A Framework for Funding MSMEs and Startups in Somalia: A Challenge for the Local Banks

A Goldmine for Employment Opportunities

Globally, small businesses account for the highest portion of economic growth and job creation. They are a goldmine for employment opportunities. But a significant reason for this global success is the working environment for these businesses in many countries. Unfortunately, this is not the case in Somalia: there is almost zero support for small businesses and startups from the government of Somalia.

Fortunately, the private sector has always been the lifeline of survival in Somalia. They offer(ed) governmental services, including education and health services. The financial industry, for example, played a crucial role in channelling diaspora funds back home. The banks do offer financial support services to businesses. This has sparked economic growth and contributed to job creation in the country.

Banks played a vital role in the financial sector. Still, this piece challenges local banks’ approach to contributing to job creation efforts in Somalia. We will review the micro-finance status in Somalia, how banks to finance startups, why banks are hesitant to support idea-stage startups and a framework for financing startups.

Startups Are Better Positioned to Create More Jobs

The growth mindset is one differentiating factor for small businesses and startups in Somalia. This is very feasible if you consider the objectives of these businesses. In Somalia, the majority of small businesses are small and stay small forever. Business growth has (is) never been the case. Almost all the businesses in Bakaro Market, the largest market in the country, do not have written documentation of their activities and plans to guide their businesses in the future. If you talk to small businesses in Somalia, you will observe that their business metrics are unusual: help pay the family bills, pay the school fees of the children, and so on. Focusing on building a bigger brand, reinvesting in the business, establishing new branches, and making profits are not their main priority business objectives.

Compare that to the recent uptake of startups in Mogadishu. Mogadishu is enjoying a new trend: contemporary brands popping up everywhere in the city. I got invited to grand ceremonies every Friday. These new startups are about every sector: cafés, home appliances, electronics, fashion, ICT, all-women stores, and many other types of startups.

Where did they get the money to finance their startups? Their most prominent supporters are, in addition to personal savings, families, and friends. Why not the local banks? Because banks in Somalia are more inclined to support well-established small businesses, not idea-stage startups. Getting finance from banks by startups is an overly complicated process: the requirements ask for a license, a bank account with a history of financial transactions, and an existing premise. There is also an unwritten rule: having a solid network of referrals. This means that if you are well-connected, you are better positioned to access bank funds.

The banks in Somalia have different reasoning than the above argument. They do not want to risk their fund portfolio with idea-stage startups. And this is very understandable considering the lack of regulations in the country and protecting their clients’ money. I remember attending the launching ceremony of Premier Wallet and Mr Jibril Mohamed Hassan, Premier Bank Board Chair, emphasizing their reluctance to give out loans to idea-stage startups due to the lack of regulations in the country. According to him, the banks’ policies will be more conservative unless the Somali government produces a regulatory framework that protects their fund.

Somali banks are more risk-averse. They are, understandably, scared of higher default rates if they go for supporting a higher number of idea-stage startups. But business also involves risk-taking. This does not mean playing with clients’ money but getting aggressive in doing business. As they say in economics, more risks attract more gains.

This is where I want to challenge the banks: if the Somali government is slow enough to enforce regulations that help banks protect their funds and support idea-stage startups, would the banks sit down and wait? Or would they look for an alternative just like our private sector used to do during the absence of a permanent government? Let me propose a framework that helps banks entertain another perspective of funding idea-stage startups.

A Proposed Framework for Financing Startups

Avoiding higher default rates is the main objective of local banks. But let us first dissect how a higher default rate happens and accumulates in the first place. First, higher default rates might occur if there is no history of financial interaction between banks and loanees. This is more likely if it is a walk-in startup founder who just shows up with a well-crafted proposal and asks for loans. Even if the bank takes the new founder through its vetting process and is happy with the documents, it is still possible that this new company might default. This is because we might never know the passion and commitment of this founder and his/her acumen for business. And that is something banks cannot verify with just documents (which can be written by third parties).

Second, banks are more favourable to loaning out new businesses if they are referred by a client (company or person) respected by the bank. But then again, this increases the chance of default rate because this specific client has been reviewed with positive and blue eyes due to his/her affiliations with the bank’s network. If default happens, this contributes to the existing assumption of banks that the default rates of idea-stage startups are higher.

Finally, local banks do not have windows specific to orienting new founders about the most suitable finance option for their particular case. For this reason, new startups end up getting access to funds not enough to sustain their business for a reasonable time. They end up defaulting during the grace period.

Therefore, it is essential for startup founders to be vetted enough for passion and business acumen before enabling them to access finance. And this is where the innovation hubs come in. In other words, banks should partner with local innovation hubs such as SIMAD iLab and co-design a three to six months incubation program supported by the banks.

Every startup founder must go through the incubation program before they become eligible for investment. Innovation hubs would take startups and incubate them for three to six months. During this period, the hubs are observing the viability of the startup and the founders themselves. Watching the founders is overly critical because it assures the hubs to verify the connection between the business idea and the founder. It also affirms the business acumen of the new founder. Once a startup completes the incubation program, the innovation hubs will select the most viable, investable-ready startup. Then, recommendation letters are written for them. The banks will now have a small pool of startups to choose from. This is a cleaned pool of applications. There is no need to verify the applicants’ commitments as this has already been completed. Banks will still need to take applications through their vetting process for final verifications.

We have tested this model at SIMAD iLab, the innovation hub of SIMAD University. Our partnership with Premier Bank allows us to take in startups in our incubation programs. The best performers in the program get recommended to the bank for investment. Udug Flowers is a fitting example of this partnership. This was an idea-stage startup that graduated from the incubation program of SIMAD iLab. With our recommendation, Premier Bank invested in the startup. Udug Flowers now has two branches in Mogadishu. A journey from an idea-stage startup is now a startup with two branches employing almost five permanent staff members. The startup is also now planning to stop importing flowers from Kenya and Ethiopia and establish a local manufacturing plant for flowers in Somalia. And all of this has happened within the span of one year.

With this banks – innovation hubs partnership model, more idea-stage startups worth investing in will get the opportunity to get access to funding irrespective of the power of their network affiliations or financial history interactions with the bank. Some brilliant founders “unknown to the banks” will end up getting access to the proper resources required to make their dreams real. And, in the end, banks will have lower default rates.

Mohamed Muse Hassan, Director, SIMAD iLab

3 Responses

  1. This is very serious topic. It very looks like my Thesis topic which is determinants of startup’s microfinance access in Mogadishu, Somalia. Looking forward, awareness of the local banks will raise if many of like this artice published.

  2. This is well articulated article on the subject matter! But it looks like the whole of your beautiful story tended to an interest group (the hubs) that you’re among them! Where you challenged already the guarantor of the respected persons to the banks 🙃

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