Wednesday, July 25, 2007

Traditional Methods of Investing in Africa

As mentioned in the previous blog, the next step in my progression was to show how new ideas could be used to invest in Mali. However, I thought it would be a good idea to first discuss how investors currently approach the African market.

Traditionally investment in Africa is made in the form of relief funds, humanitarian effort and debt financing. These types of investment are made because of a lack of formal equity markets and large corporations, and because the return on investment is known ahead of time. In the case of foreign aid and humanitarian work the return is often a sense of helping and improving the local environment. In the case of debt investment there is no guesswork with projected earnings the expected return is denoted by the terms of the debt instrument. To further ensure return, foreign debt is often issued in a foreign currency so that the lenders do not bear the currency risk associated by African nations. From the perspective of the African borrower the value of domestic currency often exhibits great volatility. This means that there is an increased likelihood that borrowers will be unable to repay, and therefore face higher rates of borrowing to compensate lenders for the additional risk. Recently investors have looked at new methods of investing in local currency debt in Africa. Lending on terms to be repaid in local currency reduces the risk of default by the borrower due to currency risk. Unfortunately, the borrower then increases their exposure to currency devaluation. In the extreme case the borrower could make all payments in a currency worthless to the lender. A potential solution to this problem is to diversify lending across countries by pooling the funds made available by lenders. A fund administrator then distributes lending across countries and all lenders benefit from diversification of funds across a number of countries.

A detailed explanation of this process can be found in Up From Sin: A Portfolio Approach to Financial Salvation a paper written by Randall Dodd and Shari Spiegel, January 2005 (No. 34 in a series of g-24 discussion papers for the United Nations). The paper draws on research (Haussman, 2001, 2002) that concludes developing nations are more able to cope with the negative effects created by shocks and policies errors, on ability to repay debt, if they borrow in their own currency. Dodd and Spiegel note:

“ The market risk, which consists of the uncertainty of domestic interest rates (i.e., interest rates in local currency assets) and exchange rates of each local currency security, is often significant. From 1994 to 2003, the average volatility of individual country returns on local currency debt instruments was nearly 16 per cent. At the same time, yields on local currency debt were also high, at 13.7 per cent on average, but not high enough to compensate for the risk. Hence investing in any one local currency market was not attractive.Combining the returns on individual country securities into a portfolio, however, does produce desirable results. As we will show below, returns on a diversified portfolio range from 8.10 per cent annually while the risk of a diversified portfolio drops substantially to approximately 5.5 per cent (which is in line with United States investment grade bonds).” – Dodd & Spiegel 2005

Although Dodd & Spiegel focuses on investment in debt instruments I thought their line of thinking could be applied to an equity portfolio as well. My hope was to use portfolio theory to show that the risk of investing in a company in Mali was balanced by that investments effect on the expected variance of a portfolio. The difficulties I encountered while attempting to make this connection lead me to change my course of action to steer investment to Groupe Zirasun.

Tuesday, July 17, 2007

How a consulting firm became a venture capitalist

The origin of the idea

Upon graduation from the University of Bamako, Moussa Keita was recruited by Ian Howard, one of the co-Founders of Adapted Consulting. At the time, Ian was the director for Geekcorp Mali, an NGO based in West Africa. Moussa worked and was trained by volunteers and other ex patriots who were in Mali to help bring internet and other technologies to rural areas. Through this experience he soon became an expert in wireless and open source technologies, after a bit more than a year. As the project's work gained notoriety, it was soon overwhelmed with requests for assistance by other NGOs and companies. It was then that Moussa was encouraged by Ian to open his own business. It was anticipated that Moussa would continue to support the project, but he could also serve these many potential customers commercially. His firm, Groupe Zirasun was thus created and incubated by Ian and his team. Zirasun was provided an office and shared tools and other resources. There was no shortage of work, so Moussa was kept busy.

(photo: workers build a new solar structure for a roof, under the management of Zirasun and with designs and engineering provided by Adapted Consulting)

Since, Group Zirasun has built an excellent reputation amongst its clientèle. Moussa has continued to expand his reputation as a quality provider of wireless and open source solutions. Despite the success of the firm, in terms of establishing its reputation and the stature of Moussa, it is not growing, nor profitable.

A cultural hurdle

A study by Ian and classmates at the Schulich School of Business in the Fall of 2006 concluded that Zirasun was suffering primarily by a lack of affordable financing and a lack of internal practices. Consequently, Ian brought the idea of buying into Zirasun to Adapted Consulting. He believed that it was an opportunity to both help Moussa's firm to grow and would also further strengthen the collaboration between the two firms, thereby allowing Adapted Consulting to further expand the African market.

As this idea progressed it became apparent to Adapted that Zirasun was perhaps not the only business, and Moussa was not the only entrepreneur, that could benefit from management consulting, training, capital and infrastructure.

Access to Credit: nearly impossible

There are many systems in place in North America, which protect lenders from losses due to default. For example, the World Bank’s 2006 Doing Business Report states that there is 0.0% private bureau coverage of individual credit histories in Mali. In comparison, in both Canada and the United States there is 100% coverage1. This coverage is important as small businesses often rely on the ability of the owner to borrower funds. With no way of determining the creditworthiness of borrowers, lenders must charge a high premium to compensate for risk, and consequently funds become less accessible. This is just one example of why Mali ranks in the 90th percentile with regards to ease of access to credit, as compared to the 6th percentile for both Canada and the United States2.

Access to Equity Financing: too little information

Companies in Mali also have more restricted access to equity financing compared to Canada and the United States. One major barrier in Mali is the lack of a formal equities exchange where shares of corporations can be traded. The existence of an equity market is a fundamental element to how companies can attain financing and how shareholders are protected, i.e., if the shareholder perceives too much risk verse a return (going forward), they can simply sell their stake in a company. In Mali no such mechanism exists. In addition, there are legal differences, which offer greater protection to shareholders in North America than to those in Mali. Two examples are less stringent disclosure requirements for material information, and less personal liability to CEO for actions contrary to shareholder interests. Again, legal protection to shareholders increases their willingness to invest as they perceive less risk and therefore require a lower return premium to justify investment.

First Conclusion: a new approach to entering this market is required

After identifying barriers to traditional investment into Africa I felt it was important review the current thinking of investment and then to adapt them to create a new set of rules that are appropriate for this very different market. Next we will begin to present our ideas of how to approach investing in small to medium sized firms in Mali, which will serve as an example of how it can be done in similar markets.

End Notes

1 Doing Business 2006 – World Bank,

2 Doing Business 2006 – World Bank, 90th percentile in this case denotes that it is easier to get credit in 90% of the 175 other countries involved in the report.

Tuesday, July 10, 2007

Commentary: there are fortunes at the bottom and there is no mystery that capital can unlock poverty

The idea of investing in the developing world is not new, though in the past this has been done through personal contacts and experience in these markets. Often it was ex-patriots who found new lives in developing countries who brought money to start businesses. This, for the most part, still continues to be the case. To invest in most, if not all of Africa, requires on the ground research, and the slow development of trust and information about the markets. Our friends on Wall, or Bay Street, might say is that this is high-friction and that the lack of information is a major factor for limiting investment. They might also cite a multitude of other reasons that are listed in the Doing Business Guide, provided by the IFC (a great resource).

This personal experience is how I have come upon an opportunity to invest in a business in Africa. My own business, Adapted Consulting, is largely focused on economic development in Africa and as a result we do see opportunities from time to time. Though many argue that it should be local people who are left to develop these endeavours alone, I would argue that in some cases that is certainly a good choice, but as happens elsewhere, the infusion of expertise and capital from elsewhere is an important shot in the arm in development. NGO established economic development projects are often plagued by a problem of a mis-alignment of incentives and perhaps agency issues -- the people funding and managing may have quite differing goals. These people also are not vested in the success of these operations.

While working in Africa for the better part of the last 5 years, I have developed a set of principles that I believe in, for how economic development should be done. One of these ideas has emerged from the Prahalad school of thought, that is that I do agree with his thesis that there are economic opportunities at the Bottom of the Pyramid. I also have come to agree with many of the ideas of de Soto, that capital is essential to developing more robust economies where economic exchange can happen with reduced friction (to grossly paraphrase). Moreover, in that sense, I believe that one of the weaknesses of the current 3rd party donor model, is that good ideas that have economic potential are not easily capitalized and financed so that they can be scaled. As a result, we have vested in this idea, Rob has taken lead by pulling together academic research to help fet our or practical knowledge. I trust that we are right and that we can find a scalable and sustainable means to invest in those countries where so far, few have dared but that so much is needed. There are fortunes at the bottom and there is no mystery that capital can unlock poverty. This next decade is again about innovation, but the greatest triumphs will be in finding new ways to do business. There is great potential in these undeveloped markets, we just need to find out how to do it. Here is our effort to that end.


Wednesday, July 4, 2007

My summer job


I have created this blog to track my progress, and to receive feedback on, my summer job. My summer job consists of helping uventurecap encourage micro-equity investing into lesser developed markets, specifically Sub-Saharan Africa. My main deliverable as an employee of uventurecap is the preparation of a paper documenting my assignment in terms of my approach to completing it, hurdles faced by along the way, resources I draw on and conclusions (for better or worse) that I draw along the way. I look forward to feedback from anyone who thinks they can improve on or offer insights into what I come up with. Below is the first installment:

In no way is this literature meant to be the final word in how to profitably enable growth in Africa. Instead my hope is to define a starting point for continuous critical review of investment practices, eventually leading to a widely acceptable model for investment. The starting point for my research was my summer internship; requisite to the IMBA program at York University’s Schulich School of Business. My internship was with μventure, an offshoot of Adapted Consulting. Adapted Consulting is a firm who specializes in providing IT solutions to small business and NGOs in remote areas. Adapted is a Canadian firm who operates a great deal in West Africa. After hiring local workers Adapted provides skill development and on some occasions encourages employees to go out on their own. It was one of these employees who lead the directors of Adapted to identify an opportunity to earn a profit while enabling SMEs to better serve there market and ultimately create wealth in some of the world poorest nations.


Rob Tudhope