Conduits of Capital

The specialised services offered by offshore centres
depend on a well-developed legal and regulatory
environment, expertise (professional, administrative and
clerical); and, scale (i.e., returns from servicing a sizeable
market). Onshoring such a service industry will require a
huge effort and, even once successful, the specific services
provided would serve only a narrow-base (predominantly
accounting / taxation / legal / clerical services to the PE
industry). Building trust in local capacity would be at best a
medium-term endeavor. Altogether the development impact
would take considerable time, require a concerted effort, be
very costly to achieve, and be quite small.
1.2 Onshoring Services Rather
Than Centres
The overwhelming challenges faced by countries wishing
to onshore activities currently undertaken by offshore
centres taken together with the rather narrow nature of
the business being undertaken by these centres suggests
that an alternative approach
to onshoring might be
more appropriate and
contribute more significant
development outcomes.
The key challenge faced
by investors in Africa is
the lack of a pipeline of
viable, bankable projects,
particularly in looking beyond
the established cadre of
medium and large scale
enterprises. Invariably
investors are left chasing the
rather small universe of more
Source: EMPEA.
well-established and larger
companies. In the case of infrastructure, projects constraints
may well relate to the legal / regulatory framework for
undertaking private-public partnerships, whereas in the case
of SMEs, investments are constrained by the SMEs’ limited
capacity to develop bankable projects coupled with investor
/ lender risk-aversion. The supply of early, risk-bearing
finance for small enterprises in Africa is very scarce. Banks
are notoriously cautious in providing loans to SMEs and due
to the high-risk environment, the costs of bank borrowing
are high. While subsistence entrepreneurs may initially rely
on short-term funding provided by family and friends and to
some extent by microfinance institutions and Savings and
Credit Cooperatives (SACCOs), it is recognised that there
is a ‘missing middle,’ where bank funding is insufficient
and risk capital is unavailable. 2 To support their expansion
and innovation SMEs need risk-capital as well as good
business advice.
As illustrated in Figure 1, the market for private equity
remains relatively small in Sub-Saharan Africa. In
interpreting this data and the steady growth of PE fund
investment commitments in recent years, see Figure 2,
it should be emphasised that the PE industry in Africa is
highly heterogeneous, and much PE investment targets
larger, well-established, brand-name enterprises. Servicing
larger enterprises is more lucrative, as it requires PE fund
managers to invest less capacity in developing / assessing
business proposals, preparing investment proposals (often
entailing enterprise restructuring), and, once investments
have been made, monitoring project performance. This
partly reflects scale economies, but also quite severe
capacity scarcity and
resultant high costs. Thus,
were PE funds to modify their
business models, they could
potentially provide a crucial
source of risk-capital thereby
increasing the boundaries of
available funding.
From their active involvement
in investee enterprises PE
fund managers would also
be an invaluable source
of business advice, e.g.,
in developing enterprise
strategies, introducing
utilisation of market
intelligence, strengthening financial management of
investee enterprises, and supporting recruitment for key
staff, etc. However, as of now the contribution of PE funds
to SME development falls far short of potential.
There can be little doubt about the high potential upside
associated with onshoring of fund management and
investment expertise. Local knowledge of potential
borrowers, the risk profiles of their businesses, their
management skills, their liquidity and inventory cycles,
etc. are indispensable to any third-party investor or lender.
2
See: Beck, Thorsten and Robert Cull, SME Finance in Africa, World Bank Research Working Paper #7018, 2014, and Berg, Gunhild and Michael
Fuchs, Bank Financing of SMEs in Five Sub-Saharan African Countries: the role of Competition, Innovation and the Government, World Bank Policy
Research Paper # 6563, 2013.
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