Navigating the risks and opportunities of investing in African SMEs

Africa is rife with risk and opportunity for international investors. On the one hand, countries throughout the continent offer explosive economic growth and the potential for high returns. On the other, impenetrable legislation in many countries, coupled with poor corporate governance at unlisted companies, can spell disaster for the naïve investor.

African businesses, particularly SMEs, have not always understood the value of corporate governance, since adopting best practices can seem expensive and complicated for small businesses in a growth phase. A lack of confidence in corporate governance standards and legal frameworks in many African countries is a major reason that there is a mere trickle rather than a flood of foreign investment into the continent’s private sector.

Many African businesses are family-owned and operated enterprises that are run along informal lines rather than operated in adherence to corporate governance best practices. These businesses are not run transparently, and the interests of management and/or majority shareholders are sometimes put above those of minority shareholders and other stakeholders such as employees, consumers, the general public and creditors.

Yet many African entrepreneurs now recognise the value of following good corporate governance principles, understanding that it can help companies to attract funding from domestic and international investors – indeed, most serious investors insist on it. How does one separate the potential gems from the more risky propositions?

Who can help you to identify well-run businesses?

The first problem that would-be investors into the continent face is that the expenses of identifying potential investment targets and conducting due diligence are often not justified by the size of the investment and the expected returns.

In some African countries, a combination of poor records, weak property rights and protections might mean that ownership of a certain piece of land could be disputed by several people in a long legal process that ends with someone who has just paid thousands of dollars for the property losing out. That could mean a costly financial investigation before an investor feels comfortable putting money on the table. But there are a number of ways to work around this challenge.

Perhaps the easiest route is to look at companies listed on the many stock exchanges throughout Africa. Many of these exchanges (such as those in Kenya and South Africa) have development capital or venture capital boards for smaller companies.

Listing requirements are slightly looser than on the main boards, but companies are still obliged to comply with certain financial and governance controls. Investors are also able to trade liquid shares. The risks are still relatively high, but one at least knows that proper financial records are kept and that audits are conducted.

Another option is to approach one of the many organisations that are striving to help African SMEs develop their businesses, since they may have done a great deal of the homework.

As the CEO of AMSCO (African Management Services Company), I use it as an example because it is the organisation I’m most familiar with for obvious reasons.

AMSCO supplies experienced managers and technical personnel to private companies in Africa, with the ultimate goal of transferring the skills and knowledge of these professionals to local managers and business owners. When we choose which companies to work with, we look closely at their corporate governance and financial systems, and strengthen these when appropriate. As such, an established AMSCO client will comply with the fundamentals of corporate governance.

Other organisations such as International Finance Corporation (IFC) and the Endeavor Entrepreneurship Institute are also actively involved in the important business of cultivating entrepreneurship in Africa.

They might also be able to help prospective investors navigate the sometimes choppy waters of investing into African SMEs. Endeavor’s specific brief is to help certain South African SMEs to develop their businesses, plan for growth, and attract financing, for example.

There is also a range of private equity and venture capital funds active in various parts of the continent. Many of the large accounting and auditing firms are active in various African countries and can help investors to understand their legal rights and obligations when they invest in an Africa SME.

What investors should look for?

Investors should feel no need to compromise on global best practices in corporate governance when investing in African companies. There is strong evidence that companies with good corporate governance are more likely to be profitable and sustainable than ones without it. Concern for shareholders, employees, the broader community and the environment improve profitability rather than damage it.

The point of corporate governance is to ensure that management and majority shareholders at companies behave in a manner that balances the profit motive with the interests of minority shareholders and other stakeholders. One should look for companies that follow best practice by separating the chairman and CEO roles and appointing a strong non-executive board, in line with the principles documented in documents such as the UK’s Cadbury Report and South Africa King II.

Other elements of corporate governance include internal and external audits, risk management, succession planning, minority shareholder rights, disclosure of information to analysts and shareholders, as well as compliance with legislation, stock exchange regulations and industry regulatory frameworks, and so on.

Corporate governance is not only about legal and regulatory compliance, but also about doing the morally right things, something that governments and communities in Africa are sensitive about. Issues such as health and environmental standards and non-discriminatory hiring policies are thus a vital part of sound corporate governance.

While there is a great deal that businesses are doing to win trust from potential investors, some African governments need to tackle some basic gaps in the detail and enforcement of their legal frameworks. Property rights in many African countries remain weak (although it must be said that some countries like South Africa and Botswana provide good examples of the corporate governance standards and legal frameworks others should be imitating).

Political risk cover, exchange rate forward cover and other insurances might be a good idea if one wants protection from environmental risks that could impact on an investment.

However, it must be said that African governments are steadily sorting out regulatory and legislative issues, while chambers of commerce, accounting associations and stock exchanges are also all coming to the party by driving their members to adopt sound corporate governance.

AMSCO has developed and launched corporate governance manuals of best practice in partnership with governments and business groups in Ghana, Malawi, Mozambique, Zambia and Zimbabwe. In each of these countries, we have successfully rallied support for our cause from key business leaders.

Stock exchanges and commercial/industrial associations have an important role to play in encouraging businesses to adopt sound corporate governance and persuading governments to put the right frameworks in place to create a climate of confidence and certainty for investors.

However, it is ultimately up to African business leaders to adopt best corporate governance.