How new Central African businesses can increase their chances of getting financeRead Now
The challenges facing entrepreneurs in Central Africa were vividly described in a recent article in the newspaper Iwacu (here). Although the businesspeople interviewed are Burundian, similar problems occur across the border in the Democratic Republic of Congo (DRC). The challenges described are the lack of customers, the lack of public support for new entrepreneurs, the number of documents required to bid for public contracts, and above all, the lack of finance. Here are the words from one of the entrepreneurs interviewed:
“Founded two years ago, Edaco, a company specialising in architecture and construction, is nearly “fictitious”. It doesn’t have a physical address… It hasn’t hired anybody.
Prechore Nsabiyaremye, general manager of this business,… has been disillusioned. “I had created this business to compete for government contracts.” It’s an objective that he still hasn’t reached. His company can’t bid for government contracts as a business. It doesn’t have sufficient financial guarantees and experience. Where the trouble comes from, he says regretfully, is that no financial institution will agree to grant credits to new companies without a mortgage. Since 2016, he has won no contract.”
Source: http://www.iwacu-burundi.org/des-entreprises-et-emplois-fictifs, with my translation from the French.
Potential investors can have a number of concerns that make them reluctant to invest in an entrepreneur’s project . One concern is that the investment returns are likely to be highly uncertain, so that it is difficult to value the investment. Another concern is that the investors probably know less than the entrepreneur about the planned project, so that the entrepreneur could secretly act against the investors’ interests. Concerns about limited project information and anti-investor activity may be particularly acute in the DRC, where it is often difficult to collect information about companies or entrepreneur behaviour. It will also often be difficult for investors to ensure in law that entrepreneurs don’t act against the investors’ interests, due to difficulty in legal access and enforcement.
Potential investors are more likely to provide finance if their concerns are calmed. The entrepreneur can help to calm their concerns by doing a number of things. The entrepreneur can start by giving more project information to the investors. The information could be a business plan or detailed financial and organisational information. Such information could be released initially, or during the life of the project perhaps with extra investment being released if the information is good. The entrepreneur could also give evidence of their past successes or their skills for running the business, as well as of the skills and suitability of other people and organisations connected with the business. Additionally, the entrepreneur could look for finance from investors with whom they have worked in the past, or with whom they have social ties, since such investors are likely to know more about the entrepreneur, and their abilities and ideas.
A problem with disclosing information about the project is that the investors could use the information to undertake the project without the entrepreneur. However, if the project is small, has low or moderate profitability, or is difficult to implement, then the chance of the investors acting alone is reduced as the incentive for them to undertake the project is reduced. The entrepreneur could also avoid disclosing detailed information on how to run the project, at least before its start.
The entrepreneur could also give potential investors more control over the use of their funds, if they choose to finance the project. If the investors have more control, the entrepreneur cannot easily act against their interests. The entrepreneur could invite the investors to participate in the management of the project, perhaps as non-executive directors. Investors will probably only be interested in participation if the project is quite large. The entrepreneur could also give investors control over some business activities, such as asset sales, which could make the entrepreneur richer at the expense of the investors. Additionally, the entrepreneur could agree not to do certain things, such as selling assets or expanding the business rapidly.
There are some problems with transferring control to investors. One problem is that it can leave the entrepreneur with a reduced role in the business, even though they are likely to be its most knowledgeable and committed supporter. Another problem is that it can be difficult or expensive to enforce legally the transfer of control, particularly in the DRC where the government has limited jurisdiction over part of the country. An entrepreneur’s reputation and experience is likely to be important for showing investors that the entrepreneur can be trusted to do what they say.
The entrepreneur could also help to calm investors’ concerns by reducing the investors’ exposure to risk. If investors are less exposed to risk, then concerns about limited project information and anti-investor activity may be less important to them when deciding whether to finance the project. The entrepreneur could offer the investors some protections against risk. One type of protection is guaranteed repayment of funds before other creditors are paid, if the business closes. Another type of protection is transfer of ownership to the investors if performance targets are not met. A further type of protection is repayment of funds with a fixed additional amount after a certain time period – in other words, funding through debt, rather than through equity or something else that pays an amount linked to profit.
There are problems with reducing investor risk, both for the entrepreneur and investors. One problem is that if investors are given extensive protections, then any uses of their funds which threaten the protections become unsuitable, so the funds can’t be used for many business purposes. A second problem is that it is impossible to anticipate all potential threats to investors’ funds, so that the investors will always be exposed to some risk even if they are offered protections. A third problem is that it may be difficult to enforce in law any protections promised or written in a contract. A fourth problem is that if debt funding is used, then the investors may still be exposed to risk. The entrepreneur will receive any profit or loss from the business after debt repayment. If the entrepreneur’s potential loss is limited (for example, if their business has limited liability), then they may choose riskier business strategies that increase the expected profit or loss, but decrease the chance of repaying their debt. The risk faced by the investors would have a different form, but would still be there.
Table 1 summarises actions that an entrepreneur can take to increase their chances of getting finance, organised by their aim. An entrepreneur who takes these actions is not certain to get funds, but it’s more likely.
Table 1: Actions that an entrepreneur can take to increase their chances of getting finance
Aim: Reduce investor uncertainty
1. Give information about the project to the investors, either initially or during the project life
2. Give information about the entrepreneur’s skills or experience in running a business
3. Work with investors who have worked with the entrepreneur in the past
4. Work with investors who are socially connected to the entrepreneur
Aim: Reduce investor concerns about acting against their interests
1. Invite the investors to participate in project management
2. Give the investors control over specific business activities which could be against investor interests
3. Agree not to do specific business activities against investor interests
Aim: Reduce investor exposure to risk
1. Guarantee that the investors will be repaid before other creditors, if the business closes
2. Guarantee to transfer the business to the investors if performance targets are not met
3. Ask for debt funding, rather than equity funding (this action changes the form of investor risk, rather than removes it)
. The analysis here follows the book Shane, 2003, “A General Theory of Entrepreneurship”, chapter “Resource Acquisition”.
The blog and site are written by James Waters. He is a British economist.