PRIVATE EQUITY – A VIABLE ALTERNATIVE SOURCE OF FUNDING FOR GHANAIAN SMEs

Ghana’s workforce is predominantly employed by the informal sector. This sector of our economy is largely made up of Small-and Medium scale Enterprises (SMEs) and sole proprietorships (“one man business”). This is confirmed by available data from the Registrar General’s Department which indicates that 90% of companies registered in Ghana are SMEs. Over time, this target group has been identified as the catalyst for economic growth, serving as the major source of income and employment for many Ghanaians.

SMEs often face a daunting task accessing capital from financial institutions. Banks shy away and would want to do a lot of due
diligence before a decision is taken to partner their business financially. This stance taken by the banks is as a result of the high
credit risk associated with these SMEs. This risk may emanate from some of the following:

1. Lack of proper accounting records
2. Absence of corporate governance practices i.e. “one-man show” business
3. Unrealistic business plans
4. Poor or lack of credit history
5. Inappropriate financial structure

These possible reasons, albeit not exhaustive, are the major causes why funding remains a challenge for SMEs. This article will want to delve more into the last point of the reasons above being the issue of inappropriate financial structure and private equity as an emerging funding alternative. Typically, many large organizations we have today evolved from small businesses. Businesses which are able to survive the market at initial stages, all other things being equal, will increase their scale of operations into SMEs and over time, become large, successful companies. The right financing package for each stage of the company’s development is critical for its survival or otherwise. Studies have shown that debt capital for start-ups most often leads to the collapse of potentially viable business from the onset due to the early financial burden these young companies have to carry by way of regular debt servicing. Start-ups and SMEs require capital that does not burden the business with regular cash outflows but that which supports them in early years for them to gain solid ground in their operations and ensure financial stability.

Equity will be the best form of financing for this stage of the company’s life cycle. Equity, simply defined, is regarded as money injected into a business by owners or investors who want to be co-owners of a company. Management’s concern in terms of cash flows to shareholders will be annual dividend payments which are sometimes not declared but rather ploughed back into the business to propel growth.

Private equity or venture capital is an emerging form of financing in our part of the world and which will be appropriate for SMEs. In simple words, private equity is equity that is not quoted on a stock exchange. It is a unique source of funding and typically will involve a blend of low cost debt (mostly convertible preference shares) and equity depending on the specific needs and current financial structure of the business. Private equity is not new in Ghana but only few entrepreneurs and businesses have considered it as a means of financing their businesses. With private equity, not only does the business access cheap funding, but the business receives that added value in management through the partnership with private equity fund managers. By agreeing to invest in a company, the private equity firm normally will take a minority stake in your business and negotiate to have a representation on the company’s board to help direct the company’s operations to achieve the set targets of the company. This is because as co-owners of the business, the private equity fund managers will also want to safeguard their interest and will therefore want to keep a close eye on the business’ activities. Most private equity firms in Ghana have similar investment strategy, most of which will suit our SMEs.

1. They invest in unquoted companies with good products or services and most importantly, management teams with direct experience in their markets and industry.
2. They seek investments in companies in which they can acquire significant minority stakes (25% – 49%) and add value through their representations on their Board, close monitoring, supervision and collaboration with management.
3. They invest in early stage, growth or expansion stage businesses and their period of investment is usually for medium to long term.
4. They seek to mitigate exit risks by building self liquidating structures in their funding structure. Normally, they exit after 4-7 years by availing themselves for a buy-out to existing shareholders or new investors. This will be detailed out in the funding terms and structure.
5. They promote corporate social responsibility, good corporate governance practices and environmental management by ensuring investee companies comply with relevant laws and regulations.

Private equity is gradually becoming a popular cheaper alternative source of funding for SMEs. Most importantly, private equity funding is structured to relieve Start-Ups and SMEs of financial burden in their early stages and allow them to gain momentum in their early years and position them for debt financing in later.

Written by Joseph Ciici Arthur