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Why do many business financing decisions go wrong in Africa?

by Kenneth Amaeshi, PhD

Some ten years ago, I was involved in a US-UK research project on business financing decisions with colleagues from the Massachusetts Institute of Technology, Boston University, USA and the Warwick Business School, UK. This research project sought to understand how early-stage investment decisions in new technology ventures were made. These investment decisions are fraught with numerous uncertainties and challenges (e.g. the instability of new business ideas and opportunistic behaviours).

Yet, over the years, some professional investors have earned healthy reputations for their abilities to successfully navigate the uncertainties and challenges presented by new business ideas. For instance, companies like Amazon, Cisco, Compaq, eBay, Federal Express, Intel, Lotus, Netscape, Sun Microsystems, and Yahoo once existed as mere business ideas and are all products of venture capitalist funding. Our research study concluded that trust is the underlying common architecture for such multi-dollar investment decisions. In other words, trust stands between entrepreneurial firms receiving the funding required to come to life and the ‘valley of death’.

Trust is one of those fuzzy words that carry with them multiple interpretations to the point that they become ‘all things for all men’. Notwithstanding its definitional fuzziness, trust is an essential ingredient of the neo-classical market system. Despite its acclaimed elegance, the market system is, unfortunately and, inherently, fraught with risks and uncertainties. Navigating these risks and uncertainties requires a significant dose of trust and confidence.

For example, trust makes a financier comfortable lending to an entrepreneur with the hope that it will be repaid. Trust makes an employer feel comfortable to buy employees' labour with the hope that they will live up to the signals given through the recruitment process. Trust makes you feel comfortable that the goods and services you buy will do you no harm. Trust makes you comfortable accepting an exchange artefact (e.g., the Naira note) as a trustworthy exchange mechanism, not a counterfeit. As such, it is sensible to argue that the whole market system will crumble without trust. But what are the sources of trust?

Our research identified three types and levels of trust at play in the investment decision process. The first in the sequence is the system-level trust. This is the kind of trust that exists in a society. It is not tied to any individual or transaction. It is the sort of trust embedded in a country’s institutions – e.g. the legal system, education system, political system, culture, et cetera. It is the kind of trust that foreign investors would want to ascertain in their preliminary due diligence exercises. It helps to answer the question: is it a safe country to invest in? What happens if my investments go sour? Are there robust and efficient institutions to help me recover my investments and seek redress where I am injured? Positive responses to these questions will signal a strong institutional context with high institutional trust.

Most developed economies exhibit a high level of system trust. On the contrary, most developing economies do not have a high institutional trust and, as such, attract less foreign investments. Even if you subtract foreign investors from the equation, it is not difficult to figure out that some of the challenges in business financing in Nigeria, for instance, have strong links to fragile institutional infrastructure, which invariably raises transaction costs. No doubt, most credit recovery agents employ all sorts of tactics available to them and try as much as possible to avoid going through the Nigerian judicial system.

The second type of trust that is often evoked in the early stages of business financing is what is called a network-based trust. It is also not based on personal level trust. Relevant sources of network-based trust may include professional affiliations, old boys associations, informal networks, et cetera. Network-based trust becomes very useful when system-level trust is weak or insufficient to engender socio-economic transactions. This level highlights, in particular, the importance of the social networks in which individuals are embedded as possible sources of trust. Such networks are widely seen as supportive of socio-economic exchange. For example, It has been found that both direct and indirect ties, mediated by trust, positively influence entrepreneurs in securing funding from investors. In the informal venture capital market involving ‘business angels’, network-based trust is seen as especially important due to the importance of referrals from personal contacts.

The final and the dealmaker/breaker is personal level trust. Personal relationships are infused with values and bring norms of fairness and reciprocity. The trust associated with such embedded relationships has also been identified as a productive feature of socio-economic exchanges, minimising opportunistic behaviours, reducing monitoring costs, enabling cooperation, and facilitating information transfer and knowledge sharing. It is the kind of trust that enables the business financier to look straight into the eyes of the entrepreneur and say, “Yes, I can invest in his or her business”. It is the ‘chemistry’ between people. It takes time to develop and requires significant resources to sustain – that’s why it usually comes last in the investment process.

Therefore, trust serves as a screening and selection mechanism in business financing, given the efficiency and effectiveness required. In other words, business ideas that cannot signal trust fail to attract investments. Trust is embedded in markets, technologies, business plans, intellectual property regimes, quality of management teams, et cetera. Trust operates both at the micro-level of interpersonal interactions and at the societal level, where trust in institutions helps to shape the responses of large population groups.

The importance of trust in the market system can also apply to other human systems. Most professions and institutions are equally anchored on trust – take your doctor, lawyer, priest, and accountant for examples. What of the sustainability of the other social institutions like marriage and democracy? In a nutshell, trust is the glue of human interactions and institutions.

Financial institutions, in particular, understand the importance of trust and tend to eagerly appropriate the word in their names, as if the name in itself will automatically confer trustworthiness. Before the Nigerian banking sector's consolidation, many banks had bits and pieces of the trust word in their names. Surprisingly, some of these bits and pieces are no longer visible. This makes one wonder if our banks have found other sources of trust beyond mere nomenclature, especially as the global financial crisis could be aptly and partly described as a ‘trust crunch’.

From our research study, the crucial producers of macro-level trust are financial and regulatory institutions, the role of national governments and systems of law. I strongly suggest that these should preoccupy African governments and financial institutions. In sum, business financing decisions are bound to go wrong when trust is ignored in all its varied dimensions.

Amaeshi is a professor of sustainable finance at the European University Institute, Florence, Italy, and a professor of business and sustainable development at the University of Edinburgh, United Kingdom. He tweets @kenamaeshi and can be reached at

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