Small businesses in a fragile economy like the Democratic Republic of Congo’s face oversized challenges.
Everything from lack of finance, to disease, civil unrest, or uncertain regulation are constantly threatening success. If building a single business in a market like this is improbable, then putting together a portfolio of successful companies might seem impossible.
But persistent entrepreneurs like Huguette Bakekolo and Annie Tuluka are proving to fund managers that obstacles can be turned into opportunities. They started a small call center in Kinshasa in 2009, with a dozen phones and even fewer staff. With the help of XSML – a private equity fund backed by IFC – the call center has grown to employ close to 400 people and generate over $2 million in annual revenues.
A recent IFC study – the first of its kind to be published - confirms the difficulty private equity funds face in these markets, yet also reveals that best practices are emerging, and provides lessons from risk capital experiences across sub-Saharan Africa.
The study, Investing in Private Equity in Sub-Saharan African Fragile and Conflict-Affected Situations, found that risk capital, like private equity funds, is desperately needed in fragile states, where few SMEs have the collateral they need to qualify for loans, and are left with few options for expansion.
For example, impact investors have tended to target informal companies, and SME owners find that benefits of transitioning to more formal business practices are outweighed by higher operating costs.
The study examined how funds like XSML have achieved commercial success and found that those earning higher returns tend be highly active and hold control positions on a small set of investments, or they deploy standardized but flexible debt-like instruments to a larger group of investments.
Some companies are also better bets for investment, such as those with revenues in hard currency, those offering basic goods and services with no international competition, or those with little domestic competition or a country-specific advantage.
“There is opportunity in difficult markets and this report provides guidance to help venture capital funds grow that opportunity. Capital investments in SMEs create jobs, reduce inequality, generate tax revenues, improve government services, and help introduce environmental and social best practices,” said Kevin Njiraini, IFC’s Director for Southern Africa.
The study recommends that venture capital use blended finance tools and create a ready-to-use toolbox that can lower the cost of setting up funds in these markets.
To succeed in fragile states, funds need to tailor their approach to local context, according to IFC’s study. This means adjusting to market and population size and growth, currency risk, and political uncertainty, among other factors.
“We hope that the lessons captured in this study will further encourage private equity funds to invest in some of the world’s most challenging markets,” said Njiraini.
The study was jointly prepared by the SME Ventures and FCS Africa programs.