Flexible Growth Capital Explained: How Kholo Capital Funds the Missing Middle

Equity is too expensive for a growing business that is already making money, and a bank loan is too hard to get. Mokgome Mogoba, who runs mezzanine fund Kholo Capital, says that squeeze is the missing middle, and that a six-year interest-only loan can fill it.

The layers of funding

Speaking to Omega Fumba, a former Standard Bank and Vantage Capital dealmaker explained the difference between the three kinds of money a company can raise. Senior debt, the standard bank loan, is low risk: typically a five-year loan that is repaid in instalments and secured on assets. Equity is permanent capital in exchange for ownership, and the shareholding is gone for good. Mezzanine debt sits between them. It is repaid after the bank but before shareholders, and it is secured behind the bank's claim.

Mogoba's pitch to a business that needs to raise equity, whether to grow, buy a competitor or buy out shareholders, is to raise the same amount as a loan instead. Kholo typically lends over six years, interest only, and is sometimes willing to roll interest up in the early years to accommodate growth. After six years the business repays or refinances with cheaper bank debt, and the founders still own all of the company. "Private equity is a marriage," he said; mezzanine debt is "more like dating."

Why the middle is missing

Asked about a headline describing the missing middle as a gap of alignment rather than capital, Mogoba described the two ends of the market. A start-up that has not yet found customers cannot service a monthly bank loan, so it needs patient equity from an investor willing to wait seven to ten years. A large, established business with a long track record has banks competing to lend to it, at the lowest prices in the market.

Everyone between those extremes is the missing middle: cash-positive, well-run small and medium businesses that want to buy equipment, build a factory or hold stock but cannot get the attention of banks focused on big clients. He added a view on why: banks tend to place junior people in front of smaller clients, who are good at standard loans and overdrafts, while experienced dealmakers have often left for fund management and are better placed to structure something bespoke.

Who Kholo will back, and who it will not

Kholo Capital is a fund manager investing in private companies, as opposed to an asset manager buying listed shares and bonds. Mogoba said roughly half the businesses that approach it fit, and the other half are sent elsewhere. The firm keeps a network of other lenders, covering ranges from half a million to R10 million, R2 million to R20 million and R20 million to R50 million, plus venture capital funds for businesses that are too early stage, so that every approach finds a home.

In a short icebreaker game of "fund or pass", he said a founder who simply reports that the bank said no needs to be asked why the bank declined. A company that relies on one big client is a pass, because losing that customer means losing the business.

Mentioned in this episode

• Kholo Capital: The mezzanine fund Mogoba founded.
• South Africa's most dangerous SME funding failure is the missing middle: Our own look at the gap discussed here.