Demand side determinants of Private Equity funding among Small and Medium Enterprises in Nairobi County

Abstract

Recognizing the vital and ongoing role Small and Medium Enterprises (SMEs) play in economic development, contributing significantly to employment creation and innovation, this study addresses the persistent challenge of financing access they face, particularly in developing economies like Kenya. Given the limitations of traditional financing options often constrained by perceived high risk and stringent collateral requirements, many SMEs are actively exploring private equity (PE) as a potential alternative source, offering access to significant capital and strategic expertise. This study specifically examined key determinants of PE funding among SMEs in Nairobi County, assessing the effects of perceived high listing fees, collateral requirements, concerns over ownership dilution, and the role of managerial competence on the uptake and viability of PE financing for these firms. Grounded in the Pecking Order Theory, which explains financing preferences based on information asymmetry, and the Agency Cost Theory, which addresses potential conflicts between investors and owners, the research provided a theoretical framework for understanding SME financing decisions and the inherent challenges associated with private equity investments. Adopting a descriptive cross-sectional design, the study targeted a specific population of 97 SMEs in Nairobi County, identified from East Africa Venture Capital Association (EAVCA) records as having previously received private equity or venture capital funding over the past decade. Primary data on the study variables was systematically collected through structured questionnaires administered electronically to key management respondents within these sampled SMEs. Secondary data from EAVCA reports, firm financial statements, and industry publications complemented this by providing essential sample identification, contextual information, and validating certain firm characteristics used in the analysis. The collected quantitative data was analyzed using descriptive statistics, correlation analysis, and multiple regression modeling to comprehensively establish the relationships between the independent variables and their influence as determinants of PE funding uptake among the sampled firms. Regression results revealed distinct directional effects: perceived high listing fees had a statistically significant negative influence on PE funding uptake (β = -0.24, p < 0.05), directly deterring SMEs. Collateral requirements showed a positive but statistically insignificant association with PE adoption (β = 0.10, p = 0.459), reflecting their role in motivating SME exploration of alternatives without conclusive predictive power. Concerns over ownership dilution demonstrated a significant negative relationship (β = -0.31, p < 0.01), acting as a critical barrier to PE engagement. Managerial competence exhibited a positive yet statistically insignificant effect (β = 0.19, p = 0.072), indicating no direct impact on PE uptake in this context. A supportive regulatory environment demonstrated the strongest positive impact (β = 0.61, *p* < 0.001), underscoring its critical role in reducing transaction risks and enhancing PE attractiveness. This study contributes valuable empirical insights into the specific factors influencing private equity financing decisions and uptake dynamics within Nairobi's vibrant SME sector. The findings underscore the critical need for policy interventions aimed at reducing the costs and complexity associated with accessing equity financing, simplifying regulatory processes, and enhancing financial literacy among SME owners. Furthermore, private equity firms are advised to critically tailor their investment approaches to explicitly address the key concerns of SME owners, particularly regarding governance structures and strategies for managing ownership dilution and control. Future research could beneficial explore sector-specific variations in PE uptake and conduct longitudinal studies to assess the long-term impact of private equity investments on SME growth trajectories and sustainability.