Who are the business builders?

I am impressed by some of the entrepreneurs I met so far. They know their business, competitors and industry. They understand their finances. They now where they want to go and their future plans are ambitious. And their present business proof they are capable in building businesses. In this blog I will shortly introduce three members of the target group: strong entrepreneurs with a (potentially) fast growing business that are motivated, capable and ready for an investor. Investments in their businesses promises both interesting financial and social return.

Andrew
Andrew is a reputable businessman and a real entrepreneur with high energy level and charisma. Five years ago he established a coffee company. Presently he exports coffee under his own brand to Great Britain to several retailers. It is the only African owned coffee brand sold in the West. His company owns four coffee shops in Kampala.
The strength of the business is the vision of Andrew. Andrew works closely together with his suppliers, several thousands of farmers, to improve the quality of the coffee. Quality of supply is key and reason for Andrew to involve the farmers to his company. Half of the profits of the company are invested in the communities of the farmers, in education and training, saving and credit facilities, etc. Investments that help the farmers to improve the quality and quantity of their output and Andrew to secure his inputs.
Andrew thinks big. His vision is to build an African owned premium brand with different processed agricultural products like tea and potato’s.
The business currently employs 20 people in the coffee processing and 60 in the coffee shops. Present turnover is around 1 million (euro). He needs an investment for hiring stronger management, building an IT infrastructure and to increase his working capital for expansion. The investment sought is around $700k, equity and/or loan. Besides the 50 new jobs created this will positively affect the live of several thousand farmers that get a premium for their (quality) coffee and part of the profit is invested in their communities.

Ahmed
Another entrepreneur. As Andrew, Ahmed also has the vision that the quality of his products depends on his partners in the value chain. With his family he owns a slaughterhouse, the second largest of Uganda. What surprised me when I visited the slaughterhouse is that animal slaughtering is not central element of this business. The primary function of his company is providing a marketplace with hundreds of people selling and buying animals and meat. His position as buyer of animals and seller of meat is highly important in the meat value chain. To improve the quality and quantity of his supply he establishes long term relationships with his suppliers. He assist farmers with the many facets of raising the animals.
Currently the meat is processed under hygienically dubious circumstances. Ahmed’s dream is to build the first modern slaughterhouse of East Africa, adhering to international hygienic standards, well packaged, ready for export. The value added will lead to a price premium and an advantage over competitors. He needs €1 million to build the facility. The social benefits of this investment is the creation of another 20 direct jobs and, more important, improved food quality for the local market.

Stephen
Three years ago Stephen started a weekly publication with three partners for East Africa. The current print run is 5000 per week (for European standards this is a very small number, but in Uganda the print run of the biggest daily newspaper is 40.000 copies). Half of the copies are going to subscribers in Uganda, Kenya en Tanzania. Presently the company is profitable, but to increase the growth speed the business is looking for an investor. The investment sought is around $250k for expansion of presence in Kenya and Tanzania and working capital (to increase the print run and number of pages). The social return on this investment are both direct job creation and income opportunities for newspaper sellers.

Three strong entrepreneurs for whom it is hard to mobilize the financial resources needed for maximizing the growth of their businesses. They are looking for an outside investor. For potential investors who want to know more: a.stoel@dutch.com

Wanted: a local partner

In short, my mission is to create an infrastructure that makes social investments (with financial returns) in small and medium enterprises in low-income countries possible. In this concept local presence (starting with Uganda) is essential. I need a local partner (could be an organization or person) that can provide this infrastructure. Finding this partner is my first priority in Uganda and in this blog I will tell about my quest for the best partner …

What to look for in the local partner? Investing is not simple. It is a complicated discipline and the investment process followed by most professional investors contains technical steps. Generally, the investment process is directed to increasing return for the investor and declining risks associated with an investment. Assuring the right investment decision is made. And assuring the investments are managed over their lifetime. In most cases, the next process steps are followed to do and manage an investment:
- Sourcing of investment opportunities and effective first screening and selection. There are many companies and entrepreneurs that look for an investor. Only a few percent can be considered. Effective sourcing and efficient selection is needed to save a lot of time.
- Due diligence: a very thorough investigation into the background of the entrepreneur and all aspects of the business and business plan. This should provide the information for a solid investment decision;
- Valuation: what is the enterprise worth before and after investment. Valuation of the business is especially needed in the case of finance (the investor is becoming a shareholder) to value the input of the investor;
- Deal structuring and deal closing: there are many ways to structure the deal: equity, dept, mezzanine, or combinations and many aspects to take in consideration like ensuring commitment of the entrepreneur, staging of the financial investments, appropriately assuring the interests of the investor, taxes and investment incentives. This all should be legally closed;
- Control of appropriate financial administration and accounting procedures: Accurate financial information is the primary concern of every investor to understand the performance of his investment. Especially in Africa, where weak financial management of small and medium enterprises is often an important cause for bankruptcy and the risk of fraud and theft are significant;
- Management of the investment: One of the success factors of an investment is the short lines and appropriate involvement of the investor and his investment. Because the majority of our investors do not live in Uganda (physical distance) and do not have the time to travel and visit their investments very regular the service should be provided to govern and monitor the investment on behalf of the investor.

It will be clear that knowledge and experience with the investment process is required. Besides, there are also some important personal characteristics for the partner. Personal integrity is the most important. But to ensure the scalability of the concept also management capabilities, networking capabilities, strong work ethics, responsibility, determination, drive and energy and commitment to this project are important. Based on this a created a profile. The search can start…

How to search for a partner? Somewhat naïf I started with a search on the internet. Googling words like “equity investment”, “investment services” and Kampala. Internet is not a very effective search mechanism. Partly because the performance of the local Internet providers are not impressive. Loading pages takes a lot of time. But more importantly: most business do not have a website.

It required a change of strategy: networking. This indirect search by telling everybody interested about my ambition and benaderen local parties that can advise on organization and persons that could be partners is much more rewarding. I talked with business associations (association for management consultants and the association of accountants and auditors), the Uganda Investment Authority, Directors of banks and providers of services to entrepreneurs. Another option, using the search services of a headhunter, I did reject because this is expensive.

The results… So far I talked with around 20 potential partners. Both organizations and individuals. I think my search is very thoroughly, because some recommended organizations or persons that I already talked to, indicating the circle of potential partners is small. The knowledge on equity investments is not widespread. Although there are some strong potential counterparts, nobody fulfills the requirements in my profile. I am positively sure that there is no organization in Uganda with the skills to assist an investor in making investments in small and medium sized enterprises. Maybe when I look harder, I can find persons more qualified. But I have decided to go for a partnership with one of the persons I did find (Keith) and build the infrastructure I need with him.

Keith is a high-flyer. He worked for Shell and did an MBA in South Africa. After that he was responsible for parastetals (governmental enterprises not yet privatized) and did have several board functions. After that he joined the Ugandan pension fund as chief investment manager where he was responsible for investing millions in US dollars.

We are going to establish the first private equity management firm in Uganda. This is a gap in the market. The interest of investing in small and medium enterprises in low-income countries is on the rise. For Google.org (the philanthropic venture of Google) stimulating the investments in small and medium enterprises is one of the five pillars of their policy. East Africa is one of their target areas. In many African countries with somewhat more developed financial markets there are several organizations providing (equity) investment services. Not having one in Uganda is a threshold for foreign (but also resident) investors to invest in small and medium enterprises. It will be an Ugandan based company. Keith will be responsible for the delivery of the services. I will be responsible for searching foreign (social) investors. And the company will be the vehicle of my mission: to provide a reliable infrastructure that give investors the confidence that is needed for investments oversea.

Presently we are aligning our vision for the future of this company, jointly developing a business plan and negotiating the terms of the partnership. I am also going to do a thorough reference research on Keith. I think he is a highly integer person, but it will help me to sell him if I do a detailed background check. After all, this is one of the services we are going to provide to the investors…

My ambition

As I did explain in the previous two blogs my basic frustration is that the most important group for development within low-income societies are kind of neglected by developmental aid and conventional financial institutions (although this last group is excused by the fact that they are commercial entities chasing financial return on their investment). I believe that investing in small and medium enterprises backed by a real entrepreneurs, a business builder, is a highly effective, efficient and sustainable way to bring economic development in a low-income country that is superior to tradition developmental aid. Because it is solving the three problems developmental aid is struggling with in a very natural way:
- Ownership: Everybody knows the horrible stories of aid that did not work. In most cases the reason for the failure is that the target group does not feel ownership of the aid product. The good thing of business builders is that they have the drive and ambition to build and to change their own situation. The entrepreneur is moving, an investor is helping to speed up the process.
- Sustainability: The ultimate proof of sustainability for a business is profit and growth. This implies that customers, employees and other stakeholders are satisfied with the products and revenues of the company. Also, the effect of assisting strong entrepreneurs is sustainable because economical feasible businesses are lasting, even after the activities of investors expire.
- Cost effective impact: SME’s in both high and low-income countries are the engine behind the creation of employment. Realizing the best business plans with strong entrepreneurs maximizes impact on the social environment of those businesses. For stakeholders, these enterprises generate the perpetual stream of income needed to uplift their lives in other areas. As a rule of thumb the potential social return on the investment is one direct and 1 indirect employment opportunities per 3000 euro invested.

More financial resources should be available for business builders. According to google.org: “Today, there are trillions of investment dollars chasing returns – and SMEs are a potentially high impact, high return investment. However, only a trickle of this capital currently reaches SMEs in developing countries. Our goal is to increase this flow.” Like them, my person mission, the reason why I am in presently in Uganda, is to increase the investment flow in small and medium enterprises and business builders. I like to contribute in proving its effectiveness in bringing development and making it mainstream. My dream is that investing in medium and small enterprises will be as fashionable as micro-credit is presently.

This requires an effective infrastructure that connects social investors/ developmental aid budgets with good investment opportunities (strong entrepreneurs with strong business plans). This infrastructure is not available in Uganda. To proof the effectiveness of investments in small and medium enterprises in low-income countries I want to build an infrastructure and show that it is working!

Why business builders are not adequately supported

In the previous blog we concluded that small and medium enterprises (SME’s) are vital for the creation of employment and economic growth in low-income countries. Developing SME’s start with selecting the ‘real’ entrepreneurs (the business builders). Persons with the traits of an entrepreneur like high energy level, high need for control, thoughtful risk takers and high degree of determination. How are they facilitated to play their important role?

Actually, there are many organizations in low-income countries like Uganda that target entrepreneurs to stimulate economic development. Governmental organizations, non-governmental organizations (e.g. developmental aid organizations), banks, micro-credit providers, business associations, universities. In Uganda I counted at least 200 organizations involved in stimulating entrepreneurship. But I think we can easily double that number. A substantial amount of developmental aid is directly or indirectly focused on business owners. Actually, the entrepreneur is one of the most popular target groups for developmental effort! Problem solved?

To answer the question of appropriateness of the services provided by these organizations we should first ask the question: What are the constraints for the ambitious and capable small or medium business owner (the business builders) to grow their enterprise?

Unfortunately there are many. The single most overriding constraint (evidenced by many research) for entrepreneurs is the mobilization of financial resources. Another highly important constraint is knowledge and experience, both industry specific (technical skills, production, quality management) and general (how to do sales, financial management, HRM and people management). Depending on the industry other often referred constraints are: infrastructure (utilities and transportation), market access and regulations and corruption.

Because the mobilization of financial resources is the largest, let’s examine the financial services landscape through the eyes of the business builders. My statement is: there is also a ‘missing middle’ in the present support for business builders

Several types of organizations are active in providing financial services to entrepreneurs:

Microfinance institutions

Micro finance institutions (MFI’s) provide micro financial services. In Uganda there are 90 MFI’s active (many of them having more than one outlet). Most well known service of MFI’s is micro-credit. Microcredit is the extension of very small loans (microloans) to the unemployed, to poor entrepreneurs and to others living in poverty who are not considered unbankable. These individuals lack collateral, steady employment and a verifiable credit history and therefore cannot meet even the most minimal qualifications to gain access to traditional credit. The interest rates charged for micro-credit are significant. And so are the overhead costs incurred by the small amounts of the loans and the time intensive collection. MFI’s have adapted different methodologies to compensate for risk, like learning people to save first before they can apply for a loan and loaning to groups instead of persons to create peer-pressure for loan repayment.
Micro-credit is probably the most hot type of developmental aid. Because it works. State of the art micro-credit suppliers are capable of providing micro-credit on a self-sufficient level. Microcredit is increasingly gaining credibility in the mainstream finance industry and many traditional large finance organizations are contemplating microcredit projects as a source of future growth. The United Nations declared 2005 the International Year of Microcredit. In 2006 the founder of micro-credit in developmental countries, Mohammed Yunus, was awarded with the Nobel price. In The Netherlands Princess Maxima is an ambassador for micro-credit.

Is microcredit capable of addressing the financial resource mobilization problems of the business builders? The answer is a clear No. Because in most cases microcredit is too micro. It is a service well suited for micro enterprises (with limited growth potential). But in most cases the entrée and expansion investment for more ambitious and more promising ventures are far higher than the micro-credit loans offer. This is an important constraint of the impact of micro-credit: it is well-suited to establish micro enterprises but the impact on the creation of small and medium enterprises is limited.

Banks
There are ca. 20 to 30 banks active in Uganda, both African and multinational. The most important service banks provide to entrepreneurs are loans. The loans provided are significantly higher than micro-credit. The amounts provided are adequate for the needs of SME’s. But there are other reasons why these loans are not accessible or not suited for SME’s.
- For most entrepreneurs it is very hard to apply for a loan. They are ‘unbankable’. The criteria are harsh to meet. Most banks only loan to entrepreneurs with suffice guarantees (e.g. properties) which most entrepreneurs do not have. The procedures to apply for a loan are very burdensome. And to compensate for risk the interest rates for loans is very high.
- Presently, some banks provide loans to people without guarantees. But interest rates on this loans generally range between 25% and 30%. Capital is an expensive resource.
- The provided loan products are not adequate structured for investments in growing businesses. Most loan products are short term finance. Long term investments cannot be financed with these services. Also, in most cases after disbursement the payment of the interest and pay back of the loan starts immediately. The entrepreneur needs to payback before the cash inflow of the financed investment arrives.

Risk capital providers
There are some risk capital providers (private equity, developmental banks and international financial institutions) providing (quasi) equity. These institutions and investors are not reaching the business builders and small and medium enterprises because minimal investments are in most cases 1 million dollars. In Uganda, only large enterprises need that kind of investments.

To conclude: there is a massive gap in the provision of finance to small and medium entrepreneurs. The most interesting business opportunities are precisely located in this gap. The present financial landscape is not addressing the needs of those small and medium enterprises. Every real entrepreneur faces this gap when trying to build his business.

Target group: Business builders

Most of the people with businesses are not entrepreneurs

The Ugandan streetscape is full of entrepreneurs: the many shops and sellers are giving the impression that half of the population is selling things to the other half of the population. There are a lot of small scale craftsmanship’s like sewing, furniture making and carpenters. And the transportation sector that consists of many boda-boda drivers (moter-taxi’s) and matatus (minibus taxis). Measured on the number of business owners and self employed individuals Ugandans are much more entrepreneurial than (for example) the Dutch!

But I think the business activities undertaken by those entrepreneurs do accurately signal the problem of inefficiency and poverty in low-income countries. Many business are similar and for this reason do not really add value to the economy.

One typical example: There are several mobile telecom providers in Uganda and most of the Ugandan people own a mobile telephone. Mobile telecom is one of the biggest industries. Almost all the subscribers are pré paid: you buy a SIM card for 3000 Ugandan shilling (€1,25) and airtime ranging from 1000 Shilling up to 20.000 shilling. Airtime is sold on every street corner. Many small outlets only sell airtime. The distribution network of the telecom providers is brilliantly dense. Dutch telecom operators would be jealous. Good for them, easy for me as consumer, but is this an efficient economy?

The same patterns shows for consumer goods (shops everywhere), food (restaurants or teashops), tank stations, boda-boda drivers: there are far too many competitors to stay busy and be productive. Low productivity equals low income. It would be better if economic activity was organized differently. So, who is organizing economic activity?

The most common definition of an entrepreneurs is someone who owns and is in charge of a business. Wikipedia defines the entrepreneurs as: An entrepreneur is a person who has possession over a company, enterprise, or venture, and assumes significant accountability for the inherent risks and the outcome. In Uganda the exact number of business owners is not known. Estimations range from 100.000 to more than 1 million, making them significantly imprecise. Partly these deviations are caused by differences in definition. But the most important reason for this is that most business owners operate it what is called the informal sector: they are not officially registered as a business.

Most of the enterprises in Uganda are called micro-enterprises. Micro-enterprises are defined a business started with as little capital as possible, or less capital than would be usual for a business. Typically they have 5 or fewer employees and a seed capital of less than $10,000 (for many of them the with significant lower). The above examples of airtime sellers, transporters and craftsmanship’s are good examples. Most micro enterprise owners are in business because it is their only way to earn some income. The little income they can generate in an already overcrowded market is more than welcome. The businesses operate on subsistence level: cash in is cash out. Most of the earnings are used for the family and the level of re-investments or expansion investments in micro enterprises is very low. The ambition to grow is limited.

It will be clear that these entrepreneurs are not really entrepreneurial. And their business models will not be very sustainable when real economic development hits in. But when this happens there will be a better alternative: paid jobs. The absence of paid jobs is essentially the reason why they are in business. So the question is: how to create jobs that add value to the economy?

It is generally recognized that in high income countries small and medium enterprises (and not micro enterprises) are accountable for a significant proportion of employment. Small and medium businesses (SME’s) account for 51 percent of America’s gross domestic product. More important: small and medium enterprises are accountable for growth in the number of employment. More than two-third of the new jobs in America are created by small and medium enterprises. From 1989 to 2004, by one estimate, they created 30 million jobs, while in the same fifteen year period, Fortune 500 companies shed 5 million.

In low income countries the contribution of SME’s to employment, employment creation and gross domestic product is much lower. The most important reason for this is the small number of SME. In the literature the absence of SME’s is called ‘the missing middle’. This is illustrated by the graph below (source: Harvard).

To reframe the question again: how to create jobs by stimulating the rise of the number and size of SME’s?

I think the answer is in another definition of an entrepreneur, also quoted in Wikipedia: Entrepreneur in English is a term applied to the type of personality who is willing to take upon herself or himself a new venture or enterprise and accepts full responsibility for the outcome. In this definition the entrepreneurs is in essence a personality type. Most mentioned character traits of entrepreneurs are: high level of energy, need for achievement, drive to be independent, high need for control, (moderate and thoughtful) risk-takers, high degree of resourcefulness, high degree of determination, sense of urgency and pragmatism, high degree of integrity and strong communication skills. My estimation is that the business owners as a subset of business owners is very small, probably a few percent.

This type of entrepreneurs (that are also more or less capable) is are the best change agents for development in countries like Uganda. Supporting them also addresses the classical challenges of developmental aid in a natural way:
- Ownership: They are self-motivated. It is their own ambition to create and develop. The entrepreneurs are real owners of their business.
- Sustainability: a successful business is the ultimate example of sustainability. Successful businesses are making a profit, are growing. They are a catalyst for wider progress to be made. They provide the owner and employees with generate the perpetual stream of income needed to uplift their lives in other areas.

In the next blog I will discuss how the needs of those entrepreneurs (let’s call them the ‘business builders’) can be addressed and how they are currently supported.