Why firms must seek investors

Businesses in Uganda, especially small and medium enterprises, seem to have difficulties understanding when exactly to secure a financial investment.

And as such they end up taking out loans, most of which are not necessary thus end up being subjected to exorbitant lending rates, letalone shorter repayment schedules.

Over the last few years, there has been a rise in the number of loan defaults, with small and medium businesses being the main victims.

According to the Bank of Uganda Financial Stability report, 2016, the banking sector faced a difficult year in 2015/16, mainly because of a rise in non-performing loans, which were way beyond the limits.

Non-perfroming loans rose from 4 per cent in 2016 to 8.3 per cent in 2016, which was beyond the Central Bank’s requirement of 5 per cent.

Such a state of affairs, where businesses fail to open up to cheap funding alternatives and borrow from commercial banks is worrying, because by nature bank loans are short-term and tend to suffocate business growth.
Other sources of funding such as equity investors, are rarely used despite their favourable terms.

Financing in exchange for shares
Equity investors inject money in a company in exchange for shares and have no guarantee of return on investment.
By the 1990s Sembule Group of Companies had become a household name in Uganda investing in steel, manufacturing, electronics and banking among others.

However, along the way the company seemed to have landed on hard times, failing to services a large loan it had acquired from the PTA Bank.

The company’s failures led to its eventual collapse and was recently placed under liquidation.
Away from Sembule is Zzimwe Constructions, which was owned by the late Andrew Kasagga.
Zzimwe had built a reputation in the road construction business, however by the time of his death the company had started faltering.

Indeed after his death, creditors feasted on the little that had remained of the empire leading to its eventual collapse.
Zzimwe had built the construction business from his savings but later resorted to loans as he sought to expand, which could have exposed the company.

This was a business decision he took and according to bankers and investment managers interviewed for this article, such decisions are a responsibility of the business owner. Ultimately, whichever the decision might be, you must ensure that you have evaluated the pros and cons of investment vehicle you have taken.

While presenting a paper on business financing, Richard Byarugaba, the NSSF managing director, said bank loans are normally structured to deal with short-term financing and SME will always struggle to repay.

Therefore, he seemed to suggest, that small and medium businesses are better of acquiring long-term financing, which ultimately can be offered by equity investors.

At a recent Women Conference organised by Uganda Revenue Authority, the Finance Trust managing director, Annet Mulindwa Nakawunde, told participant that they need to ask their banks about investment options rather thaan being lured into ignorant decisions.
“Loans are good and they can also be bad. They can be very expensive and it can bring you down,” she said, adding it is important to know how and when to borrow.

At the same conference the Bee Natural Honey proprietor, Maria Odido, advised business people to always evaluate a loan facility before it is drawn out.

A business may be compelled to borrow to either finance the working capital or oversee business growth.

Either way, she said, it shouldn’t happen as a result of pressure or out of impulse for that is a sign that all is not good.
“Before reaching that point (of regrets), you should seek partnering with (equity) instead of borrowing from the bank, she said.
According to the Minister of Trade, part of the problem is that small and medium enterprises prefer to work in isolation rather than in partnership, which makes it difficult for government to help them collectively.

Uganda Development Bank recently launched a Shs6b SME equity and venture fund, which seeks to deal with affordable credit challenges.

The fund, according to the bank’s chairman, Samuel Sejjaaka, is an attempt to leverage its expertise in an area where they have become experts.

“We are putting forward Shs6b out of our capital and we will invest it as equity in viable projects. We … will work with [qualifying] small and medium enterprises until we make profit.”

In the same measure, the Bank of Uganda, executive director in charge of research and policy, Adam Mugume, believes SMEs need to find alternative and cheaper sources of funding.

“We encourage our firms to float shares in the stock market, bring in an equity investor because they do not have to borrow where there are better options,” he said recently.

But before considering equity investment, you must ensure that business is running effectively.
The business, for instance, must have proper book keeping, employ professionals and the shareholders must be willing to cede some control for the wider good.

Pros and cons of equity investors

Of course like all financing facilities, equity investment has its advantages and disadvantages.
Unlike banks, equity investors focus less on risks involved thus they might be able to provide enough money for the business to invest in growth and capital strengthening.
Beyond this, equity repayment terms tend to be more flexible, which according to Sejjaaka, gives the business ample time to repay without putting the business on stress that might result into eventual collapse.
And because investors have equity in the business, they will always be interested in its success rather than forcing it to repay.

Crucially, if the business fails, you don’t have to pay back investors as long as the collapse has nothing to do with fraud.
On the flipside, however, you may lose full control over the direction or day-to-day operations of the business because the investors will want to direct where the business should be heading.

Venture capitalists typically invest in businesses that have the potential to offer huge returns on investments and are generally uninterested in most small businesses that don’t project huge potential.
And it goes without saying that you may have to share a larger portion of your profits with equity investors, given their role and contribution.

Worth noting is that this arrangement can turn ugly for Investors have legal rights with respect to the management of the business as well as the right to sue you if the rights are violated.