Small and Medium enterprises are the bedrock of the economy. SMEs account for 80% of jobs across the continent, driving employment and socio-economic growth. In Uganda, Ethiopia, and Kenya, up to 90% of the population rely on SMEs for employment. Yet there are many challenges facing SMEs in Africa that cause them to have a high failure rate.
Beyond job creation, SMEs play a crucial role in fostering innovation, incubation, and commercialisation of new technologies, bridging the gap between early-stage ideas and large-scale industry adoption.
So why is the average startup failure rate in Africa at 54%?
Because SMEs play such a critical role in Africa’s economy, understanding why they fail and how to overcome operational challenges is important for both local entrepreneurs and international investors looking to tap into the country’s business and growth potential.
Have you seen our blog post on expanding your business into the African market? You can check it out here.
1. Financial Constraints & Access to Capital
One of the biggest hurdles African SMEs face is securing funding. Despite their critical role in economic growth, these businesses experience a massive financing gap of over $136 billion annually. The issue isn’t necessarily a lack of available funds but the restrictive lending conditions imposed by financial institutions.
Many SMEs struggle to provide the necessary collateral, navigate complex loan application processes, or meet high-interest rate requirements. As a result, banks often view them as high-risk borrowers, further limiting their access to credit. A World Bank study spanning over a decade across 100 countries identified lack of financing as the number one barrier to SME growth in Africa.
2. Regulatory & Bureaucratic Barriers
Government regulations can either support or stunt the growth of SMEs. Unfortunately, in many African countries, excessive bureaucracy, complex licensing processes, and high tax burdens make it difficult for small businesses to thrive.
Starting a business in Ghana, Kenya, and Nigeria can take over a month, and obtaining the necessary licenses can stretch from 100 days in Kenya to a staggering 350 days in Nigeria. Additionally, tax policies often place heavy financial burdens on SMEs. Kenyan businesses, for example, pay up to 51% of their total profits in taxes.
Lengthy procedures and costly compliance requirements discourage many SMEs and entrepreneurs from formalising their businesses. Thus, they are pushed into the informal sector, where access to financing and growth opportunities is even more limited.
3. Infrastructure & Logistics Issues
For small businesses to thrive, they need more than great ideas and hard work. They need proper infrastructure. A business is only as strong as the environment in which it operates, and for many African SMEs, poor infrastructure presents a significant setback. Unstable electricity supply, limited road networks, inefficient transport systems, and unreliable internet connectivity make it difficult for businesses to operate at full capacity.
For instance, in Ethiopia, the high cost of electricity is a significant factor stunting SME growth. Without adequate infrastructure, small businesses struggle to scale, compete, or even deliver products and services efficiently.
4. Talent Acquisition & Workforce Skill Gaps
Talent acquisition and retention are major challenges for African SMEs. Many businesses struggle to attract and retain skilled workers, particularly in technical and managerial roles. A lack of well-trained employees leads to inefficiencies, poor productivity, and ultimately slower growth.
The issue isn’t just about hiring but also about leadership. Many SME owners have great business ideas but lack the strategic planning, financial management, and operational skills needed to run a successful enterprise. Without proper training and experience, many entrepreneurs adopt a trial-and-error approach, focusing on short-term survival rather than long-term sustainability.
5. Market Access & Competition
African SMEs often struggle to expand beyond their immediate surroundings due to poor access to international markets and unreliable market information. High transaction costs, inadequate financial market structures, and limited distribution channels make it difficult for SMEs to scale or compete globally.
Without proper networks and access to trade opportunities, many promising businesses remain stagnant, unable to tap into larger markets that could accelerate their growth.
6. Corruption and Unethical Business Practices
Corruption remains a major roadblock for SMEs across the continent. Many small business owners are forced to give undercuts or engage in non-transparent dealings to secure licenses, access funding, or even get essential services. This drains their already limited financial resources, increases business costs, and discourages foreign investors who might otherwise support SME growth.
Without strong anti-corruption measures, many businesses struggle to survive in an environment where unethical practices are seen as the norm rather than the exception.
Opportunities For Investors in Africa
Despite the many common problems of SMEs and why they fail, African SMEs continue to demonstrate resilience and innovation. Despite these challenges, SMEs, businesses, and entrepreneurs have been contributing meaningfully to Africa’s economic growth.
Addressing these challenges requires a collaborative effort from governments, financial institutions, and industry stakeholders to create an enabling environment. An environment where small businesses can thrive and contribute meaningfully to economic development.
The Role of SMEs in Africa’s Economic Growth
SMEs are important in driving economic development, job creation, and innovation. According to the World Economic Forum, SMEs contribute over 50% of Africa’s GDP and are responsible for more than 80% of employment on the continent. These businesses provide livelihoods for millions and promote economic expansion by promoting trade, investment, and wealth creation.
Beyond their economic contributions, SMEs are key drivers of innovation and entrepreneurship. Many groundbreaking ideas, technologies, and business models originate within SMEs before being scaled by larger corporations. They serve as incubators for new products and services, helping to test and refine innovations that eventually shape broader industries.
Without a thriving SME sector, many African economies would struggle with stagnation, reduced employment opportunities, and weakened economies. Supporting and strengthening SMEs is essential for Africa to maximize its growth potential.
How Investors Can Mitigate Risks With Strategic Partnerships
Strategic partnerships and innovative financial models can help investors mitigate these risks while driving sustainable business growth. Here’s how:
Blended Finance to Reduce Risk
Blended finance is an effective way to unlock capital for SMEs by combining concessional (public or philanthropic) funds with commercial investments. This approach reduces risk for private investors through mechanisms like first-loss guarantees and concessional loans.
According to Convergence’s historical deals database, the blended finance market for Sub-Saharan African SME-focused deals includes 145 transactions totalling $11 billion. Despite the significant volume, SME transactions remain relatively small, averaging $30 million compared to $50 million for all blended deals due to high-risk perceptions and market constraints.
Risk Management Tools
To further minimise investment risks, investors can utilise financial instruments such as cash-flow-based lending, partial portfolio guarantees, and hedging products. These tools help manage challenges like currency fluctuations and loan defaults.
For example, concessional guarantees transfer some or all of the risk from investors to a guarantor, improving the overall risk profile of SME investments. This makes investing in SMEs more cost-effective and attractive while providing them with much-needed financial support, such as lower-cost capital and extended repayment terms.
Partnerships with Local Financial Institutions
Many banks are hesitant to lend to small businesses due to concerns over high default rates, which increase their expected losses. However, development finance institutions (DFIs) and other local financial entities can help mitigate this risk by sharing some of the burden.
For example, if a bank’s expected loss on SME loans rises from 6% to 8%, a DFI can provide a first-loss guarantee to cover the additional 2%. This reduces the perceived risk for the bank and encourages more lending to SMEs. By collaborating with DFIs and local financial institutions, investors can tap into market expertise, leverage existing networks, and create a more stable environment for SME financing.
Capacity-Building and Diversification
Beyond financial tools, investors can further de-risk their SME investments by diversifying across different sectors and regions. This spreads exposure and reduces the impact of localized economic downturns.
Additionally, providing capacity-building support for SMEs, such as training in financial literacy, business management, and digital transformation, can improve their long-term sustainability. Well-managed businesses are less likely to default on loans and more likely to generate strong returns, benefiting both investors and local economies.
Conclusion
Business owners and stakeholders must proactively foster an environment where SMEs can scale and compete globally. Likewise, international investors have a unique opportunity to explore Africa’s rapidly growing markets by collaborating with local businesses and leveraging strategic financial models.
Now is the time to bridge the gap between capital and opportunity. Stakeholders working together can create a more inclusive, resilient, and prosperous African business landscape. The future of Africa’s SMEs is bright, and the impact will be transformational with the right partnerships.
P23 Africa specializes in helping SMEs and investors unlock growth opportunities, mitigate risks, and build sustainable success. Contact us today to explore how we can support your investment and expansion in Africa.
