The Small and Medium Enterprises ecosystem in Africa has gained mainstream acceptance and the funding ecosystem has experienced significant growth in recent years. The continent has seen an influx of international venture capital firms and angel investors, who have injected millions of dollars into African Small and Medium Enterprises (SMEs).
In recent years, more investors have started seeing Environmental, Social, and Governance (ESG) as a risk management tool. This means that they are looking for SMEs with good ESG practices to invest in, as this reduces the risk of negative impacts on the environment or society.
There has been an increased interest in impact investment as a mainstream asset class. Investors are looking for ways to make a positive impact on society while also generating returns on their investments. African SMEs that are addressing ESG challenges are therefore attracting more funding.
Overall, the ESG SME funding ecosystem in Africa has come a long way and is an exciting area for investors looking to make a positive impact. While there is still work to be done in addressing environmental and social challenges in Africa, SMEs are playing a critical role in driving sustainable development.
So how does an ESG focused SME attract funding?
Aavishkaar Capital’s Managing Partner (Credit) Ashish Patel shares an investor’s perspective on how to get your ESG focused SME some funding, from the investor.
Question. What is ESG?
Ashish Patel: ESG stands for Environmental, Social, and Governance. It refers to an array of decisive factors that investors consider when evaluating the sustainability and societal impact of a company. Environmental factors assess how a company handles its environmental footprint, social factors focus on its treatment of employees, communities, and stakeholders, while governance evaluates the company’s leadership, transparency, and ethical practices.
Question: What criteria do you use to evaluate ESG-focused SMEs for potential investment, and what are the most important factors to consider?
Ashish Patel: When evaluating ESG-focused Small and Medium sized Enterprises, we consider a range of factors. Key criteria include the company’s dedication and commitment to environmental sustainability, its impact on local communities, labor practices, diversity and inclusion policies, supply chain management, and governance structures. We also assess the attractiveness and scalability of their solutions/products/services, market demand, and the potential for positive social and environmental impact along for financial returns.
Specific to Africa, key factors include the company’s commitment to environmental sustainability, such as, reduction of water usage, reduced environmental pollution along with reducing carbon emissions by promoting renewable energy. Social factors focus on inclusive practices, such as job creation, gender equality, and community engagement. Governance factors encompass transparent leadership, ethical decision-making, and robust governance structures. For example, when evaluating our recent investment in the textile firm Hela (Kenya), we considered their approach to reduced water usage and commitment to reducing carbon emissions by using renewable energy, positively. We will continue to work with them post investment to further improve their standing on ESG.
Question: What advice would you give to ESG-focused SMEs looking to secure investment funding, and what are the common mistakes they need to avoid?
Ashish Patel: For ESG-focused SMEs seeking investment, it’s crucial to distinctly articulate your mission, values, and the impact you aim to achieve. To attract funding, SMEs need a compelling business model demonstrating potential of financial gains. Alongside, develop a comprehensive ESG strategy and align it with your business model. It’s important to avoid greenwashing or merely paying lip service to sustainability without tangible actions. Transparency, robust data and reporting, and building partnerships with like-minded organizations are also essential.
Question: How can SMEs best present their ESG initiatives to investors to demonstrate their mission and potential impact?
Ashish Patel: SMEs should present their ESG initiatives by providing concrete evidence of their commitment to sustainability. This includes showcasing measurable goals, highlighting key achievements, sharing success stories, and providing data-driven insights on their impact. Demonstrating a clear alignment between their ESG initiatives and their financial performance is also crucial to convince investors of the long-term viability of their business model. For example, in the case of Hela in Kenya, we will work with them to measure key environmental indicators such as water usage. We will work with Hela to develop a plan to minimize water usage.
Question: Can you explain what sets ESG-focused SMEs apart from other SMEs, and how investors can benefit from supporting them?
Ashish Patel: ESG-focused SMEs differentiate themselves by equally prioritizing sustainable practices, social responsibility, and long-term impact alongside their financial goals. ESG focused SMEs do “well and do good”. This is referred to as the “double bottom line”. By investing in these SMEs, investors can align their capital with their values, contribute to positive environmental and social change, and participate in the growing market for sustainable solutions. ESG-focused SMEs also have the potential for strong risk management and resilience in the face of changing regulations and consumer preferences. Hela will set itself apart exactly for this reason. They have an attractive business model with the growing demand for fashion apparels whilst also ensuring they respect the social and environmental concerns of their customers.
Question: What is the typical timeline for securing funding for ESG-focused SMEs, and are there any notable differences compared to other SMEs?
Ashish Patel: The timeline for securing funding for ESG-focused SMEs can vary based on various factors, including the attractiveness of the business model, stage of the company, market conditions, and the strength of their proposition. Generally, it can take a similar amount of time as other SMEs to secure funding. However, ESG-focused SMEs may benefit from the growing investor interest in sustainability, which could potentially attract investors and expedite the fundraising process.
However, given the risks of greenwashing, investors generally opt for an extensive due diligence process on the company, including an Environmental & Social Due Diligence (E&S DD). Company’s preparedness and cooperation during this process becomes critical for successful completion of this activity.
Question: What are some potential risks investors should be aware of when investing in ESG-focused SMEs, and how can they manage these risks?
Ashish Patel: Investors should be aware of risks such as greenwashing, where companies loosely or falsely claim to be sustainable without substantiating their actions. They should also consider the regulatory landscape, potential reputational risks, and the attractiveness of the business model by, for example, assessing the scalability of the company’s solutions. To manage these risks, investors should conduct thorough due diligence, verify claims with data and third-party certifications, assess the company’s governance practices, and diversify their portfolio to mitigate any individual company risks.
Question: How do ESG-focused SMEs bring innovation to the market and support sustainability goals, and how can investors leverage these innovations to make an impact?
Ashish Patel: ESG-focused SMEs bring innovation to the market by developing sustainable and socially responsible products, services, and business models. They leverage technologies, novel approaches, and partnerships to address pressing environmental and social challenges. Investors can leverage these innovations by actively supporting and investing in these SMEs, providing mentorship and guidance, and facilitating collaboration between SMEs and established companies to scale their impact.
Question: What are some trends shaping the future of ESG-focused investing, and how can SMEs stay on the forefront of industry changes?
Ashish Patel: Developments shaping the future of ESG-focused investing include heightened regulations and reporting requirements, the integration of ESG factors into investment decision-making, and growing awareness and demand for sustainable solutions. SMEs can stay at the forefront by continuously monitoring industry trends, adapting their strategies to align with evolving standards, engaging with stakeholders to understand their needs, and leveraging emerging technologies and partnerships to drive innovation. For example, the Supply Chain Act of Germany will require our exporters to ensure they comply by 2026. Not doing so will place them at risk of losing German customers.
Finally, what is your outlook on ESG-focused investing, and how do you see it evolving in the future?
Ashish Patel: ESG-focused investing is poised for significant growth and impact. As sustainability becomes a mainstream priority, we anticipate increased investor demand for companies that prioritize ESG factors. We expect greater integration of ESG considerations into investment strategies, more comprehensive reporting frameworks, and enhanced collaboration between investors, SMEs, and governments to drive positive change. ESG-focused investing will continue to evolve as society recognizes the urgent need for sustainable and responsible business practices. We believe African SMEs are well-positioned to drive this positive change and contribute to the continent’s sustainable development.
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