Accessing Finance: Old Challenges, New Solutions
(Above: Owners of Alimentos NutriNaturales, in El Petén, Guatemala. The company makes products from the native Ramon nut. The company participated in TechnoServe’s national business plan competition in 2007 and was awarded $10,000 in seed capital that helped launch the business).
This is the second in a series of interviews with Simon Winter, TechnoServe’s Senior Vice President of Development. He is responsible for leading and managing strategy, knowledge management/thought leadership, strategic planning, program development, and leading fundraising and partnerships. He is also responsible for managing and incubating innovative programs, including in India, Europe and for capital access for SMEs. Previously, he was Regional Director for Africa. Simon joined the NextBillion Advisory Board this week.
Q: What are the major obstacles that small and growing businesses (SGB) face in trying to access finance in developing countries?
Simon Winter: First of all, we should be specific about whose access we are talking about here. Among the most challenged small and growing businesses (SGB) that will have a significant impact on poverty in developing countries are those comprised of farmers organized into business groups and entrepreneurs trying to build businesses in high-risk sectors, such as agro-processing. If you are a larger agribusiness multinational, you can get finance relatively easily for activities in emerging markets. Or, likewise, if you are a private individual, who is middle class and has assets, and you want to invest in higher growth sectors with relatively predictable cash flows, like telecommunications, you also can get finance relatively easily.
One of the dimensions of the obstacles these SGBs face in trying to access finance is the risk appetite of commercial financial institutions. As a legacy of the International Monetary Fund and the World Bank economic reforms of the 1990s, in most developing countries and given the risk of investing in developing countries, you have high real and nominal interest rates. As a consequence, when commercial financial institutions do have spare cash they are likely to put it into Treasury Bills or the local equivalent. And complementing this lack of incentive to finance SGBs, the local banks lack the skills to understand how to finance such sectors. They are simply not prepared to take risks on financing SGBs in higher risk sectors. This is essentially a market failure – a market is demanding capital that cannot be supplied.
The second impediment, and intricately related to the first, is that there are no well-proven models of how to help those financial institutions – and this goes for private investors as well – mitigate those risks and be able to have more confidence about lending money or investing money into these perceived-to-be high-risk communities. The SGBs we are talking about frequently lack the levels of skills, reliable sources of demand, business experience and systems, track record, and most importantly collateral that the financiers are used to.
The other main impediment is that the entrepreneurs lack the opportunity to access the type of capital most suitable to their needs. On the debt side, this would be cash flow based lending; and on the term capital side – this would be equity or quasi-equity capital that is more akin to angel capital in the advanced countries – money that is invested commercially, but is seen as very high risk where the terms of exit or repayment are highly uncertain at the outset.
Q: What role do microfinance institutions play in all of this? Are MFIs distracting? Or are they having positive effect for SGB financing?
A: I think that microfinance has been good in the sense that it has been alerting the world to the challenges of poverty. Also, microfinance has been helpful to those people who use it where it is available.
However, microfinance simply isn’t available everywhere and it isn’t available to all of the world’s poor. Despite its very considerable achievements, microfinance is only available to somewhere between 5% and 10% of the world’s poorest (roughly 150-200 million people). A great article that addresses reasons for this shortcoming is “Rigidity in Microfinancing: Can One Size Fit All?” by Dean Karlan and Sendhil Mullainathan.
While microfinance is successful in helping relatively poor people to escape the worst aspects of poverty, access food and improve their livelihoods, it hasn’t demonstrated a good record in helping them to progress to the next step. People wanting to develop small growing businesses need to choose a business that has significant growth potential and need to be able to build their skills to build a great business. Microfinance is not set up to do that well.
And in the sense that the microfinance sector has captured the public’s imagination and people and institutions in advanced countries have worked out how to make it profitable, it has become a distraction from the broader agenda of pursuing growth as a lever for poverty reduction. What needs attention now is that there are unproven challenges of how to establish an even more successful set of approaches in the next level up – financing impactful small growing businesses.
Q: What financing models get to the core of the challenges of access to finance? And what is TechnoServe doing in light of the challenges?
A: At TechnoServe, we are doing a number of things that we believe are elements of the solution. I would not say that we have solved the issue, but I think that we know what the problems are and we have designed programs to address those problem areas.
Our main focus in this area is in strengthening the demand side so that SGBs are presenting themselves to potential investors (and/or lenders) in a way that meets their needs so they might begin to extend finance. TechnoServe’s business plan competitions (BPCs) are an important part of this demand-focus effort. Our BPCs are much more than a competition. They are an 18-month experiential training and up-skilling exercise. We have conducted 35 competitions in 14 countries over the past eight years, and these competitions have been generating a pipeline of high-quality entrepreneurs and high-quality business plans that are then linked to commercial financial institutions. And they work. In a recent study, we demonstrated statistically significant results that showed the 250-300% improved performance of enterprises that had participated in the training offered by the BPCs versus those that had not.
As a follow-up to our BPCs, we provide aftercare, which helps the entrepreneurs achieve sustainability. Aftercare, as its name implies, provides those good entrepreneurs with continued access to support services and mentors as well as introductions to financial institutions. An important element of this aftercare is the support we can provide when SGBs get feedback from lenders like “we like you, but can you strengthen your marketing plan?” or “can you get audited financials?” or whatever detail it might be that they need to address but might need additional support to carry out that project.
Another way in which TechnoServe is addressing the access to finance challenge is through the development of platforms that strengthen individual businesses that can generate social impact, but are not coming though our business plans. One such example is our East Africa Agribusiness Accelerator program. This program, which has completed a successful pilot stage, is an ANDE-linked project (Grassroots Business Fund, Root Capital and others are involved on the supply side) focused on finding good entrepreneurs that are failing to access capital, uncovering the reasons why this is so, and helping these entrepreneurs to strengthen their businesses and overcome the barriers that they are facing. Some of the interventions our team is executing include developing more robust market plans, creating stronger market linkages, putting in place some kinds of standards or certification processes, or improving their financial management practices. While we can see the essential need to help overcome the missing middle market failure on the demand side, others appear not to see this in the same light. We recently submitted the Accelerator to the G20 SME Finance Challenge. Sadly, while many good related initiatives made the final round, the Accelerator didn’t make the cut into the final round. I encourage you to review these finalists and make up your own mind!
As we continue to grow these programs and refine the Accelerator approach to enable it to scale, we anticipate being able to provide a place where entrepreneurs can come to obtain the support they need to get their business financed (or at least have much higher likelihood of doing so). This will also be a benefit from the suppliers’ side as they will have a place where they can access a pipeline of potential clients.
Q: Where does TechnoServe’s programming fall short of being a holistic solution to the access to finance issues and what are the ways in which you see these challenges being addressed?
A: On the supply side, financial institutions and investors need to be identified who are prepared to offer products that are more suitable to the borrowers and entrepreneurs that are looking for this capital. This is a critical part of the solution. ANDE, the Global Impact Investing Network, and other institutions are some of the many new investment vehicles that are exploring new pathways from venture capital to private equity. It is important to continue to generate innovative ways to get more capital into this space if we expect to see real progress here.
Another missing piece (though not explicitly a necessary piece) is the establishment of angel networks for developing countries. The reason I mention this is that the Angel Capital Association of America represented $19 billion over 55,000 deals in the U.S. in 2008 while only a small percentage of enterprises were financed by formal venture capital and equity-type institutions. Clearly this is an effective model in the U.S. and various people are exploring its relevance and applicability to the SGB space in developing countries.
To facilitate the efficient movement of capital, the Angel Capital Association has created standardized tools and templates so that those seeking finance can quickly submit their proposals in a standard format. TechnoServe is beginning to develop similar standardized financing templates in East Africa, but we are certainly not spearheading this effort. By formalizing and simplifying the tools and practices in this industry, we could accelerate the growth of nascent enterprises in developing countries.
While certainly not an exhaustive list, I believe these three issues are key components of a mature capital market that would improve the ability of SGBs in the developing world to access finance.