WHITE PAPER ENTREPRENEURSHIP AND FREE TRADE - Volume I - Africa's Catalysts for a New Era of Economic Prosperity - African Development Bank
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WHITE PAPER ENTREPRENEURSHIP AND FREE TRADE Volume I – Africa’s Catalysts for a New Era of Economic Prosperity
White Paper
A white paper is a report or guide that informs readers concisely about
a complex issue and presents the issuing body’s philosophy on the
matter. It is meant to help readers understand an issue, solve a problem,
or make a decision.
Entrepreneurship
Over the next decade, many of Africa’s current development chal-lenges
will become bankable business opportunities that our youth, women and
others can capitalize on. Key drivers in this process are digitalization of
the economy, climate change and the greening of the economy, coupled
with a growing consumer market and pan-demic-induced recognition by
policy makers to strengthen the conti- nent’s resilience and generate
greater value-added.
Free Trade
The African Continental Free Trade Area is the greatest opportuni-ty for
African entrepreneurs to increase the total available market for their
ventures, which in turn strengthens their business case to investors
concerning revenue growth and profit forecasts. The com-plexities
of navigating the local business environment present a first-mover
advantage for African entrepreneurs in this context.
African Narrative
The importance of storytelling in our lives cannot be overestimated,
as it is the basis for everything we do and how we see the world. Over
the past decades, the narrative around Africa’s development has mainly
been written outside the continent, even though increas-ingly with
African participation. This White Paper aims to tell the story of the
African entrepreneur from an African perspective.
This White Paper series is being commissioned under the auspices of Dr. Khaled Sherif,
Vice-President at the African Development Bank Group, responsible for Regional
Development, Integration and Business Delivery. The task manager of the report is
Frederik Teufel, Advisor to the Vice-President, and the authors are Dr. Michael Borish
and Mohamed Ramzi Roshdi, senior consultants employed by the AfDB. Ms. Aileen
Marshall, senior consultant, has edited this abridged version of the report and Justin
Kabasele and Arsene-Stephane Konan have provided graphic design. It should be
recalled that the contents of the White Paper reflect input from individuals who are
employed at the AfDB and do not necessarily represent the views of the AfDB or any
of its shareholders.
3
TABLE OF
CONTENTS
1. Introduction 2 3. A Profile of Entrepreneurship in 23
Africa
2. Entrepreneurship as an Engine 4
for Economic Growth 3.1 Role of Entrepreneurship in the 23
African Economy
2.1 Role of entrepreneurship in 4
the economy 3.2 Supply Side: Investment in 23
7
Entrepreneurship in Africa
2.2 Macro-level characteristics
and building blocks for 3.2.1 Incubators 24
entrepreneurship
3.2.2 Accelerators 25
2.2.1 Human capital formation 7
(education and training, skills 3.2.3 Venture Capital and Private 27
development) Equity
2.2.2 Physical capital 10 3.3 Demand Side: African Start-up 30
Trailblazers
2.2.3 Financial capital 11
3.4 The Role of Governments in 31
2.3 An enabling environment 14
Partnership with the Private Sector
that is conducive to constructive
entrepreneurship 3.4.1 The Business Environment 31
2.3.1 Legal, regulatory and 14 3.4.2 The Role of Special Economic 33
institutional environment and Eco-Industrial Zones
2.3.2 Governance standards 15
and risk management principles 4. Trade and Investment as 34
Catalysts for Economic Expansion
2.4 Frontier industries of the future 17
4.1 Brief Overview 34
2.4.1 Blockchain, fintech and the 17
modernization of transaction 4.2 Role of Trade Blocs 34
processes 4.2.1 General Overview 34
2.4.2 Cybersecurity and protections 18
4.2.2 Relevance of Trade Blocs 35
for small businesses
and Free Trade for Africa
2.4.3 Food security, climate change 19
4.3 Macroeconomic and Balance 35
36
and clean technologies applied to
of Payments Indicators for Africa
production, consumption and daily
life 4.3.1 General Trend 35
20
2.4.4 Urbanization and smart 4.4 Relation of Trade and 36
technologies for planning, daily Investment Developments to
operations and mobility African Entrepreneurs
2.4.5 Logistics and connectivity 20
in support of improved 5. The Upcoming Paradigm Shift for 38
social infrastructure African Trade
5.1 General Outlook for Trade in 38 6. The Intersection of 50
Africa Entrepreneurship and
Free Trade
5.2 Business Environment 39
Challenges and Financing 6.1 Steps for Medium-Term 50
5.2.1 Domestic Financing 39 Convergence
5.2.2 The Importance of and 40 6.1.1 AfCFTA negotiations and an 50
Need for Investment improved business environment
5.3 Cross-Cutting Themes 42 6.1.2 Infrastructure investment to 50
power regional trade
5.3.1 Digitization and 42
Entrepreneurship in Africa 6.2 Near-term Next Steps 51
5.3.2 The Green Economy and 42
7. Bibliography 53
Opportunities for African
Entrepreneurs
8. Other References 55
5.3.3 Governance and Social 46
Impact 9. Endnotes 57
1. Introduction
At the outset of independence in most emerging varied businesses has been made possible by
markets, supporting entrepreneurship was trends set in motion decades ago. These include
a relatively peripheral component of the globalization of capital and financial markets,
economic development agenda and there linked together through banking networks,
was little focus on the role of the private payment and settlement systems, trading
sector. Western- oriented bilateral support platforms, and insurance and reinsurance
for private sector development began to whose shared risks required communication
pick up momentum in the 1980s and leading and coordination. The Basel framework for
development finance institutions (DFIs) capital convergence has since evolved into
supported the private sector development a comprehensive framework of standards to
agenda with a focus on institutional ensure stability, driven by both solvency and
theory. This posited that a sound business liquidity requirements. Increased integration of
environment grounded in legal and regulatory trade and investment, often regional in nature,
frameworks that promoted competition, but significantly more globalized in recent
combined with well-functioning institutions decades, now involves not only multinationals
and infrastructure, would create the conditions but also mid-sized and smaller companies.
needed for emerging markets to overcome
poverty and economic underdevelopment. With The linkages between globally integrated
the collapse of the Soviet Union and the rising financial markets and real sector
openness to the outside world of China, these economies have been largely powered by
themes picked up momentum in the 1990s. It the unprecedented pace of technological
was also in the 1980s and after that a growing innovation in telecommunications, computing
portion of international students began to power, and data and information transmission.
attend MBA programs in the United States, In today’s emerging markets, technology-
long the institutional leader for business inspired innovation has been a driving force.
management training. Such programs evolved China and India are among the world’s leaders in
over time, were replicated overseas, and have telecommunications and information systems
since matured to become far more integrated, technologies, and China often now competes
specialized, and global in focus. However, until in frontier industries like artificial intelligence
this century, the focus on “entrepreneurship” and quantum computing for global leadership
was indirect, embedded in economic theory with the US. Economic growth has been fueled
and history, and enveloped in the 20th century by companies like Alibaba, Tencent, JD.com and
within theories of the firm (Coase, 1937), agency Pinduoduo in China, and Infosys, Flipkart and
(M. C. Jensen & Meckling, 1976), and broader Ola in India. These companies have an average
business management principles. age of less than 18 years.
Today, entrepreneurship is commonly These developments and the growing
acknowledged as a critical factor in the confidence that new technologies and smart
development and culture of societies. management can transform the economic
Entrepreneurs like Elon Musk, Jack Ma and Bill landscape have encouraged a shift towards
Gates have achieved international acclaim. supporting entrepreneurship on the part of
Companies like Google, Facebook, Salesforce, development partners providing financing
PayPal and Alibaba—all founded less than a support to lower income countries. In many
quarter century ago—have grown to market cases, they view job creation as a source of
capitalization in the hundreds of billions income generation and wealth distribution.
of dollars. Google and Alibaba have already However, there is also recognition that many job
joined more mature, but equally disruptive functions will become obsolete as automation
and trailblazing former-startups like Microsoft, permeates scalable industries. Therefore, there
Apple and Amazon to eclipse the trillion-dollar is a clear focus on the need for productivity
valuation mark. Others like Tesla loom on the enhancements, efficiencies and applications
horizon. of new technologies not only for economic
development, but also for social infrastructure
Much of the success of entrepreneurs and their needs, better government and enforcement of
2
governance standards, and action on climate for Africa, (5) how all of these themes related
change, clean energy and resource depletion. to entrepreneurship and intra-African trade
intersect, and (6) summary observations and
A two-year study by the United Nations University recommendations.
World Institute for Development Economics
Research (UNU-WIDER), which culminated in The research finds there is considerable reason
the release of the book “Entrepreneurship and to be optimistic about prospects for growth and
Economic Development”, revealed that the entrepreneurship in Africa, but that optimism
role of the state is among the foundational is challenged by inadequate structures for
elements for entrepreneurship to serve as a resource management oversight. Africa is
catalyst for economic growth. This includes the at risk of depleting many of its comparative
capacity of the state to ensure a level playing advantages in natural resources unless it gains
field and create the appropriate regulatory and control both of these resources themselves and
judicial environment to support a competitive, the methods for producing and transforming
entrepreneurial culture. However, there is them into consumable products. Stricter
more to the equation, not the least of which governance standards, oversight, tracing
are intangibles and pressures that induce and certification of steps in the production
entrepreneurship. and distribution process will be needed to
safeguard Africa’s bounty. Closer intra-African
This report looks at entrepreneurship ties will be needed through infrastructure,
thematically in the context of implications trade and investment, and financial markets to
for Africa. It considers (1) entrepreneurship as accelerate valued-added on the continent. And
an engine for economic growth, (2) how this wealth creation will need to be characterized
broader context potentially applies to Africa, by more balanced income distribution and
(3) more specifically how trade can serve as a better delivery of social infrastructure and
catalyst for sustainable economic expansion, public services to meet the economic and
(4) how the African Continental Free Trade Area human development objectives of a growing
(AfCFTA) can serve as the vehicle for a paradigm and youthful population. Entrepreneurship can
shift in economic development and trade in and make an enormous contribution to all of this.
3
2. Entrepreneurship as an Engine
for Economic Growth
2.1 Role of entrepreneurship in the dynamic, not static, and is affected by changing
economy conditions and competitive pressures. These can
be positive or negative, with the former reflected
Long-term sustainable GDP growth and wealth in innovations that transform the economic
creation is typically based on rising total factor landscape in a manner that creates broad-
productivity (TFP), meaning rising growth in based improvements in social welfare, whereas
output and efficiency from each unit of land, the latter is reflected in stagnation, declining
labor and capital inputted into the system or standards of living, and reduced distribution
process of production and distribution of goods of social welfare benefits. Entrepreneurship is
and services. Economic indicators quantify these often inherently disruptive, as it involves risk-
measures and inputs, identify levels of output taking based on vision to redefine the status
resulting from these inputs individually, and quo. This is most widely known as “creative
then interpret the residual as TFP. As economies destruction”, although dozens of other theories
evolve and develop, TFP increases. Therefore, have been included in the economic literature
a single farmer on a John Deere tractor or since the early-to-mid-1900s. In this regard,
combine in Argentina, Brazil, Canada, Australia entrepreneurship has important spillover effects
and US is likely to be far more productive than within economies and societies, both positive
100 subsistence farmers on small plots in and negative, causing tensions that are often
Ghana, Cameroon or Kenya. The reason is partly challenging to remedy.
due to the superior productivity resulting from
mechanization and the larger plots that can be The current (2021) k-shaped recovery from
farmed. Combined as well with an ample supply COVID-19 in many countries partly reflects
of suitable inputs, financing and crop insurance this, with outsized wealth increases and
for working capital and weather-related risks, compensation packages for those capitalizing
warehousing facilities for storage, transport on changing patterns, while others unable to
equipment and infrastructure for distribution, re-skill or mobilize capital are marginalized, laid
and commercial markets and institutions off, or displaced by newly adopted technologies.
(including cooperatives) for downstream sales, While economic growth and TFP may increase as
the example shows the importance of TFP in a result of such entrepreneurial innovations, the
relation to individual producers as well as wealth effects are often poorly distributed in a
broader markets and business environments. way that destabilizes economic and political
environments and causes frictions in society.
However, an intangible factor not captured Therefore, while entrepreneurship is often cited
explicitly as a unit of measure in economic as a contributor to economic dynamism, growth
growth and TFP is entrepreneurship. The study of and wealth, the effects are not universally
entrepreneurship is multi-faceted, influenced by positive in society as a whole.
economic resource availability and constraints,
political and governance systems, and related The chart below provides profiles of innovations
socio-economic factors touching on education in the last two decades that have upended
and culture. While all regions and populations the status quo ante. Most are focused on
have differing degrees of entrepreneurship, it telecommunications and digital advancements,
is widely acknowledged that entrepreneurship all of which are supported by increases in
serves as both an input into economic growth computing power, more complex and faster
and wealth creation and an indicator of regional, chips and, more recently, artificial intelligence.
national and sub-national cultures and their These advances have generated the “internet of
capacity to sustain growth and wealth creation. things” that, among other powers, advances the
It is also acknowledged that entrepreneurship is use of big data through linked sensors.
4
Figure 1: Examples of Disruptive Innovation in Technology
Source: Brandon Gaille
However, while these kinds of digital advances entrepreneurial. Successive stages of human
permeate all innovation, they are also and societal development have been predicated
sector- specific in many ways, with additional on curiosity and evolution in thinking based
advances in biotech, fin-tech, robotics and on trial and error and the search for new and
logistics all culminating in a rising tendency better ways of carrying out activities. These
towards automation and smart applications. included the transformation from cultures of
The result has been considerable innovation hunting and gathering to farming and food
and enhancements to productivity, including production, all the while introducing new
targeted and specialized uses that increase forms of organization of family and clan units,
prospects for fundamental improvements human settlements and communities. Modern
across the globe in health, education and social times have been characterized by, among other
welfare. At the same time, there has also been things, various stages of industrialization and
resistance to adoption as these technologies technological development that have ushered in
are highly disruptive in an age of socio- cities, telecommunications and the space age. It
cultural uncertainty. Therefore, there is broad is a human characteristic to inquire, challenge
consensus that both benefits and costs are and pursue new approaches and find solutions
associated with rapid advances in technological to existing problems, and these are critical
innovation, and entrepreneurship is likewise components of entrepreneurship that are
viewed as beneficial for some, but not for all. reflected differentially across cultures, societies
This resistance is also longstanding, as much and economies.
of the image of entrepreneurship is associated
with rapacious destruction of natural resources Given the general benefits of entrepreneurship
and the environment, rising income inequality, in the creation of new products and processes
and shameless greed that fuels corruption and that benefit society as a whole if properly
injustice. managed, there is broad recognition that
entrepreneurship is desirable on the condition
Entrepreneurship needs to be thought of in that it opens up opportunities for the majority
micro-level terms, not just at the macroeconomic of the population and helps to improve social
or social level. While recognizing the downside welfare. This does not mean all individuals
of wealth or income maldistribution, job losses, must become entrepreneurs, but there is
and socio-cultural destabilization resulting broad consensus that entrepreneurship can be
from some entrepreneurship, there is also the a positive factor in making economies more
reality that human beings have always been productive and responsive to society’s needs, as
5
well as in creating an environment that enables level of commitment societies make to actively
individuals to use their intelligence and talents support entrepreneurial culture. In the poorest
to prosper. However, when conditions fall out of societies, these are often driven by the will
of balance, the downside of entrepreneurship to survive and social pressures to support
can set in. In response, efforts to contain or family and nearby communities. In wealthy
control entrepreneurship can swing to the other societies, drivers are usually competitive
end of the spectrum, resulting in suppression pressures in globalized and highly contested
that ultimately causes stagnation and/or economies (to generate sales, earnings, market
complacency due to the lack of dynamism, share and/or strategic benefits from upstream
innovation and creativity of daily life. and downstream opportunities), and in some
cases other factors critical to national security
It is recognized that constructive entrepreneurship and/or social stability.
requires an enabling environment with certain
characteristics. This section briefly addresses macro-level
characteristics and frontier industries and
At the macro level, these include human activities of the future that will define and
capital formation (education and training, skills be defined by entrepreneurship. Macro-
development), financial and physical capital, level characteristics have systematically
and an enabling environment that is conducive contributed to entrepreneurial successes, as
to constructive entrepreneurship (e.g., legal and reflected in countries with high per capita
regulatory environment, governance standards, incomes, diversified economic structures,
physical and social infrastructure to sustain an well-functioning institutions, high levels of
educated and healthy population). Some of the social infrastructure, and limited dependence
critical success components at the enterprise on primary resources as sources of value
level include diverse and effective management added in the economy. Frontier sectors of the
teams, vision and clear strategy, effective global economy are driving growth and wealth
market research and intelligence, prudent and creation. These include thematic activities that
resilient business models, quality operations for are emerging industries in and of themselves,
product and/or process integrity, and effective but because they are knowledge- based,
financial and risk management. data-intensive and digital in nature, will
have broader impact across sectors, product
The nexus between these macro and firm-level development, and processes. Together, macro-
characteristics can be loosely considered the mix level characteristics and frontier sectors will
of entrepreneurship found in individual societies. be the determinants of wealth creation in
While enterprise-level characteristics vary with the future. How these converge across Africa
each firm, macro-level characteristics reflect will define much of the continent’s ability to
the values, resource endowment and general achieve development objectives.
62.2 Macro-level characteristics and and numeracy from early schooling years up the
building blocks for entrepreneurship chain through a range of secondary and tertiary
level academic and technical institutions, and
2.2.1 Human capital formation (education and programs and initiatives to develop necessary
training, skills development) technical and professional skills. These are
increasingly supported by on-line offerings and
Human capital formation is based on a broad the promotion of continuing education.
range of factors. A starting point is formal The kinds of educational systems and levels of
education systems and the promotion of literacy investment vary across the countries.
Figure 2: Trends in sectoral ODA
Source: Education Commission Analysis based on OECD-DAC (2016). Note: Includes only sector-allocable
direct aid, with no sectoral attribution of budget support
IIn many cases, emerging markets are focused on education to other sectors is that governments
infrastructure investment and more immediate and societies are not always able to clearly see
health and social issues. While education is usually the near-term benefits of education investment
highly valued, it is also often a lower priority than in relation to economic growth. In countries
many other areas of public expenditure focus. with limited resources there is often pressure to
allocate funding to sectors where impact is more
Part of the explanation for the subordination of immediately evident
Figure 3: Many countries lack information on learning outcomes
Source : World Development Report 2018. Note: Regional groupings follow UNESCO definitions
7Human capital formation is also a function incentives in society for the paths chosen by its
of the broader environment. Culture and the members.
weight that society puts on learning or specific
professions will have an effect on education, Given that entrepreneurship is driven by
skills and training. This can move in different creativity, initiative and innovation, a key
directions, with some cultures extolling the question is what cultural and institutional
virtues of professions like law or medicine, factors create an environment in which it
while others emphasize skilled trades. All are can thrive, and what incentives are needed
necessary in modern society. The direction to support the research, development and
emphasized by differing cultures will affect the commercialization of ideas.
Box 1: Classification of incubators and accelerators
Business Incubators
Programs in this group primarily focus on supporting early-stage client startups in becoming viable and scalable
businesses. They are generally characterized by quality-controlled intakes of client startups and regular time bound
exits. Providing an array of support services and infrastructure through a systematic process, such programs usually
support their client startups for one to five years.
Business Accelerators
Programs in this group share a set of characteristics that distinguish them from business incubators and other forms
of capacity development services. They are generally fixed-term cohort-based programs. Normally (but not always)
focusing on catalyzing later-stage client startup growth, they provide intensive mentorship, training, networking, and
access to investment. Intake of new client startups is often highly competitive, with regular time bound exits of up
to six months.
Hybrids
A number of programs self-classify as hybrids, combining many of the best aspects of incubators and accelerators in
their service portfolios, however, for the purpose of this study, hybrid programs are categorized as either business
incubators or business accelerators, depending on their primary focus of their service portfolio.”
Source: UBI Global World Rankings of Business Incubators and Accelerators 2019-2020
The presence of eco-systems specific to and test ideas. Accelerators are closely tied to
particular activities is a key building block forward-thinking companies looking to support
for entrepreneurship. There are many models the next wave of disruptive firms within specific
for creating these eco-systems, including sectors. They are highly competitive, offer fixed
R&D conducted in-house by large-scale firms, term support including mentorship, and often
outsourcing by supply chain drivers to smaller provide initial seed investment in exchange for
and more specialized niche firms, and broad equity. Accelerators in Africa include Flat6Labs
initiatives that require the full power of (North Africa), Grindstone Accelerator (South
market players for effective development (e.g., Africa), MAN Impact Accelerator (multiple
blockchain). countries in Southern, West and East Africa) and
Impulse Accelerator (Morocco). Incubators and
Incubators provide important support for early- accelerators aim to attract additional financing
stage development to smaller firms or individuals for innovative ideas with considerable risk
with ideas but without financial backing. The associated with future development, but with
goal of incubators is to mentor, coach and guide the promise of significant returns should the
entrepreneurs and provide advice and assistance product be successfully developed and accepted
to enable them to access initial seed funding by the market.
8Box 2: Business incubators and accelerators are further divided into the following subgroups
University Public
Business incubator/accelerator Business incubator/accelerator
that derives its business that develops its business
objectives primarily from on or objectives largely independently,
more universities, by which it is often operates autonomously
often operated and primarily and primarily finances its own
financed. operations.
Private Corporate
Business incubator/accelerator Business incubator/accelerator
that develops its business that derives its business
objectives largely independently, objectives primarily from one or
often operates autonomously more for-profit corporations, by
and primarily finances its own which it is often operated and
operations. primarily financed.”
Source: UBI Global World Rankings of Business Incubators and Accelerators 2019-2020
9Relevance of human capital formation to decline in other sectors such as manufacturing
entrepreneurship or agriculture. For centuries, many countries
have experienced high levels of concentration
A critical component in the entrepreneurial in their economies focused on resource
ecosystem of countries is the capacity of the exploitation, export revenues (in Africa, often
educational system to train people sufficiently from raw materials without value- added),
to hatch creative ideas that can potentially and poorly distributed wealth creation that
be commercialized. This is cultural as well as has exacerbated income inequality and social
technical. Societies that are innovative, creative, tensions. In most resource-based cases, the
open and outward-looking will typically offer primary resource itself is often undervalued.
the environment needed for entrepreneurship, Economies dependent on commodities are also
provided fundamental education and training vulnerable to price fluctuations and economic
systems are in place. Societies and cultures shocks when prices collapse.
that are complacent, unimaginative, closed
and insular will typically be more resistant to In the mining sector, great wealth has been
change irrespective of their level of institutional created, yet producing countries have also
capacity to educate and train. Education and experienced major disparities in income
skills development are inextricably linked to distribution and environmental destruction.
entrepreneurship in the 21st century given the Ninety per cent of biodiversity loss and water
growing importance of technology, and the stress are caused by resource extraction
capacity to develop, manage and use data and and processing, and these same activities
related analytics will be critical to success. contribute to about half of global greenhouse
Digital technology is changing employment and gas emissions. In most cases, mining activities
the impact of automation (e.g., robotics, linked have left contamination of water sources as
sensors, artificial intelligence) on labor markets a legacy issue for communities, while also
may be destabilizing where large numbers of decimating forest land rich in biodiversity. By
people without the requisite skills are left out the time the mines have reached the end of
of the major wealth- and income-generating their useful lives (typically 30-40 years), the
segments of the economy. This means that area is virtually unusable while environmental
human capital formation must also allow the damage has not been priced or taxed into the
benefits of technology to be broadly dispersed cost of the product. Moreover, an estimated 20
to facilitate social stability. percent of world mining output is produced by
artisanal miners working in unsafe conditions
2.2.2 Physical capital and poorly paid for their work and output. The
future quality of the physical environment and
Physical capital varies across all economies, prospects for life sciences, health-related bio-
but essentially is composed of property, tech, food security and potable water access,
plant and equipment along with the physical in Africa as elsewhere, are highly dependent on
infrastructure in place to generate electricity better regulatory oversight, management and
and related energy/power, transportation control of the mining sector.
networks (e.g., road, rail, air, maritime) for the
movement of goods, services and people, and Some countries are dependent on a limited
other utilities needed for human interaction number of food commodities, and in many
(e.g., telecommunications, postal delivery cases, producers (farmers) receive only a small
services). Physical capital also includes natural fraction of the revenues compared to consumer
resources available to the country or market for prices paid in end-use markets. For Africa, this
economic development. Physical capital in the has been abundantly clear in the cocoa and
form of public goods (e.g., electricity, transport coffee markets , and likewise applies in other
infrastructure, ICT) has proven its importance in commodities like sugar cane, groundnuts and
those markets where entrepreneurship abounds. cashew nuts. Most farmers are poor, and lack
the resources needed for better sustainability
However, physical capital can also be a major and increased productivity. Value-added is low,
source of instability, foregone opportunities, with most processing and value captured in
and wasted resources. Typically, this has been export markets closer to consumers. Moreover,
known as the “Dutch curse”, generally defined many of the farmers are child laborers who
as the causal relationship between an increase miss out on education, depleting future human
in the economic development of a particular capital formation so critical to entrepreneurship
sector, like oil and gas, and the corresponding in the digital age.
10Relevance of lessons from physical capital to appetites are typically conservative due to
entrepreneurship
their fiduciary responsibilities to policy holders
The role of physical capital is pivotal to and pensioners, and they are subject to strict
entrepreneurship, and can be positive or financial regulation comparable to that of
negative. From the positive side, efficient deposit-taking banks. Other insurance companies
physical infrastructure and access to natural face liquidity management challenges, often
resources represent critical inputs into the with relatively short-terms policies that would
entrepreneurial process. Sustained supplies create a major mismatch if they placed funds
of electricity are essential to the operations, with risky ventures. As these insurance firms
scale and efficiency of all businesses, and a (e.g., property and casualty, maritime, auto) are
basic requirement for digital technologies. likewise regulated, they have limits on their
Physical capital can contribute significantly risk exposures. Capital markets also serve as
to entrepreneurship, but it is not sufficient. platforms for existing businesses, not start-ups.
Singapore, Israel and Mauritius serve as Challenges that start-ups face include delays in
examples of success despite limited physical testing of concepts and products, refinements
resources. A second lesson is that excessive needed to improve and ultimately go to market,
reliance on natural resources can undermine and competition that is often widespread and
the drive for diversification and relevance in the subject to considerable risk of IP theft. In many
global economy. A third lesson is that future cases individuals will seek copyright or patent
resource exploitation will need to factor in protection, only to find that IP has already been
environmental damage and related externalities stolen. In other cases, prospective financiers will
that have not been a part of traditional not bankroll a venture until they see a finished
accounting and financial valuation systems. This product, system or application that has been
will offer opportunities for entrepreneurship, used and endorsed by others in the market. In
such as improved management practices, more yet other cases, financiers will hold back support
efficient manufacturing, conservation and until a particular product has gained access in a
recycling and reduced waste. A second path of major market like the US or European Union.
opportunities will include identification and
development of new products from waste and Start-ups also face endogenous challenges that
product substitutes that reduce dependence add to risk for prospective financiers. Many are
on or use of environmentally damaging raw run by single individuals or a small team that
materials. Entrepreneurs can exploit physical may have considerable strength and experience
capital by bringing about improvements in in some aspects of the business (e.g., product
product quality, process efficiency, and value design, IT systems integration, industry
generation. sales and marketing) but not in other areas
considered important by investors. Outside
2.2.3 Financial capital investors typically do not want to be directly
engaged in the management of operations, but
As noted, one of the key objectives of incubators in their position as capital provider, likely have
and accelerators is to support ideas and a seat on the board and influence on policy as
prospective commercial ventures that have a it affects budgeting and capital expenditure,
chance of success in the market once produced compensation, and general financial risk
or delivered at scale. To achieve this, financing management. This may include having rights
is required. However, traditional financial to assign a CEO, CFO, compliance officer, or
institutions are not typically set up for the someone who can keep the investors informed.
kinds of risk-taking involved in start-ups or In many cases, investment amounts are tied to
entrepreneurial ventures. Banks are highly achievement of milestones, and disbursements
regulated and have a fiduciary responsibility to may not occur until such milestones have been
protect deposits if they mobilize such resources. met.
Even merchant banks whose funding is not
based on household deposits are restricted from The challenges start-ups face are more than
excessive risk-taking in most cases because of financial and managerial. They are also cultural.
the loan covenants in their agreements with In most cases, start-ups have very limited
creditors (bond investors, private placement financing at the start, and require enormous
investors, preferred shareholders). Life insurance levels of sweat equity to ultimately obtain
companies and pension funds are often well- financial capital for growth and progression
resourced, but their investment profiles or risk through the various product cycles and stages
11of company or venture development. This markets is one method of addressing some of
requires motivated personnel with sufficient these challenges. This can be helpful as talent is
incentives and ties to future success to keep available globally, making outsourcing a feasible
them committed to the venture. Because so option for information flows and cost reduction.
many start-ups operate on shoestring or limited Innovations like 3-D printing have enabled faster
budgets, talent acquisition and retention can be movement and development of prototypes to
a challenge. accelerate production cycles. However, many
of these arrangements expose start-ups to IP
Information exchange through platforms or violations, notwithstanding the legal claims
services focused on particular “communities” or bolstered by non-disclosure agreements.
Figure 4: How Startup Funding Works
Source : Fundersandfounders.com; paulgraham.com/startupfunding.html
12At the end of 2020, venture financing was the non-financial sector. The $300 billion value
estimated to be $300 billion globally, with annual for venture capital is also less than 1 percent of
flows in the $30-$40 billion range in recent years. the corporate bond market . Therefore, as a share
While 2020 has seen declines, they were in of total credit or investment financing, venture
evidence prior to COVID-19. Global venture dollar capital is small and often over-emphasized as a
figures of $300 billion are equivalent to less source of financing for start-ups. On the other
than 1 percent of total banking system credit hand, there are few if any alternatives apart
around the globe, estimated by the Bank for from angel financing, making the industry and
International Settlements at about $40 trillion to access to it highly competitive.
Figure 5: Global Venture Dollar Volume 2011 - 2020 Figure 6: Global Venture Deal Volume 2011 - 2020
Source: crunchbase news Source: crunchbase news
Lessons here are that start-ups face a difficult last decade, and these trends are expected to
environment when seeking to access finance, carry forward as frontier industries serve as a
and even when they do access finance, driver for financing tomorrow’s successes.
covenants and conditions are in place that The age of entrepreneurship is also about
require formalization of reporting and disclosure identifying opportunities and disrupting the
that may interfere with the operational freedom status quo to create those opportunities. There
the originators covet. Traditional financial are many reasons to believe that micro and
institutions are not set up to finance start- small- scale start-ups will have a chance to
ups, and regulatory restrictions influence attract non- traditional sources of funding to
risk appetites that pre-empt the possibility of close some of the current gaps they face. These
financing start-ups in many cases. opportunities will come from technological
advancements, working capital and other
This leaves venture capital and angel financing. financing from e-commerce players, and
Venture capital is generally underdeveloped in crowdfunding.
most countries due to the absence of ecosystems
and limited volume of potential transactions. Efficiencies that derive from blockchain and
Angel financing is constrained in many artificial intelligence will create pathways
countries because start-ups do not have the for some, while the growth of e-commerce
visibility needed with those that could provide and financing from wholesale giants will add
the financing. Even when financing is made financing streams in parallel with financial
available, start-ups have to accede to specific institutions. In the case of blockchain, the
milestones and contractual obligations to access reduction of transactions costs in markets will
needed funding for next-stage development. All create opportunities for niche services powered
of these obstacles make it difficult to migrate by novel applications. It is also possible that
from incubators and accelerators to levels of start-ups in the future will migrate to blockchain
financing sufficient to scale up and become on a step-by-step basis after having received
commercially viable. On a more favorable note, initial support from “communities” that buy into
the dollar value and relative share of angel and the initial concept. Artificial intelligence may
early-stage investment has increased over the help to accelerate progress towards milestones.
13E-commerce companies and the B2B exchange promising channel for start-ups. However, as
that has been growing for years will continue, with other unregulated markets, there is a high
opening up additional opportunities for risk of fraud and deceit. To sustain confidence
companies operating these exchanges and and trust, markets and countries need to protect
platforms (e.g., Amazon, Ali Baba, eBay) to consumers (and small investors) from scams
provide capital to start-ups that will provide and schemes that are criminal in intent. With
additional outlets for their goods and services. the advent of cryptocurrencies, organized and
In some cases, working capital (e.g., payment petty crime have new channels to avoid law
on payables, inventory management) is already enforcement. This highlights the importance
being made available. Financing for goods and of the legal, regulatory and institutional
services that require additional support to scale environment to enable entrepreneurship.
up is likely to ensue so that platforms and
exchanges have sole rights to such output.
2.3 An enabling environment
This is little different conceptually from that is conducive to constructive
the entry of Amazon, Disney, Netflix and entrepreneurship
others into streaming services, with rights to
specific movies, series and sporting events, 2.3.1 Legal, regulatory and institutional
as well as financing their own productions. environment
It is conceivable that B2B relations will be
established with financing links that would be Levels of economic and financial sector
equivalent to W2R2C with wholesale sources of development are closely associated with the
financing (from exchange owners like Alibaba efficiency of capital allocation. Higher income
and Amazon= W) providing financing to lock in markets broadly outperform emerging markets
rights to sales of goods and services produced due to their higher levels of economic and
by start- ups (microenterprises providing the institutional development (Bena & Ondko, 2012),
output for retail distribution = R) to consumers including the laws and regulatory oversight
and other businesses (=C). Therefore, instead provided, and the market scrutiny and analysis
of begging for funds from banks or venture that comes from rating agencies, credit
funds, start- ups may access needed financing information bureaus, investment analysts,
by directly approaching highly liquid firms that and related channels. The general business
are closer to the merchandise and downstream environment is central to resource allocation
markets. and risk-taking decisions by firms (Beck, 2013;
Beck, De Jonghe, et al., 2013). While sound
Meanwhile, as large-scale firms will have the financial sector development and effective
edge in market and bargaining power, start- institutions that underpin markets can reduce
ups may seek out other funding pools with a perceptions of credit risk (Gungoraydinoglu et
less distorted balance of power. Communities al., 2017), political risk can detract from other
of crowd-funders may be willing to provide efforts to strengthen the investment climate
cash resources without the degree of scrutiny (Belkhir et al., 2017; Porta & Lopez-de-silanes,
exerted by venture funds, angel investors or 1999; Zingales, 2000). In today’s globalized world,
other prospective sources, betting that the the trade environment is an important factor.
odds of making gains on some investments Research indicates that small and medium-sized
will offset losses on others. Crowd-funding businesses (SMEs) that survive international
may be particularly beneficial for very small competition when trade is liberalized grow
or micro ventures that are tailored to local faster than larger firms (Álvarez & Vergara,
communities, or as a starting point for concepts 2013). However, there are many challenges to
that later may scale up with support from overcome, and many emerging markets firms
angel investors, venture firms, or even more fail or find it challenging to grow and survive
traditional commercial finance institutions. regional or international competition.
In this case, start-ups may actually have an
edge in the form of asymmetric information. Relation to financing
They will know more about their products
and the potential markets they can serve. In relation to financing, there are differing views
The crowdfunding community is bound to be on how legal framework incentives impact
composed of generalists or others interested in leverage or borrowing. The “demand side” view
the product as a potential consumer, but less so posits that strong creditor rights actually lead
from the business management side. Therefore, to a decline in leverage because management
to the extent that retail crowdfunding markets and shareholders do not want to lose control
can gather steam, this represents a potentially if they encounter financial distress (Cho et al.,
142014). The “supply side” view (Berger et al., 2011, the market and are insulated from competition.
2015; Öztekin, 2015; Porta & Lopez-de-silanes, Consequently, much of the entrepreneurship
1999) has long claimed that lenders are more that exists in emerging markets with weak
willing to lend if they are afforded greater rights legal and institutional frameworks is found in
and creditor protections. Banking systems in the informal sector. In these circumstances,
high GDP countries that enjoy positive legal, the entrepreneurial spirit can be found in the
regulatory and institutional environments are transformation of discarded materials into
generally able to provide the financing that usable products, small-scale provision of
growing or mature economies require. To the services, and sales of small amounts of food or
extent financing is available, weak institutional other commodities on busy urban streets. This
environments typically translate into higher creativity and resilience needs to be recognized
incidence of collateral and shorter terms on and harnessed.
loan exposures (Brown et al., 2011), which result
in a higher cost per dollar for emerging market Legal, regulatory and institutional frameworks
borrowings than in higher income markets. also need to adapt to changing global
These features are also associated with a broad circumstances, particularly with regard
lack of access to credit in the first place for to addressing climate change challenges,
most businesses, adding to the stifling effects sustainable use of resources, and provision
of market development and limiting capacity of of public goods to enhance wellbeing in an
economies to scale up. era of technological innovation. Incentive
structures for the 21st century should marry
For start-ups, maximum protection for creditors the pro-business development objectives of
(in this case, more likely investors in debentures, the more conventional lines of institutional
mezzanine instruments, or preferred shares) is theory with the more recent thinking on climate
considered to be more essential due to their change. The initiative of the European Union
embryonic stage. Demand side arguments to rebalance production and consumption may
seem less relevant for start-ups given that they be a portent of how to restabilize the economy
need financing to make their ventures feasible. in relation to resources , while improvements
However, conventional financial institutions are in institutional frameworks combined with
generally ill-suited to entrepreneurial needs . financing linked to the achievement of climate
As highly regulated institutions, deposit-taking change objectives may be the foundation pieces
banks typically have a lower risk appetite for entrepreneurship in the coming decades.
than investment-oriented non-bank financial
institutions and are biased towards fixed, 2.3.2 Governance standards and risk
tangible and liquid assets as sources of collateral management principles
for loans (Campello & Hackbarth, 2012). For the
most part, entrepreneurs, start- ups and small While legal/regulatory and institutional
businesses lack assets that can be pledged as structures are important for the general
collateral for secured loans. Because intangible business environment, capacity for effective
assets are considered more speculative and implementation depends on governance.
higher risk, knowledge-based start-ups find it Governance represents the fundamental
particularly hard to access financing . Given that principles of how entities are run. It
commercializing a viable concept is the ultimate incorporates the mandate and objectives of
goal of a start-up before take-off, specialized the entity, principles of operation, policies to
investment financing is typically needed. be followed, and risk appetite that is accepted
and supported by those responsible for ensuring
Relation to entrepreneurship that management performance is consistent
with approved policies and mandates. By
The legal, regulatory and institutional extension, governance defines who has the
framework is relevant to entrepreneurship ultimate authority for decision-making, the
in that a weak environment constrains both delegation of authority to allow daily operations
supply and demand factors, thereby stifling the to run, and reporting frameworks to allow for
formal business environment for innovation and ex-post review of performance as well as ex-
entrepreneurship. Credit and equity financing ante decision-making on major items of critical
is generally limited, and when available, often strategic and/or financial importance.
subject to conditions that distort allocations and
limit competition, such as state ownership or Governance structures apply to all entities, albeit
ties to connected parties. Demand for innovation differently depending on the nature of their
and entrepreneurship is weakened when large- stakeholders, mandates and size. Public sector
scale companies have protected positions in governance counts the public as the stakeholder,
15and although governments have different forms In advanced market economies, institutional
and levels of authority, they all have frameworks investors with large concentrated ownership
in which mandates and objectives are spelled shares are in a position to exert effective
out, principles and policies are understood, and governance to counter asymmetric information
boundaries for risk-taking are set. Likewise, all and the risk of managerial opportunism (Shleifer
governments have some form of reporting and & Vishny, 1989) and to reduce the risk of ineffective
surveillance to track performance as defined directors serving on the board. Organizationally,
by the effective governing authority. These and assuming controlling shareholders do
characteristics are true irrespective of whether not have major disagreements, the exercise
the model is top-down, centralized and control- of governance or control rights is more likely
oriented, or decentralized and broadly dispersed. when the number of controlling shareholders is
smaller. This has been demonstrated in several
Private sector governance also follows these studies on hedge funds (Brav et al., 2015; Klein
principles, although the specifics of how they are & Zur, 2009), and more broadly in literature on
carried out differs across markets and firm sizes. institutional investors (Cohn & Rajan, 2013). In
In general, all firms have some form of internal effect, concerted action is then more feasible
governance, and standards become more relevant without any legal protection requirements or
externally when they seek outside financing. assistance from the courts.
Small firms that seek bank credit will have to
provide basic information not only on financial However, the economic argument regarding
accounts, but also on a range of managerial, concentrated ownership can also work against
institutional and market issues. Large-scale legal protection in the sense of marginalizing
firms that are listed on stock exchanges and/or minority shareholders, as noted in the failure
issue bonds typically have external governance of Parmalat in Italy (Melis, 2005). Majority
structures that are required as a part of market shareholders are in a position to strip assets, pay
disclosure. This applies to financial institutions themselves special dividends, establish differing
as well as real sector firms. share classes with disproportionate voting
rights, and otherwise manipulate reporting
Governance and financing and asymmetric information at the expense of
minority shareholders. Therefore, while legal
Firms need sound internal, as well as external, protection may not be sufficient for minority
governance structures to operate well (Acharya investors, it is necessary due to the potential
et al., 2011). For SMEs, governance is generally for abuse by majority shareholders. Particularly
internal as they are not listed. External in societies without strong legal systems and
governance is exercised by creditors when firms protection for minority investors, which is the
have borrowings, as described in agency theory case in most of the world, minority investors can
with debt serving as an instrument of financial be as much at risk from concentrated ownership
discipline. (B. M. C. Jensen, 2001, 2014). Even with as from dispersed ownership structures.
sound legal frameworks, external governance of
larger listed firms is often patchy. Major corporate Governance, risk management and
failures such as Enron have been attributed to entrepreneurship
poor governance resulting from passive and
otherwise disengaged boards (Downes & Russ, The reluctance of regulated financing
2005)despite the legal protections that were in institutions to provide finance to start-ups
place. and entrepreneurial ventures has been noted.
However, entrepreneurial ventures also face
Experience over the last decade is replete with difficulties in attracting financing because of
(i) companies whose share prices corporate governance issues. These relate largely
declined more than 50 percent because of to spotty risk management practices, a lack of
mismanagement and ineffective boards or, formalization to induce confidence in prospects
conversely, (ii) companies whose share price for success, weak management teams and
increased astronomically after new shareholders incomplete knowledge of business fundamentals,
(e.g., private equity firms) restructured boards and an aversion to sharing information. This
and management, However, legal protection last characteristic makes it hard for investors
is still necessary, particularly with regard to to determine a potential price (rate of return,
minority shareholder rights, given the traditional interest rate, etc.) for their financing, adding
predominance of concentrated ownership and to time and cost and potentially foregoing
control in most markets. Limitations of legal investment for what could have been a viable
protection have major implications for ownership concept with more transparency or organization.
patterns and behavior. At the firm level, research has shown that market
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