Piecing together the ‘missing middle’ puzzle in emerging markets
The economic growth potential of emerging countries is enormous, especially with respect to the massively-underserved low-income citizens who make up the majority of their populations. Multiple barriers, such as high transaction and due diligence costs, political and currency risks, legal and regulatory concerns, and lack of collateral limit bank financing of early-stage enterprises. The same issues present challenges for private investors too. According to the findings of 6th Annual Impact Investor Survey conducted by The Global Impact Investing Network (GIIN) and J.P. Morgan on investment activity and allocations:
- The most critical challenge to impact investing (industry) growth identified by respondents this year are the same as have been identified for the past three years: ‘lack of appropriate capital across the risk/return spectrum’. The highest number identified gaps related to stage-of-business noting a lack of seed, early-, and venture-stage capital.
- According to an earlier report, only 9% of global capital ($60 billion managed by impact investors) is committed to Seed/Start-up companies or Venture Stage businesses.
Financing local entrepreneurs in high-growth emerging markets in Africa, Latin America and Asia can help under-served communities at the bottom of the pyramid by improving livelihoods as well as help businesses realize their potential in areas such as agriculture, food security, healthcare and education. And with the right investment strategy and on-the-ground portfolio management, it’s good business too, promising strong double-digit returns in most markets.
Source: Asim Khwaja, Center for International Development at Harvard University (Image taken from PovertyCure)
While the microfinance movement has begun the impressive development of the smallest finance markets, and international development funds and institutional investors have made advances in emerging market public equities and sovereign debt, SMEs (small and medium enterprises) remain to a large extent the “missing middle”. There is a need to expand investment focus from the “micro” to the SME level with the long-term goal of nurturing commercially viable and sustainable enterprises through financing mechanisms that ensure social and environmental returns along with financial returns on investment. The question then is: how do we accelerate the global flow of capital to impact entrepreneurs around the world?
The impact investing opportunity in “SME Finance”
According to the recent Impact Investor Survey released by GIIN and J. P. Morgan, there is strong interest in Sub-Saharan Africa, with impact investors planning to increase capital allocations there during 2016. ESE Asia, South Asia and LAC are other regions which are seeing a similar upswing. It was also found in the survey that fund managers play an important role in connecting impact investing capital with investment opportunities. 35% of the respondents said that they invest via intermediaries and when evaluating fund managers, ‘sector expertise’ and ‘impact potential’ were seen as ‘very important’ by more than 70% of respondents that invest through funds.
My partner Dave Richards and I have held similarly-held beliefs — that successful early-stage investing can be accomplished with an efficient systems-driven investment process led by on-the-ground, empowered, professional investment teams. With our experience in successfully operating Unitus Seed Fund — India’s most active impact investor, in September 2015 we launched Capria Accelerator. Our aim with Capria was to meet the growing demand for early-stage capital in emerging markets by investing in as well as supporting indigenous fund managers in these markets. The fact that in our first nine months, more than 500 impact fund managers with varying backgrounds and experience have requested to apply to our accelerator program from over 60 countries is proof of the ‘missing middle’ and that the solution is being met with optimism.
While the experiences offered by Capria Accelerator equip local fund managers with the tools to execute their funds as well as the networks to fundraise, we knew that the emerging markets’ ecosystems are vastly different from one another. Therefore, while working with our first cohort of fund managers from Uganda, Zimbabwe, and Guatemala, we simultaneously conducted a study on the impact investment ecosystems in a subset of countries in Latin America, Southeast Asia, South Asia and Sub Saharan Africa. Some of the key findings resonate with the report from GIIN. Our research also provides insights into the challenges faced by impact investors. It’s helping us and our partners develop a roadmap to increase capital allocations and scale impact investments in emerging markets through a more systematic approach.
1. Leverage philanthropic investments through strategic partnerships
Development Financial Institutes and philanthropic organizations often make below market rate investments. While their contributions may decrease risk for other investors, it can also distort how investments are structured, company valuations, and how impact is measured. Our analysis found that DFIs and foundation funders were most successful when they strategically made investments in partnership with mainstream and impact-oriented investors. This trend is most apparent in the areas of environmental conservation, healthcare, agriculture, and education. The trend of DFIs and philanthropic organizations making successful investments in partnership with private investment groups is most pronounced in India, Rwanda, Ghana, and Brazil.
2. Collaborate with fund managers in markets where public programs support entrepreneurship
There is significant variation in the quantity of funding allocated as well as the ability of government agencies to collaborate with the ecosystem. In Mexico, India, Kenya, and Brazil, local governments appear to be making significant contributions to the ecosystem by:
a. Providing direct funding of support organizations or favorable debt financing
b. Engaging entrepreneurs to solve social and environmental issues alongside government programs.
You can read more about the key findings in our three-part blog series.
Capria Accelerator is the first step in ensuring that entrepreneurs working in emerging markets can thrive where seed capital is scarce. They need increased access to early stage capital, supported by local investors who are backed by a global network of impact capitalists and development finance institutions. We hope to see a compounding effect of our efforts as the impact investing community grows and becomes more connected, with the ultimate goal of increasing the flow of impact capital where it is most needed.
[i] Investing in the Backbone of Emerging Markets (2010) Available at: http://hausercenter.org/iri/wpcontent/uploads/2010/05/Investing-in-the-Backbone-of-Emerging-Markets.pdf (Accessed: 19 May 2016).
Will Poole is co-founder and Managing Partner of both Unitus Seed Fund, the leading impact venture fund in India and Capria Accelerator, the first global business accelerator for impact fund managers. His funds’ LPs include Bill Gates, Vinod Khosla, T.V. Mohandas Pai, Hemendra Kothari, Diane Isenberg (Ceniarth), and Jim Sorenson.
More info http://usf.vc and http://capria.vc
