Written by Ali Al-Suhail, Vice President at DAI Magister
Africa’s mid-market businesses, the backbone of the continent’s economic growth, can find themselves trapped in a financing void. With annual revenues typically surpassing $10 million, these companies find themselves in a precarious position – too large for microfinance, yet too small or risky for traditional banks. The result, we estimate, is a staggering $3 billion credit gap, a figure that highlights the immense untapped potential for investors seeking globally competitive returns while driving the growth of Africa’s most promising enterprises.
The African Private Equity and Venture Capital Association (AVCA) reports that out of the $32.1 billion in private capital raised between 2012 and Q3 2021, a mere $1.5 billion was allocated to private debt. This glaring disparity underscores the challenges faced by Africa’s mid-market companies in accessing the capital necessary for growth and expansion. Venture capital and private equity have traditionally been their lifelines, but as these markets tighten amidst the current macroeconomic climate, the need for alternative financing solutions becomes increasingly pressing.
Over the past decade, nearly 75% of debt funding in Africa has been directed towards asset-heavy businesses in sectors such as cleantech, mobility, agriculture, and logistics, according to Briter Bridges’ report on debt financing in Africa’s innovation ecosystem. While these industries undoubtedly play a crucial role in the continent’s development, the concentration of funding leaves a significant portion of the mid-market underserved.
The limited offerings from traditional banks, which often focus on collateral and cash flow centred around traditional debt coverage ratios, and rarely provide tenors beyond three years, further compound the issue. Regulatory capital requirements and local currency deposit bases also make it difficult for banks to deploy funds in hard currency (such as USD and EUR). Furthermore, banks are becoming increasingly constrained by risk-weighted asset assessments under IFRS, limiting the amount of unsecured assets they can hold on their balance sheets. This shift in risk appetite leaves mid-market businesses with even fewer options for accessing the capital they need to thrive.
While there are start-ups providing smaller SME lending solutions, such as Lendable, Pezesha, and Payhippo, the mid-market growth stage companies needing $5 million or more of unsecured lending remain largely underserved. These companies often require more flexible and tailored financing solutions that traditional banks are unable to provide, creating a significant gap in the market that private credit investors can capitalise on.
Looking at the global picture, Africa’s domestic credit availability lags far behind that of higher-income countries, hindering economic growth and development. World Bank data reveals the stark contrast in credit formation to GDP between sub-Saharan Africa and the rest of the world. In 2021/2022, domestic credit to the private sector as a percentage of GDP stood at less than 36% in sub-Saharan Africa, compared to 216% in the United States, 130% in the United Kingdom, and 162% across high income countries. This disparity highlights the immense untapped potential for private credit in Africa and the critical role it can play in bridging the funding gap for mid-market companies.
Furthermore, the World Bank data illustrates declining levels of private credit formation to GDP in sub-Saharan Africa since 2007. The region continues to lag significantly behind high-income countries, which by contrast has increased its private sector credit ration over the same period, underscoring the need for alternative financing solutions to support the growth and development of Africa’s mid-market businesses.
For investors, the limited financing options available to these businesses means that private credit investors can potentially access some of the most attractive companies in the market, particularly when they can offer the balance of the speed, price, risk and structure. As Ninety One, the global investment manager, notes, “In Africa, where access to finance can be challenging, opportunities are plentiful and offer competitive risk-adjusted returns while also contributing to economic development and sustainable growth. Africa is a large and growing market, with a deficit in global private capital, creating opportunities for institutional investors willing to make the journey.”
Companies seeking private credit in Africa should be aware that investors will primarily focus on dollar-based returns and may require an equity kicker, although the dilution should be materially less than pure equity financing. Senior secured products in the market are currently trending in the 10-13% range, and companies can expect to pay a premium for more flexible credit products with less security and more favourable cash flow profiles.
Mezzanine financing, while more expensive than traditional bank debt, offers benefits such as flexibility, control, and strategic support, making it an attractive alternative to equity for companies looking to secure growth capital on more favourable terms. Mezzanine financing in Africa provides a compelling balance between the need for funding and the desire to maintain control and ownership of the business. For investors, it offers the potential for higher returns while mitigating some of the risks associated with pure equity investments.
Investors in African private credit must navigate the unique challenges of the market, such as taking on equity-like risk in tech-enabled companies with limited security and non-traditional debt coverage ratios. Additionally, while credit can be provided on a dollarised basis, investors still face underlying FX risk and potential difficulties in upstreaming interest payments in USD from certain markets.
To mitigate these risks and cater to the diverse needs of mid-market companies, investors may need to offer a range of products, from senior debt to mezzanine structures with a cash and PIK (payment-in-kind) component, as well as an equity upside through warrants. Unitranche and other hybrid structures can present an attractive proposition by providing investors with a position at the senior creditor table during downside scenarios, whilst providing equity-like incentives for potential upsides. The key to success in African private credit is flexibility and creativity in structuring deals. By offering a diverse range of products tailored to the specific needs of each company, investors can maximise returns while managing risk.
Despite these challenges, the $3 billion private credit opportunity in Africa is not just a chance for investors to achieve globally competitive, dollarised returns; it is an opportunity to play a pivotal role in shaping the continent’s economic future. By providing much-needed capital to Africa’s most promising mid-market companies, investors can unlock the door to a new era of growth, innovation, and prosperity.
Investors are able to apply an ESG (environmental, social and governance) lens on investment opportunities whilst still attracting some of the fastest growing companies and achieving competitive rates of return. As the African private credit market continues to evolve and mature, those who can navigate the unique challenges and provide flexible, tailored financing solutions will be at the forefront of driving economic transformation and building a brighter future for the continent.