In 2004, private equity firm Pearl Capital Partners set up African Agricultural Capital (AAC) with the ambition of stimulating investment in agricultural businesses in East Africa. The fund was formally closed in 2019. AAC was one of the first agricultural impact investment vehicles in the region. Investors collectively committed $9 million in AAC, which the fund fully invested in 16 businesses.
Here are three lessons for investing in early-stage agricultural SMEs, as described in AAC’s Final Closure Report.
1. Investors have a responsibility to promote sensible, staged growth plans for SMEs
Private equity investment often aims to achieve phenomenal growth within a limited time period. This, combined with the availability and ease of access to capital with soft terms, can incentivise SMEs to develop overambitious growth plans, which they do not have the necessary management, operations or experience to execute. This can lead to underperformance and even failure of otherwise well-performing small businesses. Investors have a responsibility to promote sensible growth plans for SMEs that allow time to build the necessary management and operations to support expansion, are based upon the company’s past performance and tested business models, and are compatible with the owners’ purpose.
2. There is a continued need for, and lack of, patient, small-scale, early-stage capital
Many investee companies highlighted that AAC filled a critical gap in small-scale, early-stage capital for SMEs that is not adequately addressed by impact investment funds that were subsequently established. The trend among impact investment funds has been to try to increase financial return by moving towards larger deal sizes, companies with a stronger track record, and shorter holding periods. However, as a consequence, there is still insufficient capital for small, early-stage SMEs.
Many of AAC’s successful portfolio companies would have been excluded in the current impact investment landscape because they were very early stage and the deal size would have been too small. Nonetheless, AAC’s experience shows how transformative small-scale, genuinely early-stage capital can be. This segment should not be left behind particularly as many impact-focused investors and donors would be willing to accept the trade-off of potential lower returns for the long-term economic and social gains created.
3. Building trust with SMEs is critical, especially for family-owned businesses
Trust and alignment between the investor and the investee company are very important, however their aims and interests often diverge or are contradictory. The divergence in goals is often more pronounced for family businesses, where the owner’s interest in maintaining the business as a source of financial security may be…
Read More: Lessons learnt from investing in agricultural SMEs in East Africa