New AVCA study shows private credit as a viable solution for SME financing in Africa

Private credit remains a niche sector in Africa, with 32 per cent of respondents seeing it as a preferred strategy when investing in African PE over the next three years, according to a report by African Private Equity and Venture Capital Association (AVCA) — the pan-African industry association—in its first comprehensive report looking at the private credit asset class in Africa
The report notes that while private equity (PE) has historically been more prevalent in Africa than private credit, this asset class encompasses a range of strategies that can provide attractive alternative financing options for African small and medium-sized enterprises (SMEs).
They also play a key role in redressing the shortfalls in financing that are commonly faced by private businesses on the continent by providing other options for the consideration of investors desirous of greater clarity over returns.

 “A major factor behind increased interest in private credit in Africa relates to the difficulties that small and medium-sized enterprises (SMEs) in Africa often face in accessing financing through traditional avenues, such as banks”, the report says. “As noted by the African Development Bank, 18 per cent of small firms and nearly 14 per cent of medium-sized firms in Africa cite lack of finance as their biggest business obstacle”.

Medium-sized enterprises can be particularly hamstrung given that their financing needs are of a size rendering them unable to access credit either from microfinance institutions or commercial banks, according to AVCA.

 In 2017, the IFC estimated the finance gap for the 44 million micro, small and medium-sized enterprises in sub-Saharan Africa to be US$331bn, with over half of these enterprises being financially constrained.

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African SMEs often face challenges in accessing capital from traditional providers (banks) and may be reticent to dilute their ownership with private equity – this is the gap that private credit can mitigate.

The report also presented the results of interviews conducted with firms currently or formerly active in Africa’s private credit markets.

Respondents touch upon different topics pertinent to the industry, from its level of competition and the method in which opportunities are sourced, to the strength of the protections for debt covenants in Africa, to the extent and nature of the market’s exposure to macroeconomic cycles.

A key theme that emerged from the research revealed despite the high level of demand from African SMEs, private credit remains constrained. Respondents noted that misperceptions around private credit’s risk-return profile need to be addressed for institutional investors to become more open to backing the industry.

Private Credit in Africa provides further context to these themes through an LP survey. It found that while most LPs expect African private credit to be more attractive compared to other emerging markets and to developed markets over a ten-year time horizon, factors such as currency risk, GPs’ limited track records, and legal, regulatory, and tax issues are some of the key challenges that they face when seeking to invest in the asset class in Africa.

 “This is AVCA’s first in-depth research undertaken on the private credit market in Africa,” Enitan Obasanjo-Adeleye, Director, Head of Research, AVCA, says.

“As the data reveals, there are encouraging signs that adoption of this asset class is set to grow on the continent, providing additional avenues for companies to raise capital for their expansion and create much-needed jobs. We look forward to building on this work at our upcoming annual conference in Nairobi where we will be presenting our findings and hosting a panel discussion on the topic.”