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Investing in Black Entrepreneurs: A South African Fund Leads the Way

South Africa is home to millions of small and medium-sized enterprises. These businesses create jobs and drive economic growth — they are vibrant, innovative, and undercapitalized.

Because of financing constraints, these SMEs often cannot access the capital they need to grow. Fortunately, the leaders of the SA SME Fund recognized the opportunity created by this rich universe of entrepreneurs, so they established a fund of funds to channel more capital into the country’s SMEs and help investors tap into the sector.

The Fund invests in a portfolio of other funds focused on South African SMEs, offering investors diversification, scale, lower volatility, and more stable investment returns, alongside development impact and local job creation.

The SA SME Fund invests more than half of its capital into Black African owned and managed businesses — boosting an inclusive investment ecosystem.

In this interview, Claudia Manning, Investment Principal with the SA SME Fund, shares her insights on the evolving investment landscape in South Africa and the opportunities emerging today.

This interview has been edited for clarity and length.

Why does the Fund have such a strong mandate to invest in Black African businesses?

What relationship do you see between venture capital and impact?

Why has SA SME Fund taken a fund-of-funds approach rather than investing directly in startups?

Attendees of the SA SME Fund 2019 CEO Circle Entrepreneurs event. (Photo: SA SME Fund)

What are some of the challenges you’ve faced raising investment?

Another problem we’ve faced with non-South African investors is that we are a South Africa-focused fund. They often prefer to invest in regional funds or sub-Saharan Africa funds rather than one country fund, which they see as suboptimal.

Also, South African investors still see venture capital as very high risk. We’re working with the USAID to add a first-loss layer of capital into the fund, minimizing the risk for private investors. If the various funds perform well, everybody gets their required returns and are happy, but if the fund performs poorly, private investors benefit from the first-loss layer of capital and will be last in line to lose any money.

What are some of the opportunities you’ve seen in the wake of COVID-19?

The non-banking financial industry — whether it’s providers of microloans or larger loans to established businesses — has an ability to structure debt to these small businesses in a way that manages risk. For example, merchant cash advances are a big feature of the South African retail industry. It works as follows: you look at the financial records of a restaurant or pub and see what the value of their credit card transactions were in the last few months. Let’s say it was worth about $100,000 last month. Now you know that’s the kind of cash flow that goes through the business and that about $100,000 is likely to happen in February and March. You’ll then advance $50,000 or $100,000, knowing that whatever happens to this business, you’ve got the ability to be able to service the debt at fixed, relatively affordable rates.

This business might have missed a bank payment and yet, they’re a good risk to take, because you know what kinds of cash flow you’re lending against. I think that that’s an important industry to be building, because those non-banking institutions will continue to support SMEs particularly in hard times. They will find innovative ways of deploying capital to help these businesses, and of course turn a profit. Many of these non-bank financial institutions have been doing this for many, many years and they’ve figured out how to assess risk and have the infrastructure to disburse quickly, without charging extortionist rates.

The health tech space will be another interesting one to watch. When I look at the companies in our fund managers’ portfolios, none of the heath tech companies were COVID-oriented when they started out. Now probably half of them have pivoted into providing resources or services that respond to the disease. For example, we’ve seen technology to help detect COVID or platforms that can create raw materials used in antigens or even vaccines. That’s a space we’re very excited about because it shows the ability of fairly young startups to pivot and develop tech that can respond to a global crisis.

Read more interviews and stories featuring investors and business leaders in the Prosper Africa Blog