Stimulating Investment in Emerging-Market SMEs
DescriptionRisk capital - patient, non-asset-based capital that facilitates growth of new and expanding companies - is too scarce for small- and medium-sized enterprises (SMEs) in developing countries. Although SMEs are critical engines of job creation and economic growth, risk capital remains largely unavailable to such businesses, undermining their ability to expand and benefit their communities.
To address this issue, the Milken Institute (with support from Google.org) hosted a Financial Innovations Lab. Fund managers, investors, entrepreneurs, researchers, and representatives from development finance institutions and foundations gathered to identify the obstacles in expanding capital access for SMEs and to explore potential solutions.
A major challenge in financing emerging-market SMEs is the difficulty of exiting the investments. Underdeveloped capital markets and a shortage of buyers in these countries make exits hard to achieve, thereby increasing investment risk and decreasing the number of potential investors.
Lab participants explored both first-party exits, in which the entrepreneur buys back the investor's shares, and third-party exits, in which the company is sold to another financial investor or to a company within the same industry (i.e., a trade sale). Case studies of each exit type, prepared by Tom Gibson, president of the Institute for SME Finance, provided examples of successful SME investments and challenged participants to think about how to replicate these results.
In addition to examining the structures of successful investments, participants considered ways to increase capital to emerging-market SMEs. Reducing costs - by making back-office functions more efficient, for example - is one way to increase overall return. Furthermore, use of technical assistance can help accelerate a company's value.
Participants also highlighted the importance of the relationship between investor and investee, including good communication between the parties. Finally, several participants noted the value of the investor being local to the investment. Thierry Sanders, director and founder of the BiD Network Foundation, explained BiD's plan to use business angel networks to source deals and scale-up capital to where it is needed most.
Innovative financial solutions were also considered. Wayne Silby, founding chairman of the Calvert Funds and president of the Calvert Social Investment Fund, discussed the potential creation of a permanent capital vehicle for SMEs. Jim Polan, vice president of SME Finance at the Overseas Private Investment Corporation, explained his idea for the development of an exit finance facility.
Click here for a full report on the Lab's findings.