Omidyar Network releases African entrepreneurship report, it’s a must read

We have the pleasure of presenting the Accelerating Entrepreneurship in Africa report compiled by the Omidyar Network, the philanthropic foundation established by Pierre Omidyar — the founder of eBay — in partnership with global strategy consulting film, Monitor Group. This epic 48-page report is the result of a three-phase research project launched in 2012 aimed to better understand the state of entrepreneurship in Africa.

The project started with a survey of 582 entrepreneurs across six Sub-Saharan African countries: Ethiopia, Ghana, Kenya, Nigeria, South Africa and Tanzania which was then augmented into 72 in-depth interviews. It promises to be one of the most comprehensive studies done on African entrepreneurship to date.

Benchmarked against 19 global peers like China, India, the USA and the UK, the issues addressed were divided into four critical aspects of entrepreneurship:

• Entrepreneurial assets: financing, skills and talent, and infrastructure
• Business support: government programmes and incubation
• Policy accelerators: legislation and administrative burdens
• Motivations and mindset: legitimacy, attitudes, and culture

The second phase invited business, government and thought leaders to the 2012 Entrepreneurship in Africa Summit, held in Accra Ghana, to analyse the survey findings, and offer proposed solutions.

The report presents the findings of the survey, as well as the outcomes and solutions given at the Accra meeting. We have compiled an abridged version of the report for your reading-pleasure, but if you wish to read the full version you can find it here.

The report starts by listing financing, skills and talent, and infrastructure as Africa’s greatest challenges.

Financing

The study quotes research by the International Finance Corporation that estimates that up to 84% of small and medium-sized enterprises (SMEs) in Africa are either un-served or underserved, representing a value gap in credit financing of US$140- to 170-billion.

So there’s not enough capital right? While, 71% of the entrepreneurs surveyed agreed, the report says something rather interesting: financiers argue that many of the new ventures are simply not fundable. Financiers note a lack of fundable business plans, pointing to issues ranging from the quality and feasibility of the business idea to the commitment of the entrepreneur and his or her team.

Of the six countries surveyed, Kenya seems to fare the best in terms of capital supply — only 52% of Kenyans sees this as a challenge.

The main sources of financing are personal and family loans (45%), private equity (19%), bank debt (18%), government funding (5%), venture capital (5%), angel seed (4%) and other (4%). “Other” funding sources include corporate funding, lease / receivables financing or stock options. Some entrepreneurs in South Africa claim that their businesses are funded using multiple credit cards because most banks are reluctant to provide a loan to businesses but are willing to increase limits on the entrepreneurs’ credit cards — expensive, but easy.

The majority of respondents are in agreement that the cost of funding is too expensive — the report found that in some cases, banks require 150% of the borrowed amount in collateral. An alternative, government lending, could be more attractive was it not for bureaucracy and nepotism reported by some respondents.

The report concludes that venture capital in Africa is still an emergent phenomenon and the majority of survey respondents (67%) agree. Entrepreneurs are forced to pursue bank loans which simply are not tailored for startups. Banks see startup investments as high risk, low reward and like to quote statistics that show 9 out of ten startups fail within the first five years of operation.

Illustrating a profitable business model is critical to boosting VC activity in Africa says the report. Entrepreneurs need to focus on being rigorous business planners and demonstrating their understanding of a particular sector to investors. Entrepreneurs must “know something about everything, and everything about something,” says the founder of First Rand Group in South Africa, Paul Harris.

The report warns however, that finance is not the determining cause of a venture’s success or failure. “Rather, the entrepreneur’s ability to adapt to market changes and cope with uncertainty, as well as their level of tenacity, are greater determinants of a business’ success.” Entrepreneurs also forget about market access. Without multiple product channels, revenues and profits likely stall, and this lack of growth makes funders reticent to invest.

When looking for funding it’s important to get matched with the correct funding provider and to be proactive. A mismatch might occur where a financier is looking for historical data when the venture is fledgling. Entrepreneurs must identify the availability of capital sources and the suitability of capital given their company’s stage of growth. They must also be able to assess their funding requirements and identify those funders that are most likely to fund them. The report advises that misperceptions and misunderstandings can be mitigated by enhanced communication.

The report identifies a lack of viable exit opportunities, which leads to a disincentive for funders to make investments — funders can’t recoup their investments.

48% of Ghanaian respondents report that it is uncommon for business owners to use buyouts to sell their firms. Respondents in Ethiopia (42%), Tanzania (41%), Nigeria (38%) and Kenya (37%) share the same concern. The regulations for exiting businesses are also considered rigid, and there is little awareness about the fact that large multinational corporations or private equity funds can sometimes be compelling buy-out options.

The report raises a fascinating point about how the size and power of an entrepreneur’s network shapes innovation. A larger, more powerful network, with a larger funding pool will allow for bigger ideas and lessen the chances of a startup stagnating.

The research calls for the formalising of seed and angel investing networks. It singles out successful examples, such as the Mo Ibrahim Foundation and the Tony Elumelu Foundation.

To mitigate some of the challenges, the study proposes solutions for startups in different growth stages.

Early-stage enterprise financing in Africa

• Reduce bureaucracy for early-stage companies to access government funding in order to provide ‘softer’ sources of financing for less-experienced entrepreneurs.
• Expand or initiate local angel investing ecosystems to ensure the availability of the most appropriate type of funding for start-ups, especially for entrepreneurs who lack the network of friends and family that traditionally play this role.
• Provide tax and other incentives to formal, as well as informal (e.g., family and friends), angel investors to make it easier for people who have extra cash to invest in startup businesses and reduce their risk.
• Provide tax and other incentives for large clients of early-stage ventures to provide supplier credit to incentivise and reduce the risks suppliers take when providing generous payment terms and/or stock to new ventures.

Mid-sized enterprise financing in Africa

• Leverage indirect personal sources of funding, such as pension funds to fund SMEs, so that more resources are available to fund more-established enterprises where the risks are lower.
• Expand or initiate local venture capital investing ecosystems to ensure that the most appropriate source of funding is available for companies at the mid-level stage of development.
• Use local banking systems to disburse donor or government lines of credit to SMEs to reduce prohibitive interest rates and collateral requirements.
• Provide incentives and support to mid-sized SMEs to practise sound financial management and maintain adequate records, including audited statements.

Later-stage enterprise financing in Africa

• Create capital-raising engagement programmes with leaders of well-established private African enterprises to inform entrepreneurs about the benefits of private equity funding, as well as the benefits of listing at local stock exchanges.
• Create continent-wide ‘regional champions’ programmes to facilitate access to capital (both debt and equity) for independently vetted pan-African companies that are expanding across the continent.
• Educate entrepreneurs about possible sources of funding outside banking systems.
• Train and assist early-stage entrepreneurs in the intricacies of capital-raising.
• Train the local financial community to evaluate investment opportunities on the basis of future prospects rather than historical cash flows.

Skills and talent

The report identifies a need for experienced managerial talent to complement technical talent. Startups lose out to well-established corporate firms that have the means and security to hire those specialising in management.

The research suggests that management and other entrepreneurial skills should be fostered in schools. African schools are geared for producing a corporate workforce. As entrepreneurs in Africa require training and education to allow them to succeed in starting or growing a business, more time should be devoted to entrepreneurship at primary and secondary level.

Respondents overwhelmingly agree that there is an inadequate focus within schools on the practical skills required to start, manage or work in entrepreneurial ventures. The same goes for tertiary institutions that according to respondents, lack practical aspects. Limited opportunities for hands-on learning and managing small projects mean that students are not afforded clear paths for cultivating competencies related to practical thinking and creative problem-solving — skills needed to successfully build and manage a business. As a result, most Afro-entrepreneurs do not feel adequately trained to manage a new firm, which for many leads to the tendency to look for corporate jobs.

There’s also a culture problem, says the report. Society fails to encourage students to recognise their entrepreneurial potential, as society often values and respects professionals over entrepreneurs.

The study notes that it is important to teach entrepreneurs to delegate. Taking on too much is hazardous, it is important to identify the professional skills needed, acknowledge existing strengths and gaps on the team and then source the missing skills accordingly.

Trust must also be established between businesses and service providers. Among entrepreneurs, a significant fear exists that, whilst engaging advisory services, the service providers may steal their business ideas.

How should startups attract talent, when they can’t offer corporate salaries? Providing
opportunities for problem solving in the work environment, which offers increased individual responsibility, is an effective means of attracting talented staff. Startup culture should also excite, inspire innovation and reward creativity.

The study goes on to provide recommendations for mitigating skills and talent challenges.

• Include entrepreneurial and vocational training in the education system in Africa so that learners are exposed to entrepreneurship from a young age.
• Leverage Internet-based solutions that offer training in business skills and entrepreneurial management to provide assistance to entrepreneurs that is scalable and available at relatively low costs.
• Establish communications and career counselling programmes that encourage and guide young people towards the creation of entrepreneurial ventures.
• Institute secondment, mentorship and networking programmes where seasoned executives (previously or currently employed) support SMEs for limited periods by working alongside and training SME staff on key projects.
• Offer incentives (e.g., subsidies, tax advantages) to entrepreneurs who offer strong employee value propositions to prospective professional staff, such as stock option programmes or specialised training.

Infrastructure

The report cites access to electrical power as the biggest challenge in terms of infrastructure, especially in Nigeria where only 27% of respondents believe that the physical infrastructure provides sufficient support for new and growing firms. South Africa seems to have the most stable supply, but suffers from high tariffs.

Additionally, poor quality and limited breadth of road and rail networks, and poor communications infrastructure are all highlighted as having a significant impact on the cost of doing business.

Only 38% of Afro-entrepreneurs agree that infrastructure provides sufficient support for new and growing firms. 23% of those surveyed believe that new and growing firms could afford the costs of using infrastructure.

The report suggests deploying and upgrading infrastructure first in selected productive areas where there are substantial business activity and strategically important local industries, and to favour public-private partnerships in the execution of
infrastructure projects.

Policy Accelerators

Africa might lag behind its global peers on the Entrepreneurial Assets and Business Assets front, but when it comes to Policy Accelerators the continent is in touching distance of the world’s legislation. There remains key administrative burdens to overcome though.

Legislation

The survey responses indicate that laws governing business competition are perceived to have a bias towards well established firms because they are better equipped to handle the heavy penalties for non-compliance. This bias is particularly felt with South African entrepreneurs who view the requirements of the Labour Relations Act, Consumer Protection Act, and National Credit Act 73 as onerous and time-consuming.

Heavy penalties for non-compliance also unwittingly encourages entrepreneurs to set up shop in the informal sectors where they can stay below the law’s radar, avoid paying taxes, operate without certificates and informally hire employees.

Not only did 60% of respondents say that they find it acceptable to establish a startup in the informal sector, but 62% personally knew entrepreneurs who had done so.

Formalising industries and processes is key to the state not losing out on potential tax revenues and affording entrepreneurs better access to financial and consumer-markets. Preparing entrepreneurs to operate more formally and compensating for higher operating costs in a regulated environment were identified as challenges.

Administrative Burdens

Despite acknowledgement of recent improvements of reforms to doing business, administrative burdens still plague the continent. Other than South Africa (35), Kenya (109), Nigeria (133) and Tanzania (127) all rank in the bottom half of the 183 countries ranked by ease of doing business. The same holds true for rankings for starting a business.

The report proposes that policy accelerators should offer incentives to entrepreneurs to enter and develop key sectors that are currently underserved as well as to develop more nuanced legislation that differentiates between big business and SME segments.

Legislation should also reduce the excessive costs, time and bureaucracy associated with regulatory compliance to encourage startups to enter the regulated environment. Reforms should aim to continue to reduce red tape and create a more enabling environment for new businesses.

Motivations and Mindset

The Monitor Survey suggests that pursuing entrepreneurship as a career has gained acceptance and legitimacy in Africa but for the most part African entrepreneurship culture is defined by necessity – entrepreneurship as a means of survival, a last resort, not the pursuit of opportunity or aspiration. Efforts should be placed upon changing this mindset from necessity to opportunity.

It is also noted that Africans might not fully appreciate the ‘entrepreneurial journey’ and the practical challenges that come with it, but rather romanticise the image of a bold and rich entrepreneur who conquers markets and lives a life of luxury.

The notion of a successful ‘business person’ relies on wealth and lifestyle rather than business acumen and entrepreneurial flair. This drives the mindset of young people embarking on entrepreneurial ventures, who often enter an industry without enough knowledge of said industry and therefore cannot innovate or compete effectively.

To cull these stereotypes and offer another model of success there is a convergence of the awards celebrating entrepreneurship as well as media coverage promoting successful African business stories.

The attitude towards failure was also identified as a challenge – hindering risk taking in business ventures. It was proposed that ‘bouncing back’ should be a far more effective trait to nurture.

While most respondents agree that governments have a role to play in fostering a culture of entrepreneurship, views are mixed as to the extent that that role should be. Opponents to the notion view government as – by its nature – not being entrepreneurial. They also voiced concern that a dependence on government could stifle creativity and resourcefulness.

Proponents of the notion point to South Korea, whose government successfully improved its culture of entrepreneurship after the 1997 economic crisis by encouraging entrepreneurship with creative policies that changed tax laws and bankruptcy codes.

One solution offered for motivations and mindset is to establish programmes and media initiatives that celebrate entrepreneurs’ success, honour their journeys and encourage those who have failed to rise again. Another solution would be to formulate and introduce income-insurance schemes for selected types of African entrepreneurs.