“It can be a source of deep frustration,” says Kasonde Kashulwe, manager of Challenges’ Ethiopian office. “When you’re working with a great business, with a superb product and cause, and a compelling vision for their future, but they’re being hampered by an inability to secure investment. You want to do everything you can to help them get the deal they’re looking for.”
“The barriers to investment are always complicated,” explains Kashulwe, who is heading up Challenges’ Readying Investable Social Enterprises (RISE) programme in Addis Ababa, “and regional political variations often add their own complications!”
Challenges’ RISE programme aims to help social enterprises become investment and transaction ready, with the long-term goal of supporting these businesses to secure capital and scale up, grow exports, expand their footprint and ultimately increase their employment opportunities.
Kashulwe adds: “When you find that social business with the perfect balance of impact and commercial potential then you want to do everything you can to get that organisation in the right position for a future deal. To make it investment ready in other words.”
“Investment readiness” has become a buzzphrase in many financial and social business circles, but another term — often less mentioned, less understood and significantly more problematic — is “transaction readiness”.
Investment readiness refers to a business’s level of preparation for making that deal to receive finance or investment, and has two main elements. Assuming the business is ready to expand or grow, it will need to have a clear strategy for its short and long-term growth ambitions, and have a plan to utilise finance to achieve its overarching aims. Moreover, the business will have to be in a demonstrably good condition to receive finance, through having strong internal management and operations, and is showing a strong commercial performance and a strong commercial mindset, thereby demonstrating it is ready to grow.
“We know that one of the biggest constraints to SME development is a lack of financial resources to sustain and grow their businesses,” adds Kashulwe, who heads up the RISE programme in Addis Ababa. “SMEs, and especially social businesses, are often underserved by financial institutions [such as banks], as they’re perceived as too risky, or because they don’t have the knowledge, information and capabilities to meet the requirements of funders or investors. This means that investment readiness is vital for many small and medium social enterprises looking to expand and scale up, and as they progress down the road to secure capital, transaction readiness becomes even more important.”
Becoming investment ready is one thing, but it is transaction readiness that can often trip up many small and growing businesses (SGBs), says Wika Kawina of Challenges Zambia. “Once a business is considered investment ready, it still has to become transaction ready.”
Underpinning transaction readiness, the business must prepare a dataroom, a collection of documentary evidence to support the business plan and financial model the business is using in its pitch or investment memorandum to attract investment. This can include more than 100 items of documentation, including contracts, insurances, budgets, forecasts, management accounts, audited accounts, internal and external policies, IP, copyright assignations, and so on.
The documentation is then made available to an investor or their advisers, sometimes an accounting or legal firm. It is then up to the investor or their advisers to go through the information and use it to answer many of the questions they have from the pitch or information memorandum. It is this aspect of the investment journey that is often the thing that can stall, halt or even break an investment deal, especially for SMEs in emerging economies. Most have never had experience of external investment, and those that decide to seek investment are often not told by the incubator or accelerator programmes they go through that this body of evidence will put them in a much stronger position to achieve a transaction.
Without this collection of documentary evidence , the business will have to scrape around for evidence to respond to incoming queries from investors. This can mean a period of many months of to-ing and fro-ing on quite basic questions. With a dataroom, the investor and their advisers can review the business proposition using a framework that will flush out any gaps in evidence or outstanding questions. Any subsequent queries or issues can be addressed far easier by the business, with both sides saving time and money as a result. Another benefit is that the business looks more professional, and the process of discussing deal structure and terms, and ultimately concluding a deal, can be implemented earlier and dramatically accelerated.
“The work and resources involved in putting all this documentation together can be substantial,” explains Kawina, who is driving the SME-focused element at the Private Enterprise Programme Zambia (PEPZ) in partnership with Impact Capital Africa (ICA).
However, all of the up-front effort is worth it, adds Kawina, and if the business continues to manage its dataroom over time, it can remain in a very strong position to communicate with next round equity investors or debt providers, and even use some of the information to speed up agreement of new business-to-business deals, possibly with international buyers, for example.
For SMEs looking to grow, there are investment readiness programmes that can help to businesses know what information to gather and how to order and present it, including two currently being delivered by Challenges associates in Zambia and Ethiopia.
“With the PEPZ programme,” says Kawina, “we have identified 24 SMEs that are at the growth stage, who are looking for investment between $50,000(USD) and $15 million, across a variety of sectors, and who can demonstrate a social and/or environmental impact. We’ve taken them through a pipeline to where they can start thinking about deal structures, and have all the pieces in place to enable that to happen.”
These SMES identified by Kawina and her colleagues will be pitching to potential investors at the Impact Capital Africa event in Lusaka in October. “We want to see these enterprises invested in. We want to maximise their opportunities. Last year, businesses raised $71 million at ICA. We’re expecting that target to be surpassed this year.”
The documentation is vital, obviously, but businesses shouldn’t overlook the importance of a good pitch, too. “As well as taking them through the transaction readiness process, we’ve been putting on pitch masterclasses for the SMEs, too. These have been in front of investment advisers and local investors in Lusaka and these have helped the SMEs to hone their pitch and get the mistakes out the way early. It’s been a superb way to identify, and smoothen, any potential bumps.”
Although each of the Challenges programmes is tailored to the local context; each provides tailored support to the enterprises and their specific investment-related need; and each programme offers in-depth analysis of each business’s investment readiness, as well as professional consultancy, technical expertise, group training, leadership coaching and network building.
“Every business is different. Yes, you apply a template, but you have to tailor it from day one,” says Kashulwe, whose programme in Addia Ababa is supporting 20 social enterprises to prepare for future deals using a combination of onsite consultancy support, technical assistance, group training and coaching.
And while the specifics of these two Challenges programmes vary, there are a few common themes for the SMEs involved. Common issues considered include: regularity of financial reporting; internal financial management; the commercial analysis underpinning the business; costing business activities; pricing products and services; managing cashflow; and breakeven analysis. This focus on the commercial aspects is vital of course: better performance means more surplus which in turn means the business has more capital to invest. This in turn makes the business a better prospect to investors.
And as attractive as it is, investment isn’t always the silver bullet many businesses perceive it to be. “Can your business afford the loan repayments, for instance, if you’re financing through debt? Are you prepared to sell a significant proportion of your business through an equity deal?” asks Kashulwe. “Have you fully considered what happens after your successful investment? It’s important to get the deal structure right.”
The Challenges programmes in both Zambia and Ethiopia take the SMEs through a pipeline of becoming investment and transaction ready. Part of that includes supporting the enterprises to improve their operations, to analyse costs and business assumptions. There are two major advantages of Challenges’ robust assessments of these businesses: first, by improving operations, management might conclude they do not need investment to scale up. The second is that by having this evidence and being able to demonstrate these improvements, the business will actually find it easier and quicker to attract investment. For the social enterprises, this will result in a greater impact.
“There is much more to winning investment than a polished business plan and practised pitches,” argues Kashulwe. “Becoming transaction ready requires considerable effort on the part of the management team, and while it can be enormously beneficial to undergo this journey and bring this information together, the actual net result may in fact be that the business turns away from taking on investment … and it can be all the healthier for it.”
And of course, the transaction, whether it’s for equity or debt or structured in some other way, is really just the start! The real objective is the continued success and growth of the business — perhaps second round investment further down the line — as well as a positive and engaging relationship with the new investor.
“It’s an exciting breakthrough winning investment; a massive vote of confidence in your vision as well as recognition for the work in getting transaction ready. And after the celebrations, well it’s time to deliver and get back to growing your business!”