Building across the SME Finance Tech Stack in Emerging Markets

In this article, we explore the dynamics and opportunities of building across the SME Finance Tech Stack in Emerging Markets. Given the deeply integrated workflows across the stack, we believe the fintech winners will be those with a wedge that enables them to expand into a full financial platform over time. In our analysis, we break down the different functions across the stack, highlight considerations for founders building in the space and deep dive into two segments we believe could be lucrative wedges — AP/AR automation and payroll processing.

First, let’s align on the economic importance and scale of SMEs in Emerging Markets:

• Across Africa, SMEs account for ~80% of jobs, with Nigeria alone having ~40m MSMEs contributing a significant 45% to the country’s GDP.
• In Southeast Asia, SMEs account for 10–30% of exports, boosting foreign exchange earnings and propelling export-oriented industries forward.
• Similarly, in Latin America, SMEs represent 90% of all enterprises and provide employment to approximately half of the region’s workforce.

Keeping this scale in mind, the inefficiencies around how SMEs operate are disproportionate to their crucial economic roles. In LATAM, 43% of SMEs still resort to pen and paper for financial operations, exacerbating the region’s ~$1.2T SME funding gap. In Africa, 5 out of 7 SMEs fail within their first year, while a concerning 65–80% struggle with access to credit.

While operational inefficiencies exist across various functions, i.e. marketing or product development, it’s crucial to recognize the profound impact of those in the financial realm as these inefficiencies have far-reaching repercussions on wider business operations, e.g. strategic planning, expansion efforts, supply chain management or access to capital.

At Alter, we’ve broadly categorized finance functions into 1) Credit, 2) Payments and 3) Systems as shown below:

Today, the finance functions of most emerging market SMEs are managed manually, with one bottleneck having a direct effect on other operations. A prime example would be how the increasing SME credit gap is, among other factors, a function of undigitized AP/AR flows and inaccurate accounting systems. To that end, efforts to bridge this gap should not be exclusively directed towards financing, but encompass improving accounting efficiencies too.

With this in mind, we believe founders building in this space should aim to own the entire finance tech stack, likely by launching with a strategically and operationally impactful product that gradually allows them to expand their product roadmap and, in turn, unlock robust underwriting mechanisms.

Horizontal Expansion as a Winning Strategy

As illustrated above, more developed markets are already showing signs of an active horizontal M&A market. For instance, in May 2021, Bill.com, a provider of AP/AR automation tools, acquired Divvy, an expense management start-up for $2.5bn — instantly creating a holistic B2B payments offering for its clients. Players in this space are also increasingly converging with financing, e.g. Ramp’s introduction of ‘Flex’. With Flex, Ramp would pay invoices upfront on behalf of their SMEs, with the SMEs paying Ramp back in 30, 60 or 90 days. This financing product surpassed $1B in annualized volumes in only 6 months — less than half the time it took Ramp’s cards to reach that threshold.

While acquiring the full stack is increasingly the end-goal for several players, intensifying competitive pressures emphasize how crucial the initial product wedge is. Further, the success of this wedge in unlocking sticky adoption relates to the maturity of the various SMEs in one’s target market. In some emerging markets, for instance, many businesses may not be at the maturity where spend management is as much of a pressing need as working capital financing. With that, the question becomes — What is the best wedge through which to own the entire finance tech stack, and what are the key considerations in such an endeavor?

Considerations for Founders Building in the Space

1. Strength of Synergies Across Products Vary

Founders should account and track for natural product adjacencies when looking to expand horizontally. For instance, the combination of spend management and corporate card issuing unlocks strong synergies, similar to invoice financing and accounts payable management software.

2. Software vs. Financial Products

When considering horizontal expansion and product strategies, key differentiating factors emerge between traditional software and financial products. For example, unlike financial products (lending, acquiring, card issuing etc.), software products typically have minimal regulatory requirements and can launch fairly quickly. Conversely, given financial licenses are often quite difficult and time-intensive to obtain, tapping into more tooling may require accounting for 1–2 years of product development lead time.

3. Priorities vary across SMEs and Enterprises

Startups operating within the SME finance tech stack need to have a clear target persona due to the heterogeneity of SMEs today. For example, the priorities for micro and/or small enterprises often lean towards simplicity, affordability, and swift implementation rather than platform customization or end-to-end functionality.

On the other hand, we’ve recently seen both Brex and Ramp move upmarket to serve larger customers instead of startups or SMEs, their initial focus. While we’ve yet to learn how this shift plays out, at Alter, we believe focusing on one initial customer segment would ground founders’ product priorities and strengthen GTM efforts, particularly in the early days. We expect this to result in a focused growth strategy and a fulfilled user base, yielding exponential benefits for both the business and its respective customers.

4. Revenue Diversification

Firms in this space need to diversify their revenue streams to unlock sustainable growth. For instance, looking at Spend Management, companies historically relied on either interchange fees (Ramp, Brex) or subscriptions (Airbase, Emburse) for their revenue. Now, there’s an increasing shift towards monetizing on both given interchange fees’ low margins and significant volume requirements.

Alter’s Initial Focus Areas

As we’ve discussed, the lines separating the different functions within the SME Finance tech stack are getting increasingly blurry. This is driven by increased competitive pressures, horizontal expansion efforts and the integrated workflows across these functions.

At Alter, we’d like to deep dive into two functions we believe would be intriguing wedges to launch with, acknowledging we’re keen on exploring other functions in the future as well.

Accounts Payables/Receivables Automation

As illustrated above, a traditional B2B transaction process involves the customer creating a purchase order, the supplier or vendor fulfilling that order, the supplier’s Accounts Receivable (AR) department creating an invoice, and the customer’s Accounts Payable (AP) team finally processing and paying that invoice. This process often takes 30–90 days with several inefficiencies along the way:

• On average, businesses spend 40 hours per month on invoice management. Today, most invoices are sent, received and updated via emails, spreadsheets or Whatsapp.
• Financing options are further restricted due to teams spending hours processing the invoices and managers later finding themselves short on cash. They’d call vendors or banks requesting extensions, cash advances or credit lines, with such options typically involving tedious applications or heavy collateral requirements.
• As companies scale with more complex needs, e.g. cross-border payment facilitation, the necessity of customizable, automated workflows increases exponentially as well.

Ultimately, Automated AP/AR tools unlock savings across the payment flow with features like:

• Automatic invoice capturing vs. manual data entry that can lead to significant inaccuracies
• Automatic invoice matching with Purchase Orders through integrations vs. manual matching and distributed purchase orders across departments
• Streamlined, electronic approval process
• Real-time payment processing with physical/virtual cards or alternative digital means
• Efficient reconciliation

As we’re deep diving into the model more, below are a few considerations that have supported our conviction in AP/AR Automation tools as sufficient wedges into the full financial stack:

• De-risked and Robust Financing: Embedded factoring and working capital financing, using GL data for underwriting, would be a solid moat.
• Diversified Business Model from Day 1: Companies building in this space typically adopt a diversified business model from the start, charging both take rates on Total Payment Volumes (TPV) and client subscriptions for the software used. We’ve seen fees on TPV going as high as 3.6% depending on the payment method, with a potential 0.4% increase if the company is charging FX fees for cross-border transactions.
• Healthy Margins: Due to the product’s software nature and the low cost of servicing customers, margins are quite high for this segment even prior to introducing financing. As an example, Bill.com is currently booking ~82% gross margins.
• Solid Wedge and Clear Upselling Opportunities: AP/AR automation tools align well with the maturity of most SMEs in emerging markets by tackling working capital challenges from Day 1, a pressing pain point for many. Typically, these platforms start with automation tools and reconciliation before integrating solutions such as FX and payment financing. We’re also seeing more companies offering expense management solutions, creating a more holistic B2B payments offering.
• Network effects and GTM: AP/AR solutions enjoy differentiated network effects via, for example, an invoice requiring its recipient to also create an account on the platform to process payment. This highlights how customers themselves would drive sign-ups and scale the network further.

All in all, given the solid unit economics and network effects of such solutions, we believe AP/AR automation tools are one of the strongest wedges into the finance stack. The payment and SaaS components help diversify revenue streams, and the direct pain points they address minimize user friction, unlocking horizontal expansion opportunities into expense management, treasury, and working capital.

Payroll Processing

The second product segment we are particularly excited about is payroll processing. As a result of its intersection with HR systems, payroll is one of the few functions within the finance stack that can withstand vertical expansion, thus making it a potentially lucrative wedge into SME banking.

In emerging markets, 50–80% of SMEs process payroll manually, with almost 50% of their respective employees being paid in cash. While this translates to inefficiencies on the SME side, ranging from wasted time on payroll compliance to fees lost due to payroll and tax errors, the impact is even more detrimental for employees as they have minimal accessibility to financial products and increased friction around their adoption. Additionally, the lack of payment interoperability further complicates payroll processing in EMs. In several markets, SMEs find themselves interacting with two different payment infrastructures, mobile money and traditional banking. This is especially true for SMEs in Africa where mobile money is surging, capturing 70% of the world’s $1T mobile money market.

To that end, online payroll processing digitizes one of the largest cost centers for any SME. On average, 20–30% of a company’s revenue goes towards payroll, with the percentage increasing further in service-heavy industries. Ultimately, with the lack of alternatives in this space and incumbent banks’ decreased appetite towards SME payroll processing, we expect minimal friction for new companies’ customer acquisition and adoption flows. Further, we expect horizontal expansion into business overdrafts, given their oversight of payroll data, and spend management, due to the existing engagement with employees, to be quite seamless.

On the consumer banking side, we believe one of the main bottlenecks around digital payments adoption is the cashing-in process. While this has been solved by agent networks and various distribution plays, we argue that a B2B2C approach towards consumer banking, via a payroll processing offering, helps alleviate this friction. Employees would receive their monthly income via the payroll provider’s consumer app, benefitting from features that include P2P transfers, bill payments, access to savings accounts and more. Notably, given how critical lending is for the mass consumer market, payroll processing firms would also be able to effectively roll out Earned Wage Access features, thereby providing instant value to users and building strong engagement on the consumer banking front as well.

A few considerations for founders here include:

• Having a compounding, yet focused product strategy — product innovation velocity would be key given the multiple horizontal expansion options available.
• Building a sales organization structure that allows for offline SME acquisitions at scale. This is due to the strong offline nature of SME onboarding in EMs, and how there still remains a high necessity around in-person interactions.

Considering its unique position to monetize on both business and consumer banking functions, from payroll processing to interchange fees, payroll builds a compelling case as a strong starting point to the remaining finance tech stack. As an example, in Egypt, where 60% of SMEs still process payroll in cash, Axis helps them pay their employees and suppliers digitally using its AxisPay wallet. In this way, the company is addressing financial inclusion on the SME and consumer front, with payroll as the wedge to both.

Conclusion

The digitization of the SME finance stack is still in its early innings across Emerging Markets. While we’ve seen the model begin to play out in more developed economies, there’s a host of considerations that founders need to be cognizant of building for EMs. For instance, in the realm of SaaS solutions, which includes AP/AR automation software, finding sustainable acquisition channels and booking healthy adoption rates have been challenging. This could be a product of pricing sensitivity or cultural factors, making product market fit attainability difficult. Other considerations include navigating cash-intensive economies where most suppliers only accept cash, resulting in decreased incentives for digital spend.

Ultimately, these considerations make solving for the finance stack digitization all the more pressing. While we’ve evaluated AP/AR automation tools and payroll processing here, we are keen to connect with founders in Latin America, South and Southeast Asia and Africa across the remaining functions as well. Within our current portfolio in this space, we’ve been fortunate enough to back Gerry from Clara at the earliest stages, and hope to continue investing further in this segment.

To that end, as we develop our thinking in this space and evaluate additional functions, please reach out if you are building or investing in this space:

• LATAM Investments Lead: Fernando Caputo, fernando@alter.global
• Middle East & Africa Investments Lead: Heba Abu Ahmed, heba@alter.global
• South & Southeast Asia Investments Lead: Siddharth Dhankhar, siddharth@alter.global

Thank you!