Is the return of the merchant banking model the key to unlocking effective investment in Africa?
Africa’s economic narrative is one of undeniable dynamism, characterised by innovation, demographic advantages, and vast untapped potential. Yet, converting this potential into widespread, sustainable prosperity hinges significantly on effective capital allocation, particularly for the small and medium-sized enterprises (SMEs) and mid-market companies that form the bedrock of its economies. While established financial models – global investment banking, private equity, development finance – each play crucial roles, we argue that a revival of the ethos and function of traditional merchant banking is essential to fully unlock Africa’s growth engine.
For decades, the global financial landscape has seen increasing specialisation. Investment banks excel at large-scale underwriting, M&A advisory, and trading, typically acting as intermediaries or advisors rather than long-term principals in the ventures they facilitate. Private equity firms deploy substantial capital but often operate within fixed-term fund structures demanding specific return profiles and exit timelines. While highly effective in many contexts, these models can inadvertently leave a gap.
Merchant banking, in its historical essence, represented a different paradigm. It was characterised by a hybrid model combining financial advisory with significant principal investing – deploying the firm’s own or partners’ capital directly into client companies, often SMEs and family businesses. This wasn’t merely providing capital; it was about forging long-term partnerships, taking board seats, offering strategic counsel grounded in shared risk, and nurturing businesses over extended horizons.
The African Imperative: A Natural Alignment
This seemingly ‘old-fashioned’ model resonates powerfully with the contemporary African context. Why?
Navigating the Ecosystem: Complementarity with DFIs
The call for a merchant banking revival does not diminish the vital role of Development Finance Institutions (DFIs). DFIs possess unique mandates focused on development impact, poverty alleviation, and tackling market failures, often deploying concessional capital or pioneering investments in frontier sectors where purely commercial actors hesitate. Merchant banks, being commercially driven, cannot and should not replace this function.
Instead, the relationship is one of potential synergy and complementarity. DFIs can provide catalytic capital or guarantees that mitigate risk, making deals viable for commercially focused merchant banks. They can fund enabling infrastructure or policy reforms. Merchant banks, in turn, can bring private sector discipline, execution speed, and co-investment capital to DFI-backed sectors or projects, amplifying impact through commercial viability. They operate in parallel, addressing different facets of the capital spectrum.
Structure Follows Strategy: The Relevance of Permanent Capital
Traditional merchant banks often invested ‘house’ capital, implicitly adopting a long-term perspective. Today, this ethos finds a powerful structural vehicle in Permanent Capital Vehicles (PCVs). Unlike closed-end funds with fixed lifecycles, PCVs offer an indefinite investment horizon.
This structure is exceptionally well-suited to the merchant banking approach in Africa:
Learning from History: Why the Model Faded and Why It Must Return
The decline of traditional, independent merchant banks in Western markets from the mid-20th century stemmed from various factors – regulatory shifts like Glass-Steagall’s legacy separating banking and commerce, the rise of specialised PE giants, increased capital adequacy requirements under Basel making principal investing costly for banks, and a focus within universal banks on scalable activities like trading and large-cap advisory. These trends inevitably influenced African markets.
However, the need for the merchant banking function never disappeared, particularly in markets dominated by SMEs needing integrated capital and strategic support. The decline was one of structure, not relevance.
Revitalising the Ethos for Modern Africa
The ‘return’ of merchant banking to Africa isn’t about recreating historical institutions. It’s about fostering the function and ethos within the contemporary financial landscape. This requires:
Conclusion
Africa’s development trajectory requires diverse and sophisticated financing solutions. While investment banks, PE funds, and DFIs are indispensable, the nuanced, partnership-driven approach of merchant banking – providing patient capital coupled with strategic expertise, particularly through long-term structures like PCVs – addresses a critical gap. Fostering the revival of this ethos is not merely an exercise in financial nostalgia; it is a strategic imperative for unlocking the full potential of Africa’s vibrant private sector and building resilient, prosperous economies for the future.