Let’s talk Debt! — Lionesses of Africa

by Lionesses of Africa Operations Dept

We saw a fascinating statistic recently regarding job applications and the differing actions of women vs men. In job applications according to an original study by Hewlett Packard and discussed by the Harvard Business Review (‘HBR’) back in 2014 (here) and continually confirmed in more recent studies such as from LinkedIn here, men will apply to jobs if they feel they match 60% of the requirements on the job application. Women? They will apparently agonize for ages over the last 5% on the way to 100% certainty.

As the Harvard Business Review concluded “What held them [women] back from applying was not a mistaken perception about themselves, but a mistaken perception about the hiring process.”  Yet what could be the worst that could happen? The potential employer says No? All you will have lost is a small amount of time – but if you don’t ask you never get, or to put it another way – the only way to guarantee that you will never win the lottery is to never buy a ticket!

We have also seen this in applications for finance, both Equity and Debt, a mistaken perception of the application process and a need for 100% certainty – no wonder the ‘No’ is so disappointing for women, given they will have invested so much extra internal discussion with themselves in the process. This obviously lessens the chance of further applications – “We have just given up!” is often the cry we hear, yet as with job descriptions, so loan applications. Yes there are certain boxes that simply have to be ticked, certain financial ratios that have to be in line, but there is also a large grey area that is still open to the investors understanding and belief in your story.

We have often discussed Equity applications in these articles but it has been very rare for us to touch on the subject of Debt. Debt, as with Equity investment, involves a large queue for a finite resource (cash) and so women are yet again placed firmly at a disadvantage! Think that we are over emphasizing this? We have mentioned on numerous occasions (so won’t go into detail again) the Harvard research into the differing styles of questions asked of men vs women by VC, PE and other investors (here), but in addition, when it comes to debt, the World Bank itself state that the average amount of collateral required is currently running at slightly over 200% for Africa. Note that this is the average across Africa on a continent where historically collateral (land, housing, other assets) has been firmly in male hands. All of this before we even agonize as to if we are truly reaching 100% the ‘requirements’! You do the maths…

This perhaps is why too often as we expand we think we have to sell equity rather than turn to debt. But selling equity and especially too much equity at an early stage is highly dangerous, not least because when you come to the next round of financing if your original investor has no wish to exit or ‘water down’ their large holding, this leaves little for any new investor. Plus, as always, we must consider the ‘Exit’! As a minority shareholder there is usually only one other buyer around – the other shareholder who will be able to control the price! Nasty!

In addition, raising PE or VC money costs in time, energy and ‘creative energy’ (given this was written on the day that the BIG4 Audit Firm EY were fined US$100 million for allowing their employees to cheat on an Ethics exam (no we are not making that up – see here), we should make clear that we are not talking accounting creativity here, but design of pitch decks etc – just in case anyone was wondering!)…

As the Harvard Business Review say in their interesting article ‘Everything You (Don’t) Want to Know About Raising Capital’ (here):

“The process is stressful and can drag on for months as interested investors engage in “due diligence”…Getting a yes can easily take six months; a no can take up to a year…emotional and physical drain leaves little energy for running the business, and cash is flowing out rather than in…Performance invariably suffers. Customers sense neglect…employees and managers get less attention…small problems are overlooked…sales flatten or drop off, cash collections slow, and profits dwindle.”

Sounds fun doesn’t it? So don’t ignore Debt, it does have a central place in business – if nothing else, what’s the worst that can happen – you get a No? Well, at least the ‘No’ is quicker!

As we speak to various Lionesses we have become struck by certain misunderstandings concerning debt and so vowed to address this head on, so here goes!

The first misunderstanding is that there is only one kind of debt (outside of the overdraft), straight up Bank Loans (200% collateral) and probably a number of other conditions. Please don’t believe all that talk about bankers being in the risk game. When it comes to lending to companies, especially SMEs, they nail risk down hard. As the saying goes, a Banker will lend you an Umbrella when the Sun is shinning, however the moment the rain clouds appear – not a chance, that Umbrella will be firmly locked away in their office.

One of the Bankers’ major Key Performance Indicators (KPI) is low NPLs (Non-Performing Loans). Search on their annual report and you will see that it is indeed very low. To be fair, many Development Financial Institutions (DFIs) have NPL ratios not much different. They too have shareholders in the form of the nation’s taxpayers and politicians they have to report to – ‘tough audience’ as our local comedy club would say. Plus they tend to lend a great deal of their cash through international banks who then on lend into local banks, who in turn on lend to smaller local banks and Microfinance institutions. So by the time the money arrives ready be lent to the final SME in a small village outside Nairobi or Lagos, it has had many hands on it and will have had many fees taken from it. This also means that it is also very difficult to see just how much of the money is flowing to SMEs or even Gender support as the working paper (here) from Publish What You Fund (here), the global campaign for aid and development transparency show:

“Lending to, or investing in, financial intermediaries has become an increasingly important aspect of DFI activity in recent years. For some DFIs it represents over half of their total investment portfolio. A lack of transparency means that it is unclear where a great deal of this development finance ends up, the development impacts that it has, and the environment and social risks that it holds for project affected communities.”

So for all the US$billions pouring into the developing world, it seems difficult to know just how much is actually reaching the places where it is most needed. Sadly the general conditions of finance in Africa is not going to get any better. Not only do we have increased interest rates across the western world, which is dragging yield searching finance back to the US, but as the OECD confirm (here): “While bank financing will continue to be crucial for the SME sector, there is a broad concern that credit constraints will simply become “the new normal” for SMEs and entrepreneurs.” Translation: Banks are being squeezed so hard on one side by regulations such as Basle III (which hits minimum capital requirements hard) and Anti-Money Laundering; and shareholder expectations of low NPLs, that by the time any cash makes it out the other side, all juice has been removed. Note ‘credit constraints’. So let’s take our personal ‘credit’ out of the equation and took to lean on something else…

Cash needs to be lent on something – if it is not your credit worthiness (think 200% collateral), then it has to be backed by something else, and this is where Asset Backed Lending and the various forms of Trade Finance arrive to the party.

So ask yourself – Why do I need this cash injection?

Often there will be a better way to finance this ‘need’ than just selling part of your company. Once you work out what it is, you will know where to look and who to approach – this is simply because different lenders have their particular areas of interest. If it is something tangible, something with a value, then there will probably be a group willing to finance this (note – no guarantees on pricing!). We say ‘probably’, because if you aim to buy machinery from Europe, or USA and have to pay in Euro or US$ whilst earning an African currency through local sales – then it will be extremely difficult to find a friendly financier. Put simply, if today I lend you $1million for machinery that you purchase in the US and bring back home to Nigeria, you need to find ₦415million to repay this loan. If your local currency then drops by 20% against the US$ (yeah – don’t we know it!), you somehow need to find that extra ₦83 million to repay – that’s enough to make anyone choke over their morning Cornflakes and financiers are no different, the doors on their Exit shutting fast.

When you go in front of your banker or fund that specializes in trade or asset finance, think of this Exit – if this deal goes horrible wrong, how can they get their money back? If you are having to source machinery abroad because there is no industry in your own country and you are wanting to be the pathfinder, there will be little or no second hand market, irrespective of any currency drop. This is going to be very tough for any investor. Often the machinery manufacturer will have contacts in their own country’s Export/Import Bank or Export Credit Agency who may (just) have a solution to your local currency problem. Worth asking the question of the manufacturer – they have the connections. What’s the worst that can happen? They say No?

If you are requiring help on your Cash Flow selling your produce abroad, think Trade Finance, if local to local, think Invoice Finance. If you have a large warehouse that moves quite regularly there is Warehouse Finance. As always think of the Lenders Exit – if your debtor’s book has ever growing days-overdue, that suggests the lender will need a great deal of patience and probably have to spend on a debt collector. Likewise if your inventory is just gathering dust, rather than fit and moving like trained Athlete, you are going to struggle. Remember that umbrella? These are both cloudy conditions.

Have no connections with such funding teams, or have no idea where to start looking? Ask all your connections, someone will have had experience of this and possible connections who play in that space.

Of course if you do have an external shareholder who owns a large chunk of your company, then why not approach them? They have no doubt agreed your expansion plans, understand your cash flow and it is in their interests that you don’t spend months searching for a friendly lender rather than driving the company and their investment forward. Plus why would they want profits to be paid on Bank interest when any debt deal you do with them can be structured in a similar way with them receiving the interest.

What’s the worst that could happen? They say No?

Stay safe.