African growth finance faces cost barrier

High set-up costs and a lack of performance data are two obstacles that the ‘missing middle’ needs to overcome in Africa.

The proliferation of growth finance in Africa is facing several obstacles, including high costs and insufficient returns.

Often referred to as the “missing middle”, growth finance involves providing capital and business support for small- and medium-sized businesses that are unable to attract capital from other sources. Target businesses for growth finance funds are typically too large to go to microfinance institutions and too small for private equity and traditional commercial lenders.

This is a high transaction cost environment.

Jurie Willemse

“This is a high transaction cost environment, and investors need to understand that 4 percent is typically what you need to manage funds at this level,” said Jurie Willemse, founder and managing director of Africa-focused growth finance provider GroFin.

Limited partners in emerging markets private equity funds are typically exposed to a “2 and 20” fee structure, whereby the fund manager collects fees of 2 percent of the assets under management and a 20 percent outperformance fee once a pre-agreed benchmark is passed.

GroFin, along with Johannesburg-headquartered Business Partners, is one of the pioneers of growth finance in Africa.

Currently the bulk of investors in the asset class are development-focused organisations. Limited partners in GroFin’s latest fund include UK government development fund of funds CDC, Dutch development bank FMO and long-time investor the Shell Foundation, a charity founded by the Shell Group that focuses on global development.

Willemse was speaking at a seminar at Cass Business School in London, at which panellists outlined the potential scale of the industry and the obstacles it needs to surmount.

One delegate said that commercially-minded alternatives investors would normally expect a 20 percent return from an emerging markets investment, rather than the net return of between 5 percent and 10 percent as targeted by GroFin.

In order to attract investors on a purely financial basis, and hence become a truly sustainable asset class, the growth finance industry needs to start producing and reporting performance indicators as well as show the “developmental” returns: the positive social impact, said Chris West, director of the Shell Foundation.

Richard Laing, chief executive of CDC, told delegates that the nascent asset class had the potential to overtake microfinance in scale.

“The growth finance sector has huge, untapped potential: 106 million of the world’s poorest families received a microloan in 2007. Growth finance has the potential to reach many, many more,” he said.

“To develop growth finance, the industry needs to introduce slick processes to drive the volume of transactions, create standard structures and standard processes,” he said.

GroFin is due to hold the final close on a $150 million Africa-focused growth finance fund – its fifth and largest vehicle to date – within the next two months.