Impact Investing in Informal Enterprises

Impact investments are investments made into companies, organizations and funds with the intention to generate social and environmental impact alongside a financial return. The Global Impact Investment Network (GIIN) states that this sort of investment provides capital to address the world’s pressing challenges in sectors such as microfinance, sustainable agriculture, renewable energy, conservation and affordable and accessible basic services such as housing, healthcare and education. The aspect of this form of investment that makes it stand out from other vehicles of investment is the fact that it is aimed at generating positive impact beyond financial return. In this sense, it is a viable solution to the sustainable growth and development of micro, small and medium sized enterprises. It is a tool that can be used to provide patient capital to entrepreneurs, more so if it is blended with grants.

(Source: http://www.blog.kpmgafrica.com)

A study that was conducted in West Africa by Dalberg found that impact investments are primarily made by private equity and venture capital funds, Development Finance Institutions (DFIs), Micro Finance Institutions (MFIs), foundations and institutional investors. “Impact investing in West Africa” noted that the needs of individual enterprises varied depending on factors such as their business model, size and maturity stage as well as human resource capacity. Beyond financing needs, many enterprises require business development services in a way that enables them to develop their ideas and create well managed, financially sustainable operations.

Some of the challenges that stand in the way of achieving the goal of developing sustainable business ventures in as far as engagement with impact investing is concerned include a lack of education, skills and difficulty in accessing information among the entrepreneurs that are required to turn their ideas into bankable projects. Also, the lack of awareness of the actual implications of engaging impact investors prevents many businesses from accepting this type of capital. This is due to the fact that owners of small and medium sized enterprises fear losing control of their businesses. Further, the study noted that the lack of incentives to convert from informal to formal business structures was a hindrance for impact investors in as far as engaging the informal sector in West Africa goes. The high costs that are linked to business formalization which include licences, taxes and other operating costs discourage most informal businesses from making the transition to formality.

The report put forward some ways in which the above challenges can be mitigated for an enhanced and more proactive engagement with impact investment. These include the need for a broader range of flexible products to address the gap for businesses with smaller financing needs. This is particularly necessary for new enterprises where the entrepreneurs’ funding needs are too small for traditional debt or equity financing. In this sense, they propose angel financing or royalty-based debt with manageable levels of interest as well as supporting business development services.

The other solution highlights the need for investors to adapt their investment practices to the local climate. By being more flexible in this manner, they will be in a better position to change their investment criteria, thus opening up their business to a large number of potentially profitable deals. This will also place local entrepreneurs in a position where they can access much needed capital to enhance their business ventures. This sort of engagement will support the growth of informal businesses to formal businesses and further assist them to transition into larger private equity and traditional commercial bank investments.

Last but not least is the proposal to build networks and awareness beyond impact investors to encompass business support organisations, relevant government bodies and development partners with the intention of increasing awareness of existing definitions of impact investing. Other goals of these networks should be to increase the awareness of the benefits of venture philanthropy among grant-making organizations, increase the understanding of equity investments among business owners and focus outreach efforts towards high net worth individuals and highly-educated Africans in the diaspora.

litualex@gmail.com

Informal Economy Analyst

 

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An Overview of the Informal Sector

The informal economy is characterised as micro and small businesses whose main reason for being established is that they offer an escape route from the tough economic conditions under which the entrepreneurs live. During the past decade, the sector’s growth has mainly been propelled by the shrinking availability of formal employment opportunities. This limited access to formal employment causes most of them to venture into alternative forms of self-employment as a means to making ends meet. As a result, there has been a change in the way people perceive the informal as being traditionally one that was the preserve of those who had attained a basic level of education. There has been a gradual shift in its perception whereby it was fondly referred to as the ‘Jua Kali’ sector, towards one which presents itself as an option for those locked out of formal employment opportunities.

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The Micro Small and Medium sized Enterprises (MSME) Survey 2016, a report released by the Kenya National Bureau of Statistics established that there were about 1.56 million licensed MSMEs and 5.85 million unlicensed businesses. The findings of the survey also show that total number of persons engaged in the sector was approximately 14.9 million Kenyans. Further, the Kenya Economic Survey 2017 indicates that the number of new jobs created in the economy was 832.9 thousand. Of these, 85.6 thousand were in the formal sector while 747.3 thousand were in the informal sector. The share of jobs in the informal sector represents a 5.9 percent growth from 83 percent in the previous year to 89.7 percent, or 13.3 million people. The problem is that employment in the informal sector is characterised by numerous low quality jobs.

Some of the challenges that informal businesses face include low capacity in as far as financial and technical skills are concerned. This makes it difficult for them to access financial collateral from financing institutions and produce materials that are not standardised. Poor and substandard physical working environments as well as inadequate protective gear means that they are less advantaged when it comes to attracting customers to their establishments and are exposed to health hazards. Limited access to market opportunities is another hurdle that those engaged in informal businesses have to contend with.

The Rockerfeller Foundation puts the number of informal workers who live in extreme poverty around the world at 700 million people, contributing to their vulnerability to poor health. Most informal workers have few resources, which makes accessing health care a challenge as it requires leaving work, which reduces their income and adds to health care expenses. As alluded to above, some of the common problems that Informal workers face include poor working conditions which puts them at a high risk of getting injuries. Most employees in informal establishments have no sick time which accentuates their job insecurity, and a majority of them do not have health or social protection.

Another important element of the informal economy is small scale farming. There needs to be a more proactive approach geared towards making it a formidable employer as opportunities for growth in this area are immense. Making farming inputs competitively cheaper, as well as capacity development through the provision of access to technical services as is in the case of agricultural extension officers will go a long way in ensuring that small scale farmers attain higher quality yields. Another area that would be worth considering is that of supporting small holder out-grower enterprises that are in a dependent, managed relationship with an exporter. These include farmers who do not own or control the land they farm or the commodity they produce as they produce relatively small volumes on relatively small plots of land. A good example in this case is that of French beans farmers who sell their produce to horticultural export companies. This move will go a long way in improving product quality that will enhance the competitiveness of Kenyan produce in the export markets thus ensuring a sustainable and equitable growth in that sector.

 

An angle that clearly presents itself as far as the rapid growth of the informal economy is concerned is that of a focus on making the sector a formidable employer by raising the quality of its employment. This can be achieved by changing the societal stereotypes whereby students who pursue vocational training are seen to do so as a second option after failing to secure university admission. The role that tertiary institutions such as polytechnics play requires a keener rethinking in as far as their significance to the provision of a strategically skilled workforce for our budding industries in the informal economy goes. Also, training in financial skills is another key factor in building up these businesses in a way that they will be well equipped to manage their growth. By developing a culture of documenting financial dealings, informal businesses will be better placed to access loans and grants from financial institutions. Further, more can be done to make it easier for informal workers to access affordable healthcare.

There is increased recognition that much of the informal economy today is linked to the formal economy and contributes to the overall economy; and that supporting the working poor in the informal economy is a key pathway to reducing poverty and inequality. To maintain sustainable growth in this sector, there needs to be flexibility in the way government operates so as to accommodate and support a hugely untapped taxable avenue. Key issues that would have to be looked into revolve around the formalization and recognition of their business operations. That being said, given the proper support and plan, the informal sector in our economy will provide an avenue to the growth and development of indigenous industries.

 

litualex@gmail.com

Informal Economy Analyst.

Barriers To Registration Of Informal Businesses

The informal sector, which is often referred to as the ‘underground economy’, is characterised by the existence of businesses which are not registered. This is mainly due to the inability of most governments to effectively monitor their activities and operations. The International Labour Organization states that as a result of operating in an unregulated environment, a large percentage of informal businesses do not pay taxes, benefits, or entitlements to their workers. This not only locks them out from accessing social protection, but also means that they compete unfairly with other enterprises. The shortfall in tax and contribution payments, which is sometimes very significant given the economies of scale, places an unfair burden on registered businesses. Moreover, when they are deprived of public revenue, governments are limited in their fiscal space and ability to extend social protection schemes and other systems which are vital to national development, such as infrastructure and education and health systems.

Some of the reasons as to why most of these informal businesses do not register include regulatory barriers, taxes, business fees and financial requirements, corruption in public administration amongst other factors. USAID defines regulatory barriers as inappropriate requirements which stem from a government policy-making environment that does not appreciate the need to keep regulatory burdens to a bare minimum in order to place fewer barriers in the way of entrepreneurs. A good example is given in the case of laws governing milk production and sales in Kenya. These are largely drawn from western models and standards. As such, they pose unrealistic requirements such as requiring traders to have fixed premises and insisting on pasteurisation. This ignores the fact that many traders are mobile and that it is household practice in Kenya to boil milk before use. The result is that the small scale traders are forced into informality.

In addition, most business registration and licensing fees are often set at levels that act as a disincentive to businesses to formalise. Most of these informal enterprises would rather choose to avoid paying such fees and instead divert those resources into the operations of their businesses such as paying suppliers and employees’ salaries. Complex tax rules push informal businesses into situations whereby they fear being caught for non-compliance of the rules they have not understood. This makes a vast majority of traders to judge it less risky to avoid the tax system all together, opting to remain informal. Also, corruption among public officials is a key reason as to why most businesses in the underground economy are discouraged from formalising. Informal economy enterprises must still pay bribes to stay in business, but they limit their contact to a small number of officials such as police, and they avoid officials involved in taxation, health, labour regulation and licensing.

Anzetse Were, a leading Development Economist, points out that steps are being taken in the right direction by the Kenya Revenue Authority (KRA) to enhance tax compliance by introducing itax, which makes it easier for individuals and businesses to pay taxes. More can be done to incentivise informal businesses to formalise by offering tax amnesties to informal businesses that register and start the journey towards tax compliance. She adds that the priority should be for the KRA to continue facilitating tax compliance as other arms of government work to support players in the informal sector to become more profitable.

litualex@gmail.com

Informal Economy Analyst