Over the past five to ten years, the SME finance landscape has broadened in both capital types (grants, debt, quasi-equity, equity), and focus (ranging from social impact, purely returns drive, and balanced between the two).
This evolution is critically important because completely filling the “SME Finance Gap” (a.k.a the “Missing Middle”) will require all types of capital, serving a variety of business models and stages of business development.
The Acumen Fund is a leader in social impact investing for SMEs in emerging markets. Funded with philanthropic capital, Acumen first used grants to invest in SMEs, but over time recognized that grants did not help businesses gain further access to the capital markets. Acumen has since adjusted its strategy towards more debt and even equity investments, and has developed its own proprietary social return methodology, targeting a “reasonable but often below-market financial return on capital invested.”
For the past 29 years, Business Partners Limited in South Africa has used a financing model that provides loans of $25,000 to $2,000,000 to lifestyle businesses, one of the largest segments of SMEs. Their for-profit model focuses on high volume investing in low to moderate growth businesses. As Nazeem Martin, managing director of Business Partners stated, “Risk finance for SMEs, especially when it is uncomplicated using debt, can adequately serve the majority of entrepreneurs.”
New and innovative investment structures are being used, such as quasi-equity which share characteristics of both debt and equity, to better serve higher growth SMEs, also known as SGBs (Small and Growing Businesses), a term coined by the Aspen Network of Development Entrepreneurs (ANDE). ANDE defines SGBs as commercially viable businesses with 5-250 employees that have significant potential for growth and whose managers desire to grow them.
Typically, SGB managers seek capital from $20,000 to $2,000,000. Unlike traditional SMEs, SGBs are neither livelihood-sustaining businesses designed to stay small, nor are they large enough to have access to traditional forms of financing from intuitional investors or commercial banks.
Equity will be the final segment of capital to fill the “SME Finance Gap”. As Keet van Zyl, investment manager of HBD Venture Capital, said, “There is already a relatively well structured debt market for SMEs in emerging markets, such as South Africa, and what’s really missing are equity investors.”
The challenge for equity is that it requires more infrastructure in financial markets and cannot be deployed in high volume as easily as debt. Hasso Plattner (HP) Ventures is a pioneer as a pure equity returns driven player and invests $800,000-$4,000,000 in SMEs. “Equity is better suited for high-growth businesses, which can benefit more from active investors,” said Andrea Bohmert, co-managing partner at HP Ventures. “Due to the limited number of current equity investors, those in the space can cherry pick the very best SMEs to invest in.”
In reviewing the vintages of SME funds, two major trends appear. First, there are many more new funds than old. Second, the newer funds are building their businesses around innovative investment structures and are embracing strategies of both social impact and competitive market rate returns. According to ANDE’s 2009 Impact Report, there are 192 funds investing in emerging market SGBs, and 81 percent of the funds were launched in the last three years. Although many of the oldest, fully invested funds have yet to determine the final fate of their portfolios or realize substantial returns, new entrants to the space have not been deterred.
Two funds currently in fundraising mode, I3 Advisors and SpringHill Equity Partners, are commercially oriented funds that also have a social bias. They are a growing breed of new funds which seek to emphasize not only the financial returns, but also the social impact. SpringHill is even seeking 3rd party verification of the social impact of its investments, similar to a financial audit, a key metric for their investors.
Success in narrowing the “SME Finance Gap” will come from a variety of new emerging market players, who have the ability to fund all types of SMEs using various forms of capital. This evolution is helping to legitimize the sector in the eyes of investors as asset classes are being defined, and new financing models are being tested.
This piece is the second of a monthly Africa.com series in collaboration with the South African Chamber of Commerce in America (SACCA). Next month, we will analyze the challenges and solutions for SME investors in emerging markets, especially those in Africa and the developing world.
For more information on the Missing Middle Initiative, please visit www.sacca.biz.
About the Authors:
J. Skyler Fernandes is the Chief Operating Officer of the South African Chamber of Commerce in America (SACCA). Prior to this role, he acted as the Vice President of Operations (2007-2009). In 2010, Mr. Fernandes led the Missing Middle Initiative, which was launched at the World Economic Forum in Davos. Mr. Fernandes also supports the development of the African Entrepreneurship Platform, showcased at the Clinton Global Initiative in 2007, and SACCA´s MBA Africa Alliance, a network of Africa-focused business clubs at leading graduate schools.
Mr. Fernandes does venture capital at Centripetal Capital Partners, investing in early-mid stage high growth businesses. Previously, he has worked at Standard Bank, raising capital for Latin American corporations, Societe Generale within the Asset Securitization Group, and at Credit Suisse doing investment banking in the Financial Institutions Group (FIG).
Additionally, Mr. Fernandes is on the Social Investment Council of Echoing Green, the YP Steering Committee of Endeavor, and acts on the Junior Board of the American Museum of Natural History. He received his BA in Economics and International Relations, graduating a year early from New York University summa cum laude, due to coursework at Harvard University.
Lena Sene is a Senior Advisor to the President of the International Economic Alliance and a Consulting Advisor to the Missing Middle Initiative, which was launched at the World Economic Forum in Davos in 2010. She recently completed the Mid-Career Master in Public Administration at the Harvard Kennedy School as well as her MBA at the Harvard Business School. Before that, Sene was appointed by the President to the White House Fellowship, a forty-six year old non-partisan leadership program, along with 13 other nationally selected Americans.
Previously, Sene was an Investment Representative at Lehman Brothers where she advised high net worth individuals on a full range of investment strategies. Prior to that she was a Private Banker at JPMorgan Chase where she worked within a team of six Private Bankers advising more than 200 high net worth families with total assets under management of over $4.5 billion. She holds FINRA Securities Licenses 7 and 63.
Sene is a founding member and Board Member of Network 20/20, a non-profit organization whose mission is to prepare mid-career young leaders in the U.S. to participate meaningfully in entrepreneurial public diplomacy by means of educational initiatives in the U.S. and through a series of policy trips and exchanges abroad. Sene also served as a Board member of the UN Association of New York and was a member of the Economic Club of New York. Sene was born in the U.S. and was raised in Senegal, Russia and Ukraine. She is fluent in English, French, Russian and Wolof. Sene graduated from Bates College with a degree in Economics and was selected in 2010 to serve as a member of the Bates Board of Trustees.