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One of the first uses of the useful phrase ‘the missing middle’ can be found in
the following passage.
SMEs are weak in Africa because of small local markets, undeveloped regional
integration and very difficult business conditions, which may include cumbersome official
procedures, poor infrastructure, dubious legal systems, inadequate financial systems and
unattractive tax regimes. Many firms stay small and informal and use simple technology
that does not require great use of national infrastructure. Their smallness also protects
them from legal proceedings (since they have few assets to seize on bankruptcy) so they
can be more flexible in uncertain business conditions. Large firms have the means to
overcome legal and financial obstacles, since they have more negotiating power and
often good contacts to help them get preferential treatment. They depend less on the
local economy because they have access to foreign finance, technology and markets,
especially if they are subsidiaries of bigger companies. They can also more easily make
up for inadequate public services.2
Access to finance is often a major problem. SMEs in developing countries face the
challenge of finding a financier who will assess entrepreneurs on the viability of their
business, as there are very few organisations offering this service. Access to quality
business services where the entrepreneur can gain knowledge and improve management
skills is also limited. Without access to both capital and business support, the growth of
the small and medium enterprise sector is hampered.3
In many emerging markets, the SME sector is one of the principal driving forces for
economic growth and job creation. And this holds particularly true for many countries in
Africa where SMEs and the informal sector represent over 90% of businesses, contribute
to over 50% of GDP, andaccount for about 63% of employment in low income countries3.
1 Policy Insights No. 7 is derived from the African Economic Outlook 2004/2005, a joint publication
of the African Development Bank and the OECD Development Centre
2 ibid.
In Britain an early recognition of such a gap was tentatively put forward by the
Macmillan committee in the early 1930s, which published its report during the
depression, in 1931. This highlighted a perceived structural failure within the
financial system, which meant that unquoted small and medium sized firms
requiring long-term investment capital were unable to afford an approach to the
capital market and were poorly catered for by the banks. This hypothesis
became popularly known as the "Macmillan Gap".
The committee found that public equity issues of less than £200,000 were too
small to be of interest to existing financial institutions, and recommended that
the gap should be filled by a new type of capital-raising agency, specialising in
the small business sector. There was no immediate response from the City of
London. During the closing years of the Second World War, plans were made by
the government to manage the transition to a peacetime economy; and at the
end of the war the commercial banks, under pressure from the Bank of England,
reluctantly agreed to set up a new, jointly owned institution, the Industrial and
Commercial Finance Corporation (ICFC), with a remit to supply risk capital to
smaller firms. This institution was founded in 1945 and later changed its name to
3i (Investors In Industry), currently Britain's largest development and venture
institution. Today 3i is capitalised at £3.4 billion, and is listed on the stock
exchange, forming part of the FTSE-100 Index of leading shares. It has also
created a number of listed specialist investment funds, also listed on the stock
exchange, including an infrastructure fund and a private equity fund.
SMEs in any country need access to short term bank finance for short term
needs, typically financing sales and debtors domestically and financing trade
internationally. But they also need longer term finance, for which short term
bank borrowing is inappropriate.
But one finds that many of the initiatives designed to help SMEs to finance
themselves consist of various forms of debt or guarantees, soft loans, improving
access to commercial banks and very few involve equity or long term loan
finance.
There is a limit to the amount any company should or can borrow, as many
companies in developed markets are discovering to their cost. There are
advantages in debt finance:
This is not to suggest that debt financing is not useful, rather that it cannot on its
own create a financial platform for stability throughout a cycle. What is needed
in addition is in our view is equity finance.
Equity finance is usually only available for large investments
While there are a number of sources of this, most of them are targeting
investments well above the size needed by the typical SME. Few envisage
investments of less than $250,000, as the following illustrates.
Ethos Private Equity Fund VI (“Ethos VI” or “the Fund”) is a private equity fund that will
invest in high growth companies in Sub-Saharan Africa. The Fund, a follow-on fund of
Ethos V (a $750m fund in which IFC invested $ 25million), is expected to make privately-
negotiated equity and equity-related investments between $ 25-75 million in 10-12
African companies6
This is not in any way to decry the activities of the above, which were selected
anecdotally, rather to illustrate the lack of equity finance at the lower end of the
scale on which investments of $25-$75 million represent the top end. We
understand that the costs of due diligence can be high in relation to the amounts
raised at the lower end of the scale. But companies that attract investments of
$50 million or more for minority stakes can hardly be described as SMEs. For
comparison the average amount raised on PLUS (a London based facility for
SMEs) was £500,000.
This is not universally true, and some funds indicate preparedness to consider
smaller investments - for example the GroFin Africa Fund and African
Development Partners.
Issuers usually only use public capital markets when they cannot use private
ones, since in general raising money through the former is more time-
consuming, more expensive and involves greater transparency and more
external accountability. The vast majority of enterprises worldwide are financed
privately: reputedly only 0.1% of the 10 million enterprises in America raises
finance in public capital markets. In China, for instance, large companies have
developed that are wholly privately financed.
Banks are not by their nature providers of equity finance and domestic
investment institutions often lack the capacity to make smaller equity
investments.
Almost all the funds we have looked at are specialised private equity funds, well
supported with investments from such organisations as IFC and EIB together with
international institutional investors and emerging markets specialists. The target
market for such funds is indicated by the stated aim of the African Venture
“This conference presents a formidable opportunity for General Partners to meet Limited
Partners who have yet to invest in Africa. The conference promises to bring LPs from
markets as diverse as the Middle East, Europe and the United States.”