55882 MAY 2010 ABOUT THE AUTHORS SME Solutions Center--Kenya: Developing KIRAGU MAINA heads the SSC program in Kenya. Alternative Financing Solutions for Small and He was involved in development of the SSC program since its Medium Enterprises inception, including refining the strategic plan, fundraising for the BPI Kenya fund, establishing the Small and medium enterprises (SMEs) in Africa have been hailed as the mechanics for the SME risk capital and TA funds, launcing of the SSC engine of economic growth. They are at the heart of developing countries' and the BPI Kenya SME funds, entrepreneurship, the source of most new employment and productive designing and rollout of the various SME products/services investment, and the basis for growth and poverty reduction. Despite the provided via the SSC, and advising new SME risk capital economic potential of SMEs, they face severe constraints related to access to fund managers in the region. resources, finance, and services, as well as procedural barriers--all of which Kiragu has nearly 20 years of corporate, entrepreneurial, and limit their potential to invest, innovate, and improve productivity and private sector development experience. sustainability. To address these constraints, IFC developed the SME Solutions Centre (SSC) Pilot Program in Kenya. The SSC value proposition centers on SCHOLASTICA BUTOYI the Program Assistant for the four key pillars: Access to Finance, Access to Advisory Services/Technical IFC's SME Solutions Center in Assistance (now SME Management Solutions), Access to Reliable Market Kenya, has over 20 years' experience in IFC, working with Information, and support for an enhanced Business Enabling Environment. SMEs in Kenya. Her role is to leverage institutional memory in This SmartLesson details the lessons learned from the SSC's experience with IFC's continued quest to address the challenges faced by SMEs. the Access to Finance pillar. NKATHA MICHIRA is a Business Development Officer at IFC's SME Solutions Center in Kenya. Her experience and under- Background standing of the micro and SME sectors in the Kenyan market In September 2004, IFC undertook a market support the SSC in developing viable and lasting solutions to the study--the Kenya SME Country Study--whose challenges faced by entrepre- findings provided insights into the SME space neurs. in Kenya and corroborated what IFC had learned and understood of the SME market APPROVING MANAGER from two previous programs focusing on SME Eme Essien, Africa SME Initiatives development in Africa: the Africa Project Corporate Portfolio Management Department. Development Facility and the Africa Enterprise Fund. The SSC developed its "one-stop shop" model Kimemia Engineering Ltd, a midsize road and with the aim of promoting a holistic and infrastructure contractor, is a beneficiary of SSC integrated approach to helping meet SME Kenya's finance and advisory services. (Photo finance, management capacity, and from SSC Picture Gallery). information needs. Part of IFC's Strategic Initiative for Sub-Saharan Africa, the model allows IFC to innovate with new services fund--which received equity from IFC, targeting SMEs to achieve greater European Investment Bank, Commonwealth developmental impact. Development Corporation, East African Development Bank, and Transcentury, a local One of the key value-added services of the private equity investment group--and a SSC's Access to Finance pillar is the separate $2.5 million technical assistance fund, incorporation of a $14.1 million risk capital provided by IFC and the World Bank through SMARTLESSONS -- MAY 2010 1 the International Development Association (IDA). Both funds are managed by a third-party fund manager, Business Program Performance: Access to Finance Results to Date Partners International Kenya Ltd (BPI). The long-term objective was to provide an alternative to the stringent and SME access to finance delivered via the in-house risk capital fund often unattainable collateral requirements for SME lending. managed by BPI has experienced growth as follows: This new source of growth capital for SMEs fills the gap left by the market failure of mainstream financial institutions · $12.873 million in SME commitments in the last three years, to provide cash-flow/viability-based SME finance. representing 91 percent of the total $14.1 million BPI Kenya SME Fund; $7.3 million has been disbursed. Through the three other pillars, the program also aimed to address other market failures arising out of lack of access to · The commitments represent 62 SME investments, averaging reliable market information, underdeveloped access to $208,000 per investment. Minimum/maximum investment: business development services, inadequate management $50,000 to $500,000. capacity within SMEs and business associations, and an onerous licensing, legal, and regulatory environment. · Forty of the SMEs have received advisory assistance, amounting Another area of focus was the development of business to $500,000, through the IDA funds. incubators supporting start-up enterprises for demonstration, with a view to encouraging both the public · Over 1,000 jobs have been created, and over 950 jobs sus- and private sectors to embrace business incubation as a tained. growth strategy for private sector development. (See box.) Lessons Learned the commitment by some investors to match IFC's investment. 1) Jumping the first hurdle: Plan for fund-raising. The delay in closing the fund presented a major credibility IFC partnered with BPI, a leading South African SME risk for the nascent SSC, which required careful management investment fund manager, to establish Business Partners of expectations both internally and externally, especially Kenya, and then led the fund-raising efforts to establish since its high-profile launch had been hailed by the Kenya's first SME risk capital fund, targeting SME deals in government as a major boost to SME access to finance. the $50,000 to $500,000 range. Fund-raising for the SME Nonetheless, the SSC team turned this "imminent crisis" Fund took much longer than anticipated. The fund aimed into an opportunity to further market the program, educate to raise $15 million but closed at $14.1 million in December stakeholders countrywide, create partnerships with private 2006, two years after commencement of the SSC program. and public entities, roll out advisory assistance and capacity Reasons for the delay: building projects, and develop a pipeline of deals to be considered for financing, once the fund was in place. · Internalexpectationsabouttheabilitytoraiseanew SMEriskfundinKenyatargetinginvestmentsaslowas Programs replicating this one should factor in the time it $50,000 were overly optimistic and not in synch with takes to raise risk capital funds for SMEs in Africa--and put the market reality at the time. To date, BPI is one of off public launches until after fund-raising is successfully onlytwofundmanagersthatmakeinvestmentsaslow completed! as$50,000toSMEs.Otherfundsinvestintherangeof $100,000to$1million,andtheirfund-raisingdoesnot 2) Does your target market understand the new product? takelessthantwoyears. Develop a communication plan to educate potential clients. · Kenyawasjustemergingfromalongperiodofeconomic recession characterized by massive defaults and The SME market had limited knowledge of how alternative, nonperforming loans in the commercial banking noncommercial bank financial products, specifically risk sector--alargeproportionofthemattributabletoSME capital, worked--and who the target market was. lending--thusscaringinvestorsawayfromtheproposed Consequently, numerous noneligible SMEs that applied to fund. the fund were subsequently rejected or declined the financing structure, leading to the initial negative · IFC'scredit/investmentpolicylimiteditsabilitytocommit perception that the SSC's Access to Finance pillar did not morethan20percentinequitytothenewfund,given actually address SME financing needs, and was after all not its greenfield status. This meant IFC was proposing to the panacea toall of the SME market's financing gaps, as establishanewfundinanarearelativelyunknownto was widely touted by various public entities. (The average themarket,butwasnotwillingtotakeaproportionately approval rate for risk capital investments is about 10 largerriskinseedingthefund,makingitdifficulttofill percent). Further, the association with the World Bank led the gap, even where there were investors willing to some SMEs to imagine that financing would be on a grant match IFC's commitment. Eventually, IFC's Funds or concessionary basis, and it took a lot of awareness Department and senior management received board creation to debunk this myth. approvaltoincreaseIFC'sexposureto40percent,which not only raised the appetite of other institutional Although initially there was no plan to educate the target investors but also reduced the funding shortfall, given market on risk capital, the gap was immediately evident. In 2 SMARTLESSONS -- MAY 2010 2008, SSC developed a communication strategy that involved media outreach, joint road shows with BPI, and collaboration with other SME stakeholders such as SME business associations and government agencies--to raise awareness and understanding of the product and, ultimately in 2009, run countrywide workshops that reached about 1,000 SMEs, training them on risk capital financing and other IFC products, such as the SME Toolkit. It's vital to develop a comprehensive ongoing communications plan for educating the SME market about how risk capital funds work, what they look for in an ideal SME investment, how they structure their investments, why they take a share of "ownership" via equity in an SME's closely held business, and why they require an SME to sign up for an in-depth technical assistance package to mitigate its risk. For the SSC, an early communications plan would have gone a long way toward minimizing the initial negative perception. 3) Partner selection is critical: Determine the criteria to be used. Before embarking on the SSC program, IFC spent significant time searching for the ideal partner with whom to launch the Access to Finance pillar of the SSC--not a simple task, given the novelty of the product, combined with the ever-present risk of providing SMEs with finance without the traditionally mandated 100-plus percent security cover to access commercial bank loans. Lending IFC's name to such a new venture and asking institutional investors to partner in it--in frontier countries, with all the risks they portend, especially in view of Heritage Foods Kenya Ltd, a small manufacturer of pet food, is a the high SME attrition rates--was a clear demonstration of beneficiary of SSC Kenya's finance and technical assistance IFC's commitment to innovation in support of SME services. (Photo from SSC Picture Gallery). development in Africa. The ideal partner would have a track record in SME risk separate technical assistance fund (IFC/IDA TA fund)--a capital investment and the right blend of commercial and singularly important lynchpin in tying the concept and developmental business ethos. Business Partners Ltd, a South emergence of SME risk capital in East Africa to good African financier providing quasi-equity financing and business practices. The TA component provides access to technical assistance support to SMEs in South Africa, had services such as business planning, financial management, made over 30,000 investments in SMEs since its establishment sales and marketing, corporate governance, environmental in 1981. It had developed a unique set of products tailored and social safeguards, quality management, systems specifically to the needs of SMEs and a set of operating integration and process automation, legal advice, and systems and procedures that maximize the efficiency of market linkages. making smaller-scale investments. Business Partners Ltd set up a subsidiary company, BPI. SSC developed and continually updates a database of experienced business development service providers, A potential issue with BPI was its "dark horse" nature, being many of whom have undergone SSC-organized training in the market with no experience in SME investment outside courses. The SSC leverages these service providers to a much more sophisticated South African market. Also, as a design and deliver TA interventions to SMEs, thus fund manager and general partner, BPI was not investing its increasing the SSC's reach countrywide. The SSC undertakes own capital in the fund, as the limited partners would be the monitoring and evaluation (M&E) to ensure quality required to do. However, BPI brought the rigor, experience, and consistency of TA delivered. and credibility that not only attracted other institutional investors such as the European Investment Bank, but also Via the BPI fund, the SSC pioneered the concept of sparked a "revolution" in the growth of SME funds in the structuring TA as subordinated non-interest-bearing region, given BPI's success in Kenya. debt, not only obligating the SME to sign an interest-free TA loan agreement, but also ensuring that the TA applied 4) More than just financing: It is critical to link loans to is mutually agreed between the SME client and BPI, and technical assistance. that the SME participates in ensuring successful application of the TA intervention in its business by the TA service IFC supports the BPI fund by facilitating its access to a provider. The SME's commitment to repay the TA funds SMARTLESSONS -- MAY 2010 3 (at zero interest) ensures that the SME fully increased capital or revenue for the SME. buys into the process and has a stake in And in time SMEs appreciate the value of TA maintaining the new business practice or as a risk mitigant and sustainability builder, process. as opposed to its just being a "nice thing to do" for their businesses. When structuring TA, it is important to bear in mind that the bulk of TA funds will not Conclusion necessarily be absorbed by the SME at the beginning, but rather, as the business grows, SSC has provided significant demonstration increases its cash-burn rate, and runs into effect by showing that a combination of risk new challenges, the uptake of TA funds may capital financing and technical assistance for increase in tandem--to support projected SMEs can facilitate viable investment growth in a challenging economic/business opportunities. As a result, a robust emergence environment. of new SME-oriented risk fund managers is deepening SME access to finance in Kenya. We have also learned that a large injection Eight new funds targeting SMEs have of capital is not necessarily a panacea for benefited from guidance and market SMEs' growing pains at start-up, early-stage, information from SSC Kenya. Such funds/fund or growth phases. Frequently, such managers include Grofin Kenya Ltd, TBL enterprises require more hand-holding, Mirror Fund, Acumen Fund, Care Enterprise mentorship, and other capacity-development Partners (now Africinvest), Root Capital, assistancebeforethey can effectively absorb Investeq, In-Return Capital, Enablis, and Fanisi, new capital. This tends to further debunk wielding close to $400 million in equity the myth that money is the cure-all for all targeting SME investments. IFC's Funds SME problems. We have seen SMEs that Department has subsequently invested in a realize they do not need to take on new number of these funds. In addition, banks capital immediately if they can seal revenue have introduced new and flexible SME lending hemorrhage, streamline working capital products, premised on viability of free SME management, aggressively manage costs, cash flows, with a significant impact on their improve management systems, and increase SME loan portfolios over the last three years. effectiveness of their business development initiatives and quality of their products and The SSC program's Access to Finance pillar has customer relationships. Saddling such SMEs thus acted as a catalyst in the SME market, with debt only compounds their financial demonstrating increased awareness and woes. appetite for cash-flow­based lending among traditional providers of SME finance. The SSC And finally, we have learned that SMEs are also has made concerted efforts to work with more willing to take up and pay for TA when other financial institutions (local banks) to it's linked to either access to finance or make alternative types of viability-based access to markets/contracts, since it leads to finance available to their clients. DISCLAIMER IFC SmartLessons is an awards program to share lessons learned in development-oriented advisory services and investment operations. The findings, interpretations, and conclusions expressed in this paper are those of the author(s) and do not necessarily reflect the views of IFC or its partner organizations, the Executive Directors of The World Bank or the governments they represent. IFC does not assume any responsibility for the completeness or accuracy of the information contained in this document. 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