Missing the point of the ‘missing middle’

The African mid-market needs to move beyond being a magnet for ‘social’ capital and demonstrate that it can justify investment on purely commercial grounds.

Return expectations must rise for Africa's mid-market. That was the opinion of one panellist at the second annual PEI Africa Forum, held in June in London, who was speaking about the risk-return dynamics of Africa’s “missing middle”.

Simon Merchant, chief executive of the Jacana Venture Partnership, which invests in SME-focused fund managers in Sub-Saharan Africa, said: “There is a need to see people achieving commercial returns because social capital won’t provide the whole need. You need commercial capital, too.”

Merchant: higher returns are 'appropriate' 

The “missing middle” is the term frequently used to describe the perceived financing gap which exists between the maximum amount that can be committed by providers of microfinance (typically around $100,000) and the minimum commitments that can be made by private equity firms (normally in the region of $2 million). It also tends to be seen as the African mid-market space, though the average deal size is much smaller than in most other private equity “mid-markets”.    

Merchant was responding to a survey conducted during the packed conference session, which found that nearly half of the audience (47 percent) expected an internal rate of return from investing in the African mid-market of between 10 percent and 20 percent. In a subsequent poll, the largest vote (39 percent) agreed with the proposition that this return range was the most appropriate given the level of risk. 

Merchant professed surprise at this. “You arguably do the mid-market a disservice if you say it is just for social investing,” he said. “The case for investing in African SMEs for the purpose of job creation is well accepted and reflects returns of around 10 to 20 percent being seen as acceptable. But we think it can exceed that benchmark ultimately.”

Fellow panellist Gordon Carrihill, managing director of the Global Environment Fund, agreed that a “higher return should be appropriate” given that “the chance of getting it wrong is much greater” than in the larger deal space.

The panel – which also included Ian Anderson of the Gatsby Charitable Foundation and Coco Ferguson of Maris Capital – was in agreement that purely financial investing might be seen as more viable once a longer track record has developed and the tough lessons of investing in the space have been learnt.