing public money and list on the stock exchange. Becoming a public company is, however, a significant contributor not only to the development of a company, but to the further robustness of the local capital markets.

Despite the existence of capacity-building and scale-up programmes, such as incubations, but according to assessments based on publicly available information there are just few incubators in existence, and have limited capacity, i.e. most incubators can only support around 20 SMEs per year on average, which is only a small fraction of the SMEs that could benefit from such services.

Moreover, that ecosystem has focused on more ICT-related sectors rather than agriculture or healthcare or energy, where more patient capital is needed.

Moreover, there is a general lack of trust between SMEs and support providers, and so although business support providers are emerging, a lot of SMEs aren’t using them because of a lack of knowledge and trust between the service provider and the SMEs.

Lastly, angel investors and venture capital funds, which would normally provide equity finances to SMEs are almost not in existence, currently less than a per cent of start-ups are being financed by formal angel investors and venture capital funds.

There is a positive trend, however, with the number of visible angel investor groups, networks and initiatives having recently grown. For instance, the establishment of the World Business Angels Investment Forum - WBAIF Tanzania Chapter may add an impetus. However, capital remains scarce and the industry-specific knowledge and mentorship of these angels is limited.

To conclude, the existence of this profound financing gap preventing efficient deployment of private capital can be largely attributed to a lack of visibility of these companies to early-stage investment.

Many investors do not feel comfortable investing in SMEs on the grounds of unestablished credibility and lack of trust, as a result entrepreneurs are forced to finance the growth of their businesses independently.