Empact Growth Fund: Filling the Void in SME Finance in Ethiopia

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Empact Growth Fund: Filling the Void in SME Finance in Ethiopia

Ethiopia
Project Summary
Elevator Pitch

Concise Summary: Help us pitch this solution! Provide an explanation within 3-4 short sentences.

Empact Capital is seeking to launch the Empact Growth Fund (EGF), a US$50 million private equity fund targeting Ethiopia’s SME sector. The Fund will be the first multi-strategy investment vehicle focused exclusively on Ethiopia, designed to realize the commercial and developmental objectives of both development finance institutions (DFIs) and private investors.

About Project

Solution: What is the proposed solution? Please be specific!

The financial sector in Ethiopia has always been strictly controlled. With commercial banks primarily focused on short-term loans and trade finance, the private sector’s financing requirements come last in the pecking order and lending criteria are draconian. Unsurprisingly, SMEs suffer the greatest discrimination from banks’ credit policies: credit analysis and risk pricing mechanisms are rudimentary, collateral requirements, generally property-based, are effectively insurmountable and cashflow-based lending is not considered. As a result, SMEs will remain under-attended or entirely overlooked, and the continuum of financial products needed to help businesses migrate from start up to small and medium-sized and beyond will remain absent. For the reasons highlighted above, Empact believes that the timing is particularly favourable to launch a private equity fund targeting SMEs in Ethiopia. This perspective is the result of three years of research and engagement with the private and public sectors and the Ethiopian government. The Empact Growth Fund will be the first multi-strategy investment vehicle focused exclusively on Ethiopia, designed to realize the commercial and developmental objectives of both private international investors and DFIs.
Impact: How does it Work

Example: Walk us through a specific example(s) of how this solution makes a difference; include its primary activities.

Despite its diverse economy and enormous growth potential, Ethiopia remains one of the world’s poorest countries. Given the dearth of risk capital available to Ethiopian SMEs and the vital role they play in the country’s economic and social fabric, Empact considers that the social impact of the Fund will be significant, particularly in the following areas: • wealth creation and poverty alleviation through employment generation as portfolio companies grow; • strengthening the management and governance of Ethiopian SMEs, thereby enhancing their competitiveness within and beyond East Africa; • improving the environmental and social performance of portfolio companies by enabling portfolio companies to pursue sustainable expansion strategies • alleviating foreign exchange shortages and balance of payments pressures as hard currency earnings of export-orientated portfolio companies increase; • reducing import dependence (and associated demand for foreign exchange) by supporting the domestic manufacturing sector; • establishing private equity as a commercially-viable asset class, a critical step towards the development of effective capital markets and mobilization of domestic savings in Ethiopia; Empact recognizes that measuring and reporting development impacts are critical to prospective investors in the Fund. Robust monitoring and evaluation mechanisms will be implemented to ensure that key development indicators are tracked throughout the investment cycle. In addition, all portfolio companies will be required to commit to implementing international environmental, social and governance standards in line with World Bank/International Finance Corporation standards.
About You
Organization:
Empact Capital
Visit website
About You
First Name

Michael

Last Name

Gizaw

Your Organization

Empact Capital Partners, LLC

Country

, DC, Washington

About Your Organization
Organization Name

Empact Capital

Organization Phone

+12027230986

Organization Address

Addis Ababa, Ethiopia | Washington, D.C.

Organization Country

, AA

Organization Type

Private Institution

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Your solution
Country your work focuses on
If multiple countries, please list them here. If your solution targets an entire region, please select it below
Region(s) your solution focuses on:

Africa.

Range of turnover in your target firms, in USD

$1-5 Million.

Average turnover in USD of your target firm

$3.5 million

Number of employees in your target firms

50-74.

Average number of employees of your target firm

60

Specify the size, average and range of expected loans or investments in each target firm

Over the past two years, Empact has been developing a pipeline of investment opportunities for the Fund that it intends to execute immediately upon the First Close of the Fund. With over 200 businesses already screened and over 40 companies vetted and qualified, Empact expects to invest US$250,000 to US$5 million in approximately 10 to 20 companies that are well-placed to take advantage of domestic and cross-border growth opportunities. The Fund will seek to create a diversified portfolio of investments across a range of sectors, including, but not limited to agribusiness, manufacturing, fast moving consumer goods (FMCG), hospitality & tourism, construction & engineering, and services.

What stage is your solution in?

Operating for 1‐5 years

Innovation
How does your proposed innovation leverage public intervention in catalyzing private SME finance?

Empact Capital intends to primarily target development finance institutions, international foundations, and multilateral institutions to raise capital for the Empact Growth Fund. Moreover, the Fund has benefited from the concerted engagement efforts of the World Bank, IFC, and IMF with the Ethiopian government in creating the enabling environment to facilitate FDI and familiarizing private equity as a form of FDI.

What barriers does your proposed solution address?

Asymmetry of information, Lack of collateral, Lack of financial capacity, Lack of SME access to skills / knowledge / markets, Unavailability of financial products tailored to SME needs, Lack of competition / incentives for financial intermediaries to serve SMEs, Underdeveloped local capital markets (term local currency funding, exit options for SME equity), General barriers to SME development related to investment climate, Lack of financing to women entrepreneurs.

If you checked any of these barriers, describe how your solution addresses them

In Empact’s view, the Fund represents an important milestone in redressing a vital, missing instrument on Ethiopia’s financial landscape: risk capital. Empact believes that, in addition to channeling investment capital to resource-starved SMEs with high-growth potential the Fund will help SMEs to overcome the following 4 challenges, among others, which impede their expansion and profitability:
1. Weak Management Capacity and Corporate Governance: As indicated above, short-termism, volatile cash flows, the inability to accumulate working capital and the inimical operating environment have encouraged many Ethiopian SMEs to avoid formalization. Ad hoc financial management practices and lack of financial controls combine with the lack of robust corporate governance arrangements to make SMEs weak and vulnerable from an institutional perspective.
2. Lack of Transparency and Complex Ownership Structures: Although there is a vibrant, highly informal share-trading market in Ethiopia, the absence of formal capital markets and a tradition of secrecy in response to years of centralized, socialist economic policies has exacerbated the lack of transparency in most SMEs. For similar reasons, ownership structures tend to be opaque, and it can be difficult to discern not only the actual owners of businesses, but also the locus of decision making within a company. Empact believes such practices are gradually improving, especially as more stringent yet transparent fiscal policies—and, more importantly still, even-handed implementation—encourages disclosure.
3. The Formalization Burden: Until recently, when the government began to streamline registration and administrative procedures for businesses, formalisation and compliance represented such onerous resource and time requirements that many SMEs preferred to remain below the radar screen. Empact believes that the partnership embedded in the relationship between the Fund and portfolio companies will encourage SMEs to realise the advantages of formalisation, especially as capacity constraints are alleviated in the process.
4. Inability to Scale: Empact considers that Ethiopian SMEs have traditionally found it very difficult to achieve scale and re-invest in their businesses. In addition, the dominance of agriculture in the rural economy, itself a volatile and weather-dependent sector, has meant that disposable income among the rural population to consume goods and services provided by SMEs has fluctuated. Gradual improvement in agricultural productivity, coupled with the emergence of a middle class and more significant levels of domestic demand, especially in urban centers, is providing the stimulus for demand-led expansion. However, in Empact’s assessment, risk capital will be critical to ensure that SMEs are appropriately positioned to take advantage of these opportunities in a sustainable manner.

Impact
Provide empirical evidence of your proposed solution's success/impact at present. If your project is in the idea phase, please provide evidence that speaks to its potential impact

Empact believes that the development impact of the Fund, targeting companies in one of Africa’s poorest countries where risk capital is all but non-existent and the private-sector remains chronically under-invested, will be extremely significant. More specifically, Empact considers that the Fund will be well-placed to achieve tangible, meaningful development impact in the following three areas, among others:
1. Poverty Alleviation
• employment generation as Empact portfolio companies grow which, in turn, will help to underpin wage increases with important multiplier effects at the family and community levels;
• improvements in the livelihoods of portfolio company employees, not just from the perspective of meetings basic needs, but also, empowerment, security and reducing vulnerability;
• concrete contributions to the achievement of the Millennium Development Goals (MDGs), notably:
• MDG 1: Eradication of extreme hunger and poverty
• MDG 3: Promotion of gender equality and empowerment of women
• MDG 7: Environmental sustainability
• MDG 8: Global partnership for development
• to the extent that the Fund makes investments in the pharmaceutical and healthcare sectors (which, at the time of publication of this Memorandum, the Manager believes is likely in light of the investment pipeline), the Fund may also be in a position to make contributions to more specific, health-related MDGs.

2. Corporatisation
• professionalisation of Ethiopian SMEs, whose management capacity and corporate governance require significant strengthening in order to attract complementary domestic and international financing;
• reducing the vulnerability of SMEs which, the Manager believes, often struggle to achieve critical mass due to lack of access to working capital and the resulting cash flow fluctuations and short-termism; and
• assisting SMEs to achieve international standards of accounting, financial management and internal controls.

3. Private Sector Development
• accelerated growth of the SME sector, the backbone of the Ethiopian economy;
• purveying much-needed risk capital to private Ethiopian business which, in the Manager’s view, are starved of risk capital and require equity to grow;
• demonstrating to the Ethiopian government the tangible results, in the form of increased FDI channelled by the Fund, of making improvements to the operating environment and investment climate;
• helping to re-calibrate the Ethiopian economy by forging a stronger private sector to complement the heavily-invested public sector;
• reducing costly import dependence by building domestic productive capacity and competitiveness, thereby helping to alleviate foreign-exchange shortages;
• contributing to the deepening of the financial sector by introducing vital intermediaries, such as a private equity fund, to provide an important counterweight to tightly-controlled public and private banks; and
• facilitating complementary FDI inflows as private international investors take note of the opportunities which the vastly under-invested Ethiopian economy offer;

How many firms do you expect to reach?

With over 200 businesses already screened, Empact expects to invest in approximately 10 to 20 portfolio companies. Due to the interconnectedness of the SME segment in Ethiopia, Empact estimates that its direct investments into 15 SMEs could potentially benefit over 45 additional SMEs through local procurement of goods and services that accompany expansion plans of the portfolio companies.

What is the volume of private SME finance you aim to catalyze?

Empact is seeking to raise US$50 million for SME finance in Ethiopia. Empact expects to mobilize up to 10 percent of the total Fund capitalization from private sources. Moreover, Empact plans to tap into local financial institutions to gain access to debt financing to its portfolio investments, when needed and appropriate.

What time frame will be required to reach these targets?

Empact is targeting a first close of the Fund in March 2011. Following discussions with prospective investors in the second half of 2009 and early 2010, numerous development finance institutions, multilateral development banks and high net worth individuals have demonstrated significant interest in a private equity fund providing exposure to Ethiopia’s heavily under-invested SME sector. Once the Fund closes, Empact plans to deploy the capital within the first three years.

Does your solution seek to have an impact on public policy?

Yes

What would prevent your solution from being a success?

There are two primary issues that might hinder Empact’s success. One is lack of much needed “last mile” seed capital to establish and launch the Fund. Second is raising the appropriate amount of capital needed to fully capitalize the Fund and its associated Technical Assistance facility in order to deliver the developmental impact promise of the Fund.

Sustainability
List all the funding sources that are required for the sustainability of this solution

Over the past two years, the founders of Empact Capital have been the main sources of the startup capital. At this point Empact is looking for additional “last mile” seed capital to support the cost associated with the formation of the Fund, fund management team and any additional fund closing costs. Empact requires a commitment of $300,000 to sustain operations, successfully mobilize the Fund, and invest in SMEs.

Demonstrate how your proposed solution has the capacity to graduate from dependence on public finance. What is the time frame?

Once Empact reaches first and subsequent closes on its Fund, it will be able to operate independently without public finance since it plans to charge management and other associated fees to the Fund. Empact is targeting a first close of the Fund in March 2011 and subsequent closes in Summer 2011.

Demonstrate how your proposed solution will survive a potential loss of its largest private funding source

Over the past two years, the founders of Empact have been infusing capital to reach this critical stage. If Empact isn't able to mobilize public finance to take the Fund to its final stage, the timeline for the fund will be dramatically extended.

Please tell us what kind of partnerships, if any, could be critical to the greater success and sustainability of your innovation

Empact believes that the nascence of private equity in Ethiopia and the lack of familiarity of many Ethiopian SMEs with external participation in their ownership structures mean that particularly intensive interaction and mentoring will be required in order to realize value in the Fund’s portfolio companies. Empact believes that additional resources must be brought to bear in order to put portfolio companies on a trajectory of long-term growth and profitability that endures long beyond the Fund’s exit. For this reason, Empact will seek to establish the Empact Technical Assistance Facility with commitments of up to 10% of the total target Capital Commitments of the Fund. Thus, Empact will forge partnerships with appropriate technical assistance and other relevant resource providers to leverage the TA facility.

Are there non-financial issues that could threaten the sustainability of your proposed solution?

Investments in SMEs such as those that the Empact Fund intends to invest in, while often presenting greater opportunities for growth may also entail larger risks than are customarily associated with investments in large companies. Ethiopian SMEs may have more limited product lines, markets and financial resources, and may be dependent on a smaller management group. As a result, such SMEs may be more vulnerable to general economic trends and to specific changes in markets and technology. In addition, future growth may be dependent on additional financing, which may not be available on acceptable terms when required. Further, there is ordinarily a more limited marketplace for the sale of shares in SMEs, which may make realizations of gains more difficult, by requiring sales to other private investors. In addition, the relative illiquidity of private equity investments generally, and the somewhat greater illiquidity of private investments in SMEs, could make it difficult for the Fund to react quickly to negative economic or political developments.

Please tell us if your proposed solution aims to scale up through a high growth sector, expand immediately to multiple sectors, and/or scale up geographically

Centrally located within East Africa, and at the cross roads of Africa, the Middle East and the Gulf states, Ethiopia stands to play an increasingly vital role in this commercial, economic and political nexus. Empact plans to leverage Ethiopia’s strategic position to seek for investments that are keen to expand across borders in the region. Also, Empact believes that Ethiopia’s domestic market provides tremendous opportunities for SMEs to meet a growing consumer market with a population of over 80 million inhabitants, Africa’s second-most populous country. Upon the success of the Empact Growth Fund, Empact intends to raise subsequent funds to deploy in Ethiopia and the broader East African region.