By Kofi Ganemgane@kitronconsulting.com

If you have spent a good amount of time in International Development space like I have, you would have noticed an interesting trend – Aid is either drying up or having a massive shift in thematic focus. If you again follow the intersection between capital, private business, and development, you would also have noticed that one of the big thematic trends is the Financialization of Development.

When I managed a development innovation fund over a decade ago, they still had the essence of what made them Aid – they were essentially still by and large, grants. Of course they offered “soft power” by backing governments, but it was aid nonetheless. What used to be grants or zero/low-interest loans from development organizations is now evolving into highly sophisticated private equity models and with it, new buzzwords – impact Investing, catalytic finance, transition capital, etc. the trend even extends these days into partnerships between hitherto western development agencies and local governments and national pension funds, given it a local face.

Between 2022 and 2024, DFIs accounted for roughly 45% of commitments to Africa-focused investment funds and that number will keep rising. If you look at it from this perspective, they are no longer simple aid agencies – they are high-return-hunting investment machines with national or conglomerate backing, commercial intent, wrapped neatly in development mystique.

The driving force is simple – there is an underlying realisation that Africa’s private sector offers higher returns than most stagnant, mature or low-yield Western markets. However, because Africa may still be perceived (real or unreal) as “high risk,” the only way to take advantage of these high yields minus the huge perceived risk, is to ask for high return rates and if that proves uncompetitive, to structure private sector ownerships, or form partnerships that both offer high yields as well as control – i.e. hybrid, yet sophisticated often equity instruments to African startups, most of which African Entrepreneurs are either new to, do not fully understand, or do not have the legal sophistication to decipher. On paper, many of these funding instruments and deals look straightforward, but often, they are subtly packed with “conversion triggers.” E.g. If you miss a target by X%, or if the macroeconomy devalues, the underlying debt “metamorphoses” into equity. Suddenly, you aren’t the owner you thought you were. As an entrepreneur you may find yourself very quickly changing from an owner to an employee – in the very company you struggled to build.

This article is by no means exhaustive – but I hope to highlight a few things that Ghanaian and African Entrepreneurs must “watch”, before accepting financing of any kind from some international impact-themed sources. Of course the field of investment finance is continually evolving and perhaps some of the things to be shared in this article may change tomorrow, or in just a few weeks, months or years. The focus here, is to give you both a thinking framework and examples of types of financing deals that could rob you of your entrepreneurship ingenuity.
In laying this foundation, it has to be stated, that there are Good Impact Funds out there – domestic and international. And if you’re an entrepreneur, then you will be able to tell which the good ones are by applying the framework and examples in this article. Just remember – like everything else, NOT every investment offered to your nascent business, is created equal, and NO ONE is your partner or helper unless the terms of the investment offer your business commercial fairness and growth without a takeover agenda.

So, here are 5 things you should look out for:

1 – THE COMPOUNDING PAYMENT IN KIND (PIK)

Whether the investment takes the form of a Loan or Preference Shares doesn’t really matter. What matters is the rate of fixed interest (or dividend) payments and how they are structured. Payment-in-Kind (PIK) interest or dividend means the interest or dividend isn’t paid in cash, but instead, added to the principal. This may not seem dangerous in year one, in fact you might even think this is so kind of the investor or fund; that they are taking pressure off you from paying interest or dividend for a few years… BUT by year 4-8, it has roughly doubled the overall liability or investment they made into your business and by year 10, that accumulated investment may very likely exceed your company’s entire market value. Here’s the real magic – the original investment will still grow even if your business isn’t doing well. Eventually, the original investment becomes so large that the only way to “pay” it is to hand over the majority of the company. Either you never allow interest or dividends to compound into equity, or if you do, agree an upper limit (a cap) on the total percentage ownership it can convert into.

2 – THE BOOBY TRAP CONVERSION

Some funding clauses may have either or both of these clauses (1) If you don’t hit specific earnings or profit target (usually EBITDA – Earnings Before Interests, Tax, Depreciation and Amortization) the lender or investor gets more shares for free to compensate for the lower-than-expected growth. (2) If the investor or lender decides to convert their preference shares investment or debt into ordinary shares (a liquidation event) they get X2 or X3 or X4 the value in the number of ordinary shares. The argument you may get here is – “well, we are converting your indebtedness into ordinary shares, which is both long-term capital and it keeps the balance sheet clean”. Both of which are true – but it also multiplies the investor’s ownership without introducing new capital into the business. Both these options may become valuation traps or punishment for market cycles beyond the owners or business’ control. You may consider ensuring that these clauses are 2-way clauses – i.e. the business gets back double, triple or quadruple its shares if the business overperforms. The trick of course is establishing at the onset what a REALISTIC performance level is. Secondly, for any conversions into ordinary shares, you must strive to negotiate for a One-to-One conversion rate. Anything outside of this, is a takeover waiting to happen.

3 – “THE TENANT IS THE LANDLORD” SCHEME

Often as a business owner and entrepreneur, you are most vulnerable when 2 occurrences converge at once – (1) your business arrives at a point where scaling is the only way forward and (2) you need big funding to make that scaling happen. But knowing that you are at your most vulnerable is helpful for also keeping an eye open for being taken advantage of. Beware of (1) veto rights or (2) disproportionate ordinary voting rights to investors or lenders compared to their capital inputs. Some clauses may allow the investor to have veto rights on “Reserved Matters” or a large number of ordinary voting rights to vote for or against anything. Be very careful what those reserved matters are and never look at them and say “these don’t look like events that will happen anytime soon”. Wrong! In business, anything can happen soon. Generally this may be alright for big strategic decisions like selling the business, etc – of course your biggest investors would like to have a say in matters like that – you would too, if the tables were turned. But if these rights can prevent you from taking operational decisions to move the business forward without seeking approval, then it could also be used to cripple you and force a conversion or takeover. My advice – limit veto rights to issues of capital structure changes and sale of assets above a sizeable threshold or the number of voting seats per owner. In rare circumstances, it is possible to have an investor’s observer on the Board without a voting right or not interfering with the work of Executive Directors.

4 – DRAG, TAKEOVER WAIVER, REDEMPTIONS

Believe it or not, you can come across clauses that force you as the owner of the business to sell your ownership IF the investor(s) find a buyer for theirs (drag-along rights). Believe it or not, you can come across investment contracts that allow the investor or fund to demand their entire investment back in cash at a specific date and if you don’t have the cash to settle it (and you most likely wouldn’t if you are still in your growth stage), to settle the debt by taking over your remaining ownership in the business or a disproportionate percentage of it, as compensation for your inability to settle. Whereas in most justifications if a single shareholder reaches a certain percentage holding (30-40%), they are required to make an offer to the remaining shareholders to buy out their holdings and take over the business as majority owners, it is possible to have some investors or funds insist on these protected rights of smaller investors to be completely waived before they invest – watch out – it may be the closest you get to the investor’s future intentions. Always make the efforts to negotiate a “Right of First Refusal” (ROFR) or a “Right of First Offer” (ROFO) so you have the chance to buy investors out before they drag you. You should equally seek to ensure that any redemption can only be triggered by a “Bad Leaver” event such as fraud or gross negligence, and not merely the passage of time.

5 – THE ANGEL OF DOMESTIC CURRENCY DEVILS

Most investors are likely to invest in USD or Euros or other Western denominated currencies. If on the contrary, you operate your business entirely or largely, or your revenue streams are largely in local currency with a history of exchange rate fluctuation or depreciation – then brace yourself, because neither you or your investor needs to do anything bad or creative to edge you towards inability to settle your indebtedness – the depreciation of your local currency alone does all that work. There is not much you can do with this one other than the obvious – diversify your business segmentation portfolio into foreign currency earning markets if practical; negotiate to receive disbursement and repay the investment/facility in local currency; find your investment via or from a local investor or fund with local currency denominatios; IF it is possible to do this and still be competitive, charge margins bigger than the rate of fluctuation between your local and investment currency. I must admit this is a wild one to manage. But it also means if an investor is offering you a deal to help manage the currency component of their investment, you need to read it carefully too.

A lot has been said and suggested, but in practical terms, two things matter most when negotiating DFI investment deals:

Get a truly independent legal counsel – not just lawyers the investor or fund recommends or is happy to pay for. More importantly, find a lawyer who knows or has some experience in DFI investment negotiations. They may cost you, but they may also save you much later. DFI investment agreements are drafted by top-tier international law firms who have done hundreds of these deals and the legal asymmetry can be dangerously costly to your business if you let it.

(2) Explore domestic or local funding alternatives before accepting structured DFI capital. As an entrepreneur, your genius doesn’t end at an idea that works – it must extend to finding financing that is in the best interest of your business. It may mean a choice between a longer, slower organic growth and intentionally building financing relationships with government schemes, domestic pension funds, sovereign wealth funds, Afro-regional DFIs, local private equity, diaspora individuals or capital pools or as weird as it may sound – wealthy political players.

As harsh as it may sound, sometimes seeking domestic capital in the African context means making a choice between “immorality-with-ownership” AND “accessibility-with-dilution.” In fact, there is an African proverb that poses a question around this dilemma – “would you rather be the tail of a lion or the head of a lamb?”