Why small businesses fear private equity investments

Small businesses remain cautious of taking up large equity investments, despite it emerging as a key source of capital financing. This is even as interests grow in structured debt.

The reluctance to accept large investments has been attributed to the need to maintain control of their company until an exit, such as a sale or an initial public offering (IPO).  

This is because taking on significant funding can dilute ownership, reduce decision-making authority, and introduce investor-driven pressures, such as demands for rapid growth or an early exit.

However, some micro, small, and medium-sized (MSMEs) enterprises are gradually allowing venture capitalists to structure around that, but at the same time, get better risk-adjusted returns.

According to Paul Matellanes from Africa Go Green Fund, all MSMEs require more flexible credit financing solutions. “To bridge that gap, we think that private credit lenders should strive to offer that flexibility that the businesses require,” said Matellanes.

Associated risks

Most small businesses do not qualify for traditional lending from banks. To fill the gap, private creditors are increasingly offering blended financing to reduce associated risks.

This, according to private capitalists, offers an opportunity for private credit lenders as they do not focus on collateral, which is different from traditional lenders.

Private credit lenders look at the health of the business, analyse the cash flow, and also look at growth. “The opportunity that has been tapped is that many private credit lenders do not focus on taking land as security; they’re not looking at debentures necessarily,” said Sammy Ndolo from CDH Kenya.

He notes that the approach is cheaper and makes it easier to close a transaction.

Even as investors try to navigate the underweight market like Africa, private credit investors continue to grapple with a myriad of challenges, such as the regulatory environment and legal background.

Weaknesses, such as an unpredictable legal regulatory environment, are holding people back from being able to perform more in the private credit space, despite steps and advancements being made to make it more accommodating of investment.

Historically, in Kenya and most of the South African countries, credit has not been regulated. This is unlike the deposit-taking business.

“Over the last seven or so years, there has been a shift toward regulating credit,” Ndolo said. The Central Bank of Kenya (CBK) is also looking to regulate lending. These regulations have been informed by conflicts that arise primarily from the consumer market.

The East Africa Competition Authority is also looking to regulate money transactions that have a cross-border effect. Generally, East Africa faces major challenges in attracting institutional investors, despite available opportunities for investments in different sectors.

“It is very difficult to fund raise for the subordinated tranche or the catalytic tranche,” said Faisal Jiwa from AFRICINVEST. He noted that even the finance institutions are looking to catalyse private capital into the continent, but are still coming in as a commercial layer.

For lenders, other than the challenge of fundraising, there’s currency risk and getting appropriate costs and competition. Jiwa advises private players to be as flexible as possible when it comes to structuring the fund itself.

Despite the challenge of competition, the financing needs for businesses in East Africa remain huge. Speaking at the ninth annual private capital conference in Nairobi, board chair at East Africa Venture Capital Association David Owino said the African region is growing, and there is a need to catalyse more capital.

“We need a more cohesive, integrated region, because investors look at the region as one,” Owino said, noting that governments across the region need to harmonise the environment to attract capital.

According to the board chair, small businesses are reluctant to take on large credit investments due to an information gap.

“They need to understand how the market works. It is dangerous for a business to attract private equity if it does not know how it works,” he warned. He noted that private equity money comes with its own requirements.

“The association can help educate the SMEs on how to prepare for private equity coming in,” he said, adding that small businesses need to be investor-ready, even mentally, to partner.

He notes that Kenya is a viable market for private equity investments, given the number of debt funds coming into the country.

He said the CBK regulations on lenders are a result of increased interest by people getting loans away from traditional sources.

“Capital flows don’t like too many regular changes in laws, they want stability,” he said that investors want to catalyse their money for a longer period. According to Owino, regulatory predictability is a key issue affecting debt investors in the East African region.

Private Capital Policy Monitor, 2025 shows that the Kenyan economy has matured into a destination for private equity and venture capital, drawing $3.3 billion (Sh429 billion) in investments between 2019 and 2024. Out of this, 84 per cent of all funds raised in East Africa.

According to the report, companies need to conduct a legal audit to ensure compliance with applicable laws and close information gaps prior to entering any transaction.

The report notes that informally structured, smaller or long-established businesses, particularly in family-owned businesses seeking to secure funding, are burdened by the lack of formal records and clear corporate governance, leading investors to seek to be overly compensated via structural means.