East African SMEs need to do more to meet the expectations of foreign investors

"Entrepreneurs need to show very specifically what their plan is," says Walter Lamberson, a partner at Open Capital Advisors.

East Africa has in recent years received a lot of foreign investors looking to invest in upcoming SMEs, but many entrepreneurs still cite access to funds as their biggest challenge. How we made it in Africa’s Dinfin Mulupi caught up with Walter Lamberson, a partner at Nairobi-based Open Capital Advisors, a strategy consulting and financial advisory firm that offers SMEs support and prepares them for funding, among other things. Lamberson talked about the opportunities in East Africa, the high expectations of risk averse investors, untapped potential in Kenya’s health sector and what entrepreneurs need in order to become investor ready. Below are excerpts. A lot of the investor traffic into East Africa is not resulting in actual investments. Why is this?

I think it is a fair criticism that we see a lot of capital being raised but we don’t see a lot of investments. Fund raising is outpacing investments. We are hoping to change that. That is what Open Capital is about. We see a landscape where, on the one hand, you have a lot of investors who have raised a lot of money and want to invest in SMEs in East Africa. On the other hand, you have a lot of companies that everyone believes could be the engine for economic growth in Africa that have great needs for capital, but you don’t see deals happening.

Part of the reason is that SMEs need more than just capital. They need to be more prepared to meet the expectations of international investors. They need to have clear growth strategies that are thought through rigorously and methodologically.

What do SMEs struggle with?

Management is the biggest constraint in Africa. We love to work with SMEs that have a great manager because we can give them a great strategy. I am not so interested in a bad manager with a really good idea, but I am really excited when I meet a good manager with an idea that can be improved. That is where we are most valuable. We can build an executable strategy. Unlike a lot of consultants, we focus on making recommendations that are implementable and action-oriented.

So what should entrepreneurs do to become investor ready?

It is hard. There is often a misunderstanding of investors' expectations. I think they are actually quite high; investors are quite risk averse even though they have brought their capital to what many perceive as a risky economy. Entrepreneurs need to show very specifically what their plan is. They don’t just need capital; they need capital to do something very profitable for their company and investors. What kind of capital do they need? Do they need equity or debt? Are they expanding all operations or focusing on a specific business line? How much can they expand operations? How big is the market for that particular product? How is it changing? An entrepreneur needs to demonstrate that they have thought through the details such that an investor is going to trust them with someone else’s money. I mean, it’s a big responsibility being an investor. You don’t just hand out money unless you really believe that the person you are giving it to has a clear plan and you know what they are going to do with it.

There are also a number of entrepreneurs who say they want nothing to do with investors. What is the reason behind this thinking?

Some people just want to preserve a lot of equity in their company. I understand that, that’s true everywhere. That is a human problem. It also depends on the capital intensity of the business. There is a lot to be said for bootstrapping; some people don't need much capital. Sometimes the best advice we provide to our clients is: ‘don’t take that deal, don’t take that money, you can do better on your own’. I think entrepreneurs should be pickier and they should demand more from investors. I wish entrepreneurs worried less about equity stakes and interest rates and more about what an investor can do for them beyond writing a cheque. Investors should worry about this too.

Name some of the challenges investors face when they come to East Africa.

They are attracted to this place because they have seen a lot of other funds get raised, some apparent success stories and they think it is going to be easy but it is not easy. Often these fund models have very limited staff and they are investing in a marketplace that is very time intensive, especially on the pre-investment side.

Investors come and say: ‘I see a lot of companies that I like, but none that I can invest in because no one is ready’. They don't have the staff or ability to make those companies ready. Companies need more help thinking through their strategy or they cannot make a compelling case to the investor. There are lots of opportunities here, investors just need to tailor their investment model a little bit more. The off-the-shelf private equity venture capital model from America is probably not the best model for Africa. I see very little innovation in terms of fund structure and I think that’s what people need. You need to be able to provide a lot more direct support to your investees.

We are seeing a lot of grant funding and the growth of social enterprises. Is this a distortion from ‘real’ business and could it discourage profit seeking investors from coming to East Africa?

I am not on a crusader against grants. It’s complicated and there are grants everywhere. I think Equity Bank received quite a bit of grant money and I don’t think anyone regrets that. Even M-Pesa began with grant money. Soft capital allows innovation and I think Africa is a place where we need innovation. I don’t think it is a distraction per se. Are there places where soft capital crowds out more profit seeking capital? Yeah. On a case-by-case basis, you see a company that could really generate strong returns but receives soft capital, and then an investor who can’t accept really low returns doesn’t get access to the deal. Sometimes soft capital allows companies to continue with a bad idea longer than they should. Either way, you have to be really careful before you lambast all grants.

You are doing a lot of research on the healthcare industry. Why the focus on this sector?

It is a huge space because Kenya is a country of 40 million people who have a disproportionate share of health problems. The private sector has an important role to play because often government hospitals and clinics are not cutting it. Kenya has a massive, growing middle class and health is definitely something they spend their money on. We know the private sector can offer the middle class better quality and better prices. We have seen huge success in other business models that serve that middle class in telecoms and banking, for example, but none yet in health. I am excited about the potential of low cost, mass market health insurance. There is a lot of potential for that and it could revolutionise the entire healthcare sector. Kenya is under-insured and some people see this as a challenge but I see it is an opportunity. As the middle class get wealthier they will want insurance, and that insurance will bolster demand for all other healthcare services.

What other sectors do you find attractive?

There is opportunity everywhere. It’s about finding the right business models. We are excited about agribusiness and different parts of that value chain from primary production to processing. We are active in renewable energy, which we see as a big opportunity, where there is going to be a lot of innovation and different business models in the near future. There are all these other things that are hard to classify: manufacturing, distribution, logistics and ICT and telecoms, where there is still more potential.

Any advice for foreign investors coming to East Africa?

When I came here I was more cautious and perceived it to be harder and more risky than it actually turned out to be. Everything is easier than you would think. People hesitate more than they need to. I think Kenya is in many ways a great place to do business. The hang ups are few and far between. The cost of many things is still comparatively low, especially from the perspective of an international investor. I hope Kenya will embrace these advantages and continue to be one of Africa's most attractive destinations for investment.