Lending a hand to African businesses

Kenyan truck driver Charles Githuka Ngugi started a small animal feed business two years ago. His business flourished, thanks to strong demand for his products, and he was quickly turning a profit. But when he approached local banks for a loan to expand, they turned him away.

Fortunately, he heard about a new investment programme for small businesses that arranged financing and coached him on how to improve his business. He has since raised production, attracted larger clients, hired more staff and is competing with bigger rivals.

The experience of Lima Feeds shows how a new approach to supporting small businesses in Africa can contribute to development and help create desperately-needed jobs. For years development specialists, economists, aid organisations, and corporate philanthropists have sought ways to support local entrepreneurs and stimulate small businesses in Africa. Small firms create less than 10% of jobs in most African countries, compared with more than 50% in Europe, according to the World Bank.

Although they are the backbone of wealth and job creation in most industrialised countries, providing assistance for them in developing countries has largely fallen outside the remit of traditional not-for-profit aid programmes. It’s time to change tactics, believes Kurt Hoffman, director of the Shell Foundation, an independent charity focusing on development that was set up with a $250 million endowment from Shell. “Creating millions of jobs should be at the heart of the efforts of the international community’s endeavours,” he said. “Jobs generate cash and with cash, you can access food, clothing, shelter, healthcare and education.”

Finance gap

Small and medium-sized African companies like Lima Feeds are often caught in a finance gap. On the one hand, microfinance, the Nobel Peace Prize-winning system of loans starting from as little as a few dollars, while helpful for a tiny start-up, provides insufficient funds for established businesses looking to grow. On the other hand, many small businesses aren’t yet big enough to attract traditional project financing and venture capital, involving amounts above $1 million. Banks, traditionally averse to risk, avoid them because entrepreneurs often lack business experience, have little or no collateral to secure loans and cannot provide audited accounts. That leaves few options for start-up and growing companies seeking funding between $50,000 and $1 million.

Using his personal savings, Githuka Ngugi started Lima Feeds – named after the Swahili word for farming, lima – on the outskirts of Nairobi in 2005. He had learnt the ropes of the animal feed industry working at a poultry co-operative and began selling his own blend of feed for chickens, pigs and dairy cows. Demand for his products, made from a mixture of maize, cottonseed, bread dust, coconut cake and other ingredients, quickly outstripped what he could supply. But a lack of capital and expertise kept him from expanding. In order to grow and to compete with his bigger rivals he needed to purchase raw materials in bigger quantities to get a discount from suppliers. He also needed a new truck to make faster, more frequent deliveries. “I wanted to grow Lima Feeds, but I didn’t have the proper skills and training to do it,” he said.

Githuka Ngugi got his break when a friend introduced him to GroFin, an African company that gives business development assistance as well as finance. It invests in companies through a range of tailor-made means from loans to equity stakes. It seeks sound small and medium-sized companies that have steady growth and generate cash, like Lima Feeds, and which also need business development assistance such as personal coaching, mentoring and training. This maximises their chances to become established and profitable and helps ensure a return to investors in GroFin’s funds. GroFin has already created more than 1,500 jobs in Africa and indirectly improved the livelihood of more than 10,000 people by providing business development assistance to almost 500 firms since it was set up in 2002, its director Jurie Willemse said.

New approach to development

The Shell Foundation helped GroFin with grant funding and together they developed a model that provides finance and business development assistance, as well as delivering financial returns. “We worked with GroFin to develop a new service that overcomes the barriers faced by small businesses, and have helped raise funds from investors,” said Shell Foundation Deputy Director Chris West. “Six years ago there were just two staff at GroFin, plus myself and a whiteboard. Now GroFin has over 60 staff and manages funds of over $100 million – it’s quite a significant scale-up.” GroFin draws on connections with local banks and corporations including Shell to help identify the small businesses eligible for investment.

GroFin now manages more money than other funds such as AfricInvest, and is the only financier in Africa that focuses upon providing less that $1 million to small and medium-sized businesses. GroFin is now working in six countries in sub-Saharan Africa, more than most other funds. The size of its investments is about $350,000 on average, compared with $1.5 million for AfricInvest.

The model aims to provide a net return on investment of 5-10% on average to investors. It has recorded no defaults so far and is gaining credibility, as shown by the list of investors in GroFin and the Shell Foundation’s Aspire East Africa Fund. They include the UK government’s Capital for Development (CDC) and the Netherlands Development Finance Company (FMO). Even leading African banks, reluctant to invest directly in small and medium-sized companies, invest in GroFin funds. They already provide over 50% of the capital raised to date by GroFin. And the fund in East Africa won the 2006 Africa Investor Award for best initiative in the small and medium enterprise sector.

GroFin’s business experts worked closely with Githuka Ngugi, a high-school graduate who never went to business school, to overcome the obstacles holding his business back. They gave his company an immediate boost with financing totalling 6.3 million Kenyan shillings (about $95,000), allowing him to buy the delivery truck he needed. GroFin’s experts also helped him employ an accountant and two sales people and advised him on how to market his business to win new clients.

The combination of business development assistance and finance helped boost production and the company’s turnover began to grow. Lima Feeds now produces 1,700 70-kilogram (154 pounds) bags of animal feed a month, up from about 1,500 bags a month before it began working with GroFin. Charles expects revenues of 33 million Kenyan shillings ($494,000) for 2007, up from 28.2 million shillings ($422,000) in 2005. He expects output to rise to 2,500 bags of feed a month later this year.

“Firm foundations”

Past efforts to support small and medium-sized businesses in Africa have often failed because the providers of technical assistance and finance were separate entities or poorly integrated. The people who got loans often didn’t have the management skills to put them to good use or simply defaulted on repayments, scaring off potential investors. In the past, fund managers also tried to replicate venture capital-type approaches that were successful in places such as California for early-stage investing in small companies. Those approaches relied on investors picking rapidly-growing start-ups they thought would see exponential growth and cashing in after the companies had become successful. That model did not prove transferable to East Africa, where start-ups often need skills as well as finance to grow. “The prospects for this kind of approach look set on much firmer foundations than some of the other approaches that we’ve seen in the past,” said Rod Evison, portfolio director for Africa at CDC.

Today GroFin operates in seven countries. Jurie Willemse expects GroFin’s funds to grow to $1.5 billion and staff numbers to rise to 500 in over 25 countries worldwide by 2020. An independent assessment by Barnellan Equity Advice Ltd. found that early results of studies of companies with GroFin support showed an “extremely promising” outlook.

Back at Lima Feeds, Githuka Ngugi now has an accountant and a computer to keep financial records efficiently. “I would like Lima Feeds to grow into a big company,” he said. Next time he approaches banks for loans and they ask for a commercial track record, maybe they won’t keep their doors shut.

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