Opportunities in the Nigerian Capital Market for Business Owners
In recent conversations, the lack of awareness about the Nigerian capital market and the opportunities available to investors, highlighted a critical gap in financial literacy among Nigerians. This conversation made me realize that businesses, especially small and medium enterprises, lack the financial literacy to tap into opportunities offered by the capital market. While a lot of investment literacy targets individuals and HNI investors, this article has been specifically crafted to highlight three opportunities the capital market offers to businesses.
- Investment Opportunities
A foundational concept in finance and project evaluation is the computation of return. Organizations calculate the expected return from a project or investment and compare it against their hurdle or expected rate, making the critical decision of how to deploy capital based on this analysis. I am curious to know what return expectations local organizations, especially SMEs set for their businesses?
In the current economic climate and high-interest rate environment, the hurdle rates for expected return might be the Monetary Policy Rate (MPR) which is currently at 27.5% for projects with less than 1-year tenors or the return on the 10-year FGN bond which is currently over 18%.
You might wonder why a business would invest money instead of putting that money towards its own operations? Using the project evaluation criteria, if the return on the business isn’t higher than the hurdle, in this case, the current return on Money Market instruments in Nigeria, the capital is better utilized when invested in the fixed income product that offers the higher return.
Applying this strictly would be to the detriment of the economy as businesses play such a critical part in economic development by providing employment, contributing to productivity and innovation. However, an understanding of this finance concept and adoption of project evaluation can enhance the operations and returns of SMEs. For instance, ideal funds can be invested in Money Market Instruments to enhance the overall return to the business.
For instance, firms with good inventory management systems can negotiate payment terms with suppliers to manage cashflow efficiently. Firms with 90 to 180 days to pay for products can invest the funds allocated for the inventory in short-term investment products and match the maturities to their payment timelines to optimize their use of funds.
For short-term investments – Treasury bills (T-bills) offered by the Federal Government of Nigeria (FGN) and Commercial papers offered by Corporates offer returns that outperform what is obtainable from traditional banking services. Medium term offers include the Federal Government Savings Bonds which are offered for 2 and 3-year tenors. Long term offers include Federal Government Bonds and Corporate Bonds. Businesses can also invest in the shares of listed companies as long-term investment assets and a means to diversify their capital structure and revenue streams as fundamentally sound equities offer returns in terms of periodic income from dividend payments and long-term capital appreciation.
2. Capital Raising Opportunities
Products offered by Issuers in the capital market – whether structured as debt instruments (Bonds, Commercial Papers), equity (Shares) or a Hybrid (ETFs, Funds, REITS) etc.- are investment opportunities for the investing public but capital-raising initiatives for the Issuers. It is important that local businesses understand how investment products are created in the capital market to envisage the opportunity for them to also become issuers of capital market securities in the long term. The requirements to raise capital from the capital market might seem daunting to SMEs however the rules, requirements and guidelines are conceived as minimum operating standards for world-class organizations, so such requirements should be seen as aspirational rather than deterrents. Typical requirements in simplified terms include registration as a Public Company (Plc), regulatory compliance, audited financials, solvency, profitability & sustainability assessments, governance structures and operating standards. However, it is good to note ongoing measures to simplify, streamline and reduce the cost of coming to the market.
The issuing of Commercial papers to meet short-term working capital needs is one route we have seen a lot of listed and unlisted Nigerian companies raise capital. SMEs with long-term visions to scale can benefit from studying the capital market requirements and working with registered financial advisors to start building and structuring their business and operations to succeed in coming to market in the long-term. It is important to state that raising capital in local currency is more sustainable than raising foreign currency capital due to exchange rate risk. Also, raising capital by issuing equity is considered obtaining patient capital therefore growing the local capital market by deepening participation and product offerings will translate into positive long-term benefit to the economy and the Nigerian people.
3. Learning Opportunities
Due to public interest and investor protection requirements by the regulators of the financial markets – The Central Bank of Nigeria (CBN) for the Money Market and the Securities & Exchange Commission (SEC) for the capital market – the financial markets are information driven. The Issuers of securities must be public entities and meet ongoing disclosure requirements. This provides a gold mine of publicly available information that startups, small businesses, researchers and institutions can mine. For listed companies in particular, ongoing disclosure requirements include the publication of annual and quarterly financial statements and publication of all material updates on their business and operations. There are also a lot of financial institutions, intelligence platforms and analysts watching and commenting on the performance of listed companies. SMEs especially can tap into this pool of information to develop business strategies, benchmark performance and evaluate projects.
It is important to note that certain concepts in finance and economics when applied to the Nigerian economy do not provide the expected results as conceived in the theories – this is due to systemic, regulatory and operational differences between Nigeria and the economies of the countries where most of these concepts are developed or tested. Typically, these countries are the developed economies of the United States, UK and Europe. Engaging licensed professionals to understand how you or your business can tap into opportunities in the Nigerian Capital Market is critical as context and practical application is important. For instance, transaction fees in certain developed markets are much lower than transaction fees in Nigeria, therefore applying trading or investment strategies from such climes without adjusting for transaction fees might lead to losses. Similarly, the tax system in Nigeria is different from that of some developed countries, venturing into these climes without a proper understanding of these discrepancies can lead to less-than-optimal outcomes. Startups developing products for the Nigerian market, especially products in the investment space, will also benefit from consulting licensed professionals in the development phase of their business plan to ensure proof of concept and regulatory alignment.
In Conclusion
The capital market is often described as a barometer of the economy. There are numerous economic and social benefits inherent in the growth and development of the market, greater local participation and creation of innovative products and solutions. Local businesses, especially SMEs, must develop the literacy and capacity necessary to tap into the opportunities for organizations in the Nigerian capital market.
Written by
Chinazom Izuora
Parthian
