IMPLEMENTING THE NEW PARTNERSHIP FOR AFRICAN DEVELOPMENT (NEPAD) BY PROMOTING THE DEVELOPMENT OF THE SME SECTOR IN THE CONTEXT OF CAPITAL MARKETS IN AFRICA

by Chief Dennis O. ODIFE
(Article Reference: Document No.18, November 2002)

Background
Sometime ago, I had the privilege to address members of the Lagos Chamber of Commerce and Industry at their Year 2001 Second Lecture Luncheon held in Lagos. In my presentation, I drew attention to a number of minor contradictions contained in the Nigerian banks SME funding Programme. In my view, these shortcomings needed to be addressed to facilitate implementation of the Scheme. I have read that paper again and see no reason to alter the views I expressed at the time. The issues I raised are fundamentally, design rather than implementation issues.

I had raised some of the same issues in an earlier paper titled "Promoting SME/SSI in Nigeria" when I provided a background to the formulation of economic policies for the promotion of SME/SSI in cooperation rather than competition with government to develop the economy. I shall summarize some of the issues raised here to the extent that they are of relevance to other African countries as well:

1. Government says it is committed to private sector leadership of the economy.
   
2. Government erroneously assumes that the private sector comprises only those who are players in it today, especially the Organised Private Sector (OPS), ignoring the informal sector.
   
3. This leads to the true but unfortunate comment that the private sector has not been able to generate growth.
   
4. An economy, in which government has been as dominant and for as long as it has been as in ours, will of necessity hardly have a private sector worth speaking about which one can expect to generate growth.
   
5. We may for now, ignore the equally valid argument that the private sector that exists has been battered and is not in any position to generate growth.
   
6. Going by the size of our population and the potential yet to be tapped, the existing private sector is a tiny fraction of the size of the private sector that can drive this economy and provide the needed leadership.
   
7. How will the 'private sector' be expanded to be able to have a chance to provide the much-desired economic leadership?
   
8. The first step is to achieve successful privatisation.
   
9. Second, the private sector will expand as a result of new entrants who come in to exploit the tremendous opportunity sets to be released by the freeing up of competition prior to and consequent upon privatisation.
   
10. Third, the private sector will expand as a result of entry by (a) our own entrepreneurs whom we must now encourage to start up their companies and (b) exploit the opportunities which we need to show them, and (c) based on funding which we have to provide through the banks and (d) from financing opportunities which we must provide for them through capital market reform.
    
11. Fourth the private sector will further expand when the existing businesses recover and begin to use up more capacity and even to expand.
    
12. Fifth the private sector will further expand as a result of foreign investment whether by Nigerians bringing back their money or by foreigners, including Africans in Diaspora coming to exploit new opportunities in Nigeria.

Private sector ownership and leadership of the economy is therefore of strategic importance to every African country. Hence if the Scheme were to fail it would not in my view be because implementation was faulty. Rather it would be on account of design errors, which are still present in the conception of the Scheme. For these reasons, I shall expatiate on the issues once more in the hope that they will be better understood this time. It is my hope and prayer that policy makers will use them to enhance the design of the scheme to make implementation easier and more straightforward.

In so doing I shall be repeating some of the points made in the earlier papers. I shall as much as possible be doing so only where, in my view, the issues involved can be better focused, this time with possible examples to make them better understood. I shall also introduce a number of other concepts that may have been mentioned earlier though only in passing.

a) Clearer Identification of Beneficiaries
Who are the intended beneficiaries of the SME Funding Scheme?
There is need for the beneficiaries of the scheme to be more clearly identified. Whereas the promoters of the existing SME and SSI in the country think that they are the sole beneficiaries of this fund, and even the banks may think so as well, they all do so in error. Since the fund is a growing one, its beneficiaries must include not only existing SME/SSI but also potential ones.

The requirement for African ownership and leadership of NEPAD adds a further dimension. Seen as a component of NEPAD all Africans will be obliged to embrace the promotion of SME and SSI wherever they live in their respective domains and countries as a way of achieving rapid growth and development therein. There lies the promise of growth. Nigerians, young men and women, old and young, and indeed all Africans, who are desirous of establishing their own businesses, will now have a chance to do so under this scheme. They must be told and they must be encouraged to reach out to the scheme and to take advantage of it to set up their own SME or SSI. Some will fail, some will succeed, and that is how it should be.

Clearer identification of beneficiaries will lead to an expansion of the universe of persons to which the scheme should apply. Young graduates as well as retired persons who think they are able to set up SME are thus challenged and invited to strive to participate. They are all invited to learn more about NEPAD, to learn about this scheme, to understand the need for entrepreneurship training and to find out which SMEs are best suited to their localities. Thereafter, they are invited to think more of investing than of making frivolous expenditures. They are to be encouraged to see their destiny as a matter of choice and to find ways to accumulate capital for enterprise promotion. This can only be good for both the banking system and for the African economy.

To help this later group participate in the SME programme may also require that we look to the idea of incubation centres such as they have in Israel and Malaysia, to name a few places. Promotion of SME/SSI development in Africa would probably require more extensive and aggressive enterprise incubation than in other parts of the world, in view of the scale of the problem.

b) Provision of Entrepreneurship Training for the Beneficiaries
All beneficiaries of the SME programme have something in common; they all need entrepreneurship training to enable them to refocus their ideas and to bring out their best. Banks, as implementation agents of the scheme, must find ways to assist SME promoters in this regard. Banks can do so by themselves running entrepreneurship-training programmes all over the country, not just in Lagos and Abuja, and by running such training programmes at affordable prices. Alternatively, they may encourage other training organisations including NGOs to provide such training. The same would apply to other countries once the programme is adopted continent wide.

Such training should also include the identification of potential projects especially where it is backed with research showing the gaps in the production or demand/supply of particular items in the country.

The identification of projects that could be done in particular areas of the country should therefore be a major national research effort in the drive to discourage trading and to promote industrialisation. African countries should all embrace this approach as an aspect of NEPAD.

c) SMEs need lots of Financial Advice
Even the existing SME/SSI are unlikely to automatically qualify for bank equity without some financial advice, however provided. Some banks may provide such financial advice themselves. Many of the SME in the country are already distressed and in need of reactivation and refurbishment. The books of accounts of SMEs are seldom in order and their audits may be in arrears. Not being obliged to report to anyone, most SME operators take their time in getting their records straight. Moreover, even when they do so, they probably grossly understate their incomes for tax purposes. Based on such understated incomes, they may therefore look unattractive to any potential investor. In addition, they are likely to resent the possibility of their performance and the worth of their businesses now being judged on the basis of such 'defective' records. They will need time to set the records right but time is hardly on their side. We need to persuade SME operators who fall into this category, (and they are probably in the majority) to come forward and we need to find ways for the system not to penalize them for the errors of the past.

African nations may need to review their corporate reporting frameworks to capture the essential data of SME operators without pushing them into the revolt bracket that Hernando de Soto explained to be a major cause of informality.

d) SMEs unlikely to be able to pay for Advice
Most SMEs operate on a small scale for lack of funding. They practically live from hand to mouth and scarcely have funds with which to purchase hardware, talk less of paying for 'software' in the form of financial advice. They may in fact not even appreciate that they need such advice and even when they do, they may not be able to pay for such advise.

Moreover, not many banks are competent to render the sort of advice that SMEs need. However, banks have the means to retool quickly and to pull in the experts who will give such advice as part of their services. Banks are now doing this and setting up SME Departments as part of universal banking. The existence of the SMIEIS and the large reserves banks have accumulated is an added impetus for them to set up such desks or departments and to man them appropriately.

Banks will also have to discover innovative ways of providing such financial advice to needy SME for the mutual benefit of all. In the context of NEPAD and the regeneration of the African continent, African nations will all have to refocus on how to educate their people for entrepreneurship and how to offer the sort of advice which SME operators need on terms which are affordable.

e) SMEs need Equity but prefer to take Loans
As was noted above, most SME tend to be undercapitalised precisely because the promoter did not have the resources to plough into the business. After operating as a one-man show, such promoter is however resentful of any attempt to share control of his business, which is what equity represents. The entrepreneur would thus rather prefer to take a loan, which he or she hopes to be able to repay soonest, than to receive any bank's equity investment. In addition, entrepreneurs would prefer to receive such loans at some low concessionary rate of interest.

Unfortunately for such promoters, the SMIEIS is an equity fund and not a loan fund, and banks are not permitted to give out any part of the SME reserve as loans. In addition, in the current monetary policy environment of tight money, banks are unlikely to lend other funds to the SME at affordable interest rates, until the issue of high interest rates in the economy is better resolved.

The challenge of NEPAD is that it would oblige all African nations to seek macroeconomic stability and to pursue policies that bring interest rates down to acceptable levels. Each government is thus seen as the architect of its peoples' fortunes, good or bad.

f) Banks have equity funds to give but prefer to give loans
On the side of banks, the truth is that the SMIEIS (Small and Medium Industries Equity Investment Scheme) is a fund to be invested in the capital market but very few banks understand and play in the capital market. They therefore lack the skills to handle this programme. Equity investment is more risky than lending and banks are merely being risk averse when they prefer to lend than to give equity. They usually take securities for lending and can even appoint receivers or receiver-managers to recover the loan. For their equity investment, there is absolutely nothing they can do in the event of failure, except perhaps take over such business and run it better than the promoter.

On the other hand, it may be that banks are simply disinterested, because the SME Reserve funds are already outside their balance sheets, to all intents and purposes. Banks would perhaps prefer the traditional option of lending rather than venturing into the new area of stock investing especially in unquoted securities.

From this point of view the SMIEIS represents both a challenge and an opportunity. It challenges the banks to find out the best way to deal with the problem, and it is an opportunity for them to learn about the stock market and to discover the hidden value in the SME sector of the economy and their operators.

In the context of SME funding, this aspect of getting the funds into the SME is the problem of delivery. In the context of the NEPAD, ownership is more in keeping with equity and the capital market than with the money market. Sourcing the funds from the banking sector for investment in SME equity is ingenious but the true masterstroke will be achieved when the banks are able to deliver such funds to the needy SME in the context of African capital markets. The current state of African capital markets need not be a deterrent. If existing markets are not suitable, it is perhaps because they were not designed with the small African investor in mind. The challenge under NEPAD is to design the sort of capital markets, which have the small African investor in mind and which will trade the sort of securities that he and perhaps not the foreign investor would like to invest in. Such capital markets will probably be smaller, slimmer, [thanks to IT] and be community based.

g) What is the Fair Price for the Shares of the SME and who determines it?
In all of the argument about investing in SMEs, no one appears to have taken cognisance of the fact that investment in equity means investment in the shares of a company and that there has to be a framework for determining the initial fair price to pay for such shares.

First of all, the shares must exist, which is to say that the capital of the SME must be large enough to accommodate the planned investment by banks. To achieve the appropriate capital size, appropriate stamp duties must be or must have been, paid to the relevant government office such as the Corporate Affairs Commission. This is usually a significant investment that many SME are reluctant to make at all.

Second, is that as said earlier, the SME promoter probably understated his true earnings in the past. He now has to sell his shares not on the basis of past achievement but of future potential. He must thus pay for fresh feasibility/viability studies, including projections as a way of justifying the value of the shares. An independent broker or firm of valuers or firm of chartered accountants may have to be appointed by both parties to value the shares.

Most crucial of all is the answer to the question; does the bank intend to be able to re-sell the shares at any stage to any party other than the promoter? In a private company, the bank has to offer the shares first to the promoter. If the promoter does not wish to buy the shares or does not agree with the price, he can of course block any sale. He can do so because in a private company, the right to transfer is usually restricted. It is only in a public company that shares may be freely transferred. In venture capital parlance, we are speaking of an 'exit strategy'. No bank would wish to make an investment for which it cannot envisage an exit. The capital market framework, representing the ability to sell the shares at will, represents such exit.

The public company is therefore the ideal vehicle for the investment of shareholder's funds by any bank. The value of shares in a public company can be determined at any time by reference to the official list of the stock exchange. For public but unquoted shares, the OTC (Over the Counter Market) where it exists, usually provides a reference price. Nevertheless, this would mean that the SME has to become a public company for the purpose of participating in this scheme. Is this what the scheme intends?

Even if the scheme did not intend this, I urge that we need to amend the new initiative by banks to fund SMEs to enable it to provide for this. I argue further that the scheme will only succeed to the extent that we expand our market infrastructure to include markets for trading in the shares of eligible SMEs, and so continually determining the price of their shares.

As I have argued above, even though SME promoters are looking for money they may not necessarily want bank staff on their boards, telling them what to do. It should be recalled that bank SME directors may not even be the most senior bank staff, and that it would not even be in the best interest of our economy for senior bank staff to abandon the management of the banks to run from one board meeting to the other in the SMEs in which their banks have invested. Moreover, for all their wisdom and skill, banks do not of necessity have competence in the running of SMEs. Their contributions, on the boards on which they serve are thus likely to be questionable and possibly unproductive and acrimonious. Both parties would therefore need umpires to keep them on their toes and of good behaviour at all times. Such umpires are best provided in the form of other holders of the shares of the same SME and an impersonal framework like the equity market.

In an earlier section, I drew attention to the possibility of slimmer IT-enabled community-based capital markets focused on the small African investor rather than the foreign investor. I have in mind market frameworks such as the OTC, Over The Counter market, or Capital Trade Points. Such frameworks would enable any shareholder, including the investor bank or banks to sell their shares to other investors and to withdraw gracefully when necessary from the project and without killing the SME. It would also make it possible for other investors who may have appetites for SME/SSI equities to be able to participate in them without owning them exclusively. These ideas are not new. The concept of Capital Trade Points as a framework for the trading of SME equities in various zones of the country was a major proposal of the Panel on the Review of the Nigerian Capital Market in 1996 , which it was my privilege to lead.

As a final note, I have to observe that 'public-ness' may need to be redefined in the context of SME ownership. The company laws of most nations now prescribe a minimum of fifty persons to make up a public company. It should be possible, if the laws are suitably amended for NEPAD, for less than that number to make up a public company. This has recently become the practice in some jurisdictions outside Africa.

---

[5] Dennis O. Odife, "Banking, Insurance and the Capital Market in Nigeria: New Synergies for Economic Recovery", Lagos Chamber of Commerce and Industry, 13th September 2001.

[6] Dennis O. Odife, "Promoting SSI and SME in Nigeria", contained in "Financial Markets in a Democracy", Tolbrook Limited, Ikeja, Nigeria, 2000, [205 p].

[7] Hernando de Soto: "The Other Path: The Invisible Revolution in the Third World", I.B Taurus & Co, Ltd. Publishers, London, 1989.

---

>> Next: Compulsory Education for the Banks
>> Back to Table of Contents