Financial Sector Development in Africa: Opportunities ... - World Bank

Financing Agriculture: Selected Approaches for the Engagement of Commercial Finance 101
remains, however, of how best to fund long-term growth to help these
businesses reach the scale and professionalism of management required
to serve domestic needs, as well as potentially compete in international
markets.
Undercapitalization of Agribusiness
A recurring worry of bankers in response to proposals to increase credit
allocation to agriculture seems to be a perception of the “undercapitalization”
of agribusiness. By this they mean businesses that are constantly
having short-term cash flow issues as a result of having insufficient investment
or access to longer-term capital.
These issues can be the result of a number of causes. Perhaps the business
is growing too fast in relation to its longer-term capital (typically
called overtrading), and is struggling to finance production while it awaits
payment on previous sales. Perhaps the owners understand this problem
but are unable or unwilling to make further investment in the company
themselves. Typically they will then try to access expensive short-term
credit (if it is available), which will compound the problem. Perhaps the
owners do not understand the implications of expensive credit, or are
stripping the company of cash for other purposes. After all, a profitable
company should be able to retain earnings and build up its capital over
time in line with growth.
These are some of the issues that bankers look at very carefully when
assessing a credit proposition. Lack of cash is a business killer, and lending
to an undercapitalized business is a dubious proposition. That is why,
when bankers get a request from a customer for a major increase in longterm
lending, they like to see a significant contribution of equity investment
as well. It is difficult to generalize, and it varies from bank to bank
and sector to sector, but for illustrative purposes many commercial bankers
may start to take a close look at an SME if it has more debt than
equity, as a general principle (that is, on the assumption that the debtequity
should be a 1:1 ratio or better).
Clearly, many business owners may take a different attitude. Some
of them perceive that they have already risked a lot and expended
much effort in building what they see as a profitable operation. They
feel that it is now up to the banks to fund long-term growth while
they begin to reap the profits. This gap in expectations is a feature of
every market, particularly in emerging markets where business owners
may have less commercial experience and poor access to good financial
advice.