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Towards a vibrant venture capital sector in Africa


What needs to be done, by policy-makers of African governments and others, to create a thriving economic environment for emerging entrepreneurs in Africa? Lerato Nage, an independent finance professional based in South Africa, will share results of his research on this question in a series on VC4Africa on venture capital and IPOs in African markets. 

For the economic development of African economies, a vibrant venture capital sector is critical. For any economy to thrive; to create employment and combat poverty, whilst contributing positively to economic growth, the creation of new ventures is important.
The current economic environment in African economies needs to improve if the venture capital sector is to thrive. The lack of relevant and appropriate legislation hampers the rapid establishment of new enterprises. And the shortage of financing for these enterprises remains one of the greatest challenges that need to be addressed.

Apart from an environment that is not conducive to starting an enterprise much faster; the entrepreneurs have to also contend with the sustainability of their enterprises beyond their existence. The exit of a venture by one entrepreneur to another or an institution remains a challenge in African markets, thus affecting the sustainability of enterprises. Most of the securities markets in Africa are not properly maintained and are illiquid.

Forms of financing

There are various guidelines African economies could follow in order to successfully address finance challenges. There is an abundance of literature on the importance of small medium and micro enterprises and the way to financing them. Authors like O’Rourke indicate the importance of micro-financing institutions and their structures. O’Rouke argues that creating a structured partnership between commercial lending institutions and Micro Financing Institute can provide the best long-term sustainability results.

The other forms of financing in which African governments can play an active and significant role are Public Private Partnerships. These partnerships will be between the government and private sector financial intermediaries. In South African there are many state institutions that can partner with the private sector, for example Khula Enterprises and SEDA.

Other African countries have begun to specifically set aside funding for the creation of new ventures. One recent example of how African governments can contribute positively to the creation of enterprises was the announcement by the Zambian government that it has created a venture fund to assist entrepreneurs with their ventures.

Exits

Apart from the funding and legislation challenges facing the venture capital sector, the sustainability of the enterprises being created is also crucial. The exit of mature ventures through IPOs is the most viable and profitable method for venture capitalists to exit their investments, and also for the ventures this is the most beneficial and sustainable form. For the venture capital industry to flourish and operate at an optimal level, African economies need to create an environment that encourages this exit method, starting with properly functioning Securities Exchanges.

In order to achieve this, the African economies will need to embark on many initiatives and one of them is: an investor education. Leading African research house pointed investor education as one of the most critical component to a well functioning securities exchange. For example, securities exchange like TSX and LSM AIM are far ahead in terms of educating the small business owners on the benefit of listing on securities exchanges.

Some might argue that exiting ventures through securities exchange in the current African markets environment is premature given the challenges currently in place. However, empirical evidence points out that exiting a mature business by an entrepreneur through a well functioning securities exchange is more beneficial in the long run for both the founder and investors alike compared to the private placement sale exit method.

In Africa most of the exits of ventures still takes place through a private placement method. Various reasons can be named for this, such as the listing costs in the securities exchange: it is extremely expensive to list an entity, and that some of the securities exchanges are illiquid. African economies need to ensure that the securities exchanges are maintained to the highest standards. This in turn will lead to high volume trading and listing on mature ventures in those securities exchanges.

It’s evident that for any sector including the SMMEs to thrive, the right kind of intervention is required. African economies need to institute reforms in both their respective governments and economies.

About the author: Lerato Nage is an Independent Finance Professional. His area of interest is assisting entrepreneurs set up their operations. This piece is an extract from a thesis he submitted as a fulfillment for a Masters in Finance and Investment Degree requirement in 2011.

VC4A is grateful for this piece by Lerato Nage and welcomes members of the community to express their views and opinions on the subject in the comments below!