THE DEVELOPMENT OF MICRO-CAP SECURITIES MARKETS IN
SUB-SAHARAN AFRICA: NEW APPROACHES TO FOSTERING ENTERPRISE GROWTH
by Professor Stuart R. COHN
(Article Reference: Document No.18, November 2002)

The Problem of Capital Financing
Where do start-up and developing companies obtain their working capital? This is a universal dilemma not confined to sub-Saharan Africa. Throughout the world, small and growing businesses mainly rely on family, friends and small bank loans as their principal capital sources. In the United States, many young companies are funded through multiple credit card borrowing, a source not readily available in the region where credit cards are not commonly available. In some more developed countries, governments have established financial assistance programs for smaller companies, whether by way of direct grants or indirect loan guarantees. These programs are not generally found in the sub-Saharan region.

Today's business market is capital intensive. Information technology is expensive, so too is meeting regional and even global competition that the IT boom has generated. Without access to needed capital resources, businesses stay small. A small business might find a comfortable market niche, but without substantial input of additional capital it is not likely to grow. Where can growing businesses turn for additional capital? Once friends, family, and other personal resources are exhausted, where is the source of new capital? Unfortunately, those sources are very limited. They are limited by reason of access, not because they do not exist. Restrictive company and securities laws do not make it feasible to attract capital through securities offerings. Without the ability to make limited public offerings, companies are stymied in seeking new infusions of capital. In some more developed countries, venture capital firms provide a major source of funding. Unfortunately there is relatively little venture capital in the SSA region. As a result, by default and by tradition, banks are the principal capital funding sources for SME's.

Bank financing presents two significant hurdles. One is that banks are notoriously reluctant to loan a significant amount of money to smaller businesses in the absence of collateral or solid personal guarantors, neither of which are usually available. Bankers are remarkably unimpressed by pro forma financial statements showing anticipated cash flows and profit potential. As the old maxim goes, if a bank is willing to give you a loan, you probably don't need it.

The second problem with bank financing is more endemic to SSA, and that is the historically high interest rates charged on commercial loans. Rates vary among countries, but interest in the range of 25%-35% is quite common, and it is rare to see interest rates below 20%. Such interest rates are beyond the capabilities of many SME's. For many developing companies, research and development costs, marketing expenses, and capital outlays are very high in early years relative to revenues. Even if profits are attained, margins are not likely to support interest payments in excess of 20%. Even seasoned and well-established companies would have difficulty meeting such payment obligations. If loans are sought outside of the formal banking system, payment terms are no better. The informal lending market generally charges more, not less, interest, as they are accustomed to dealing with higher risk ventures and peg their rates accordingly.

If bank financing is not available or too costly, there is little alternative for the entrepreneur but to hope that the undercapitalized business is able to generate profits on the proverbial shoestring. That hope is often long on optimism and short on reality.

The lack of adequate funding sources in SSA requires that new approaches are needed to address capital financing concerns. Otherwise, economic development will continue at its slow, inadequate pace and NEPAD's goals will not be achieved. What I propose is an overhaul of company and securities laws and regulations that will permit the development of micro-cap securities markets for SME's. Nothing is suggested that is not already working in other countries. In that regard, the suggestions take into account the important goal of investor protection, an inevitable concern when discussing easing limitations on capital raising. Measures are recommended in this paper to address that concern.

---

>> Next: Current Impediments to SME Securities Offerings
>> Back to Table of Contents