Logan Yonavjak and Giulia Christianson

Chasing Gazelles to Achieve Poverty Reduction, Development Goals

Thirty years of research shows that a small percentage of SMEs create the vast majority of net new jobs and GDP growth in the U.S. and Europe, but how does this translate into opportunities in emerging markets?

A group of experts convened at the IFC headquarters last month to discuss the potential for fast growth Small and Medium Enterprises known as “High Impact Companies” (HICs) or “gazelles” to achieve poverty reduction and development goals in emerging markets. Panelists included:

Chrysanthos Miliaras – RTI International

Chris Grewe – United States Treasury

Jenny Everett – Aspen Network of Development Entrepreneurs (ANDE)

Paul Reynolds – George Washington University

Jose Ruisanchez – Andean Development Corporation (CAF)

MIT economist David Birch introduced the term “gazelle” in the early 1980s, defining a gazelle as a private business with at least $100,000 in annual revenues (that’s roughly $250,000 today) and annual revenue growth of more than 20 percent over a four-year period. In his seminal study, Birch filtered SMEs by their growth rate, and although most of these companies had 100 employees or less, Birch found that these companies created 70-80 percent of the jobs in their respective economies. Gazelles come from across industries, are typically younger (the average age is 12 years) and more productive than other firms.

It can be politically sensitive to support high-growth SMEs for organizations like the IFC, which uses public money to target gazelles. However, if these high-growth SMEs in emerging economies have the potential to carry as much weight in terms of economic growth and job creation as they have in the U.S. and Europe, more research on this issue is certainly warranted.

The distinction between clients of venture capital companies and gazelles

The clients of venture capital companies only make up a small subset of the gazelle group, according to the recent IFC note, “High Impact Gazelles: Should They Be a Major Focus of SME Development?” by Tom Gibson and Hugh Stevenson. To give some perspective, in the U.S. 300,000 to 400,000 businesses qualified as gazelles over the last decade, and only 3,500-4,500 received venture capital financing – that’s about 1 percent. The typical gazelle, in contrast to a venture capital client, is a more “normal” company that is growing very quickly, but not, in the vast majority of cases, the company offering spectacular rates of return.

In order to sustain high growth, according to the IFC report, the gazelles will require more widely available, long-term, non-asset-based risk capital instruments. The report cites that the most important thing missing is second-stage financing. It’s this second-stage financing that comes after the gazelle has exhausted available sources of early-stage financing (i.e. friends and working capital loans from banks) that really allows the gazelle to sustain its growth.

A dearth of information exists on gazelles outside of OECD countries

Although the data from developed countries on gazelles is persuasive, data from countries outside the Organisation for Economic Co-operation and Development (OECD) is relatively sparse. There are, however, a couple of highlights uncovered by the IFC in its recent note as part of a pilot project aimed at providing confirmation of the gazelle population in growing countries:

  • A study in Brazil found that high-employment-growth gazelles constituted 8.3 percent of Brazilian private businesses and created 57.4 percent of new jobs between 2005 and 2008.
  • The information that the IFC collected suggests that the percentage of gazelles in the private sector may be higher in developing countries than in wealthier ones. For instance, while the percentage of gazelles in the private sector is 3.9 percent in Germany, 3.8 percent in Belgium, and 5.4 percent in Norway. In Lithuania, Bulgaria, and Romania, the proportion of gazelles is 22.3 percent, 20.3 percent, and 18.2 percent, respectively.

What research does exist for gazelles in emerging markets?

The IFC is currently undertaking a pilot project to collect data on the revenue growth of SMEs from a detailed database managed by the World Bank called the “Enterprise Survey Database.” Through the process, IFC is getting an indication of not only the typical growth of formal SMEs, but also of the percentage of SMEs on the gazelle trajectory of 20 percent and greater annualized revenue growth. The available data will allow IFC to review the situation over four years in 13 countries: the Democratic Republic of Congo, Mali, Niger, Botswana, Cameroon, Cape Verde, Chile, Peru, Uruguay, Argentina, Bolivia, and Colombia.

A group called AllWorld has embarked on a project to establish the Africa 500, the Arabia 500, Asia 500, Eurasia 500, and Latin America 500 based largely on the model of Inc. Magazine’s annual “Inc. 500” fastest-growing companies. The results of a few of these initiatives are slated to be out by the end of December 2011.

The RTI-ANDE SME Roundtable Series held three discussions on gazelles in early 2011 that were intended to refine and advance the fields of SME finance and development. They are now in the process of coming up with a policy brief.

Key Insights

The event at the IFC highlighted the importance of extending the knowledge base about gazelles in emerging economies, and how best to support them. More research is needed to substantiate whether high-growth companies are the best investment from a poverty reduction and development standpoint, but the approach does offer some promise. From the perspective of one of the IFC organizers, Alan Johnson, microbusinesses and lifestyle SMEs are unlikely to generate the type of economic growth/job opportunities that development organizations are seeking. So what is needed from his perspective is a more sophisticated understanding of what gazelles look like in developing countries; for instance, how they create jobs, and how many net jobs they create.

What other information do we need about gazelles?

Chris Grewe and Jenny Everett gave some specific examples of the type of information needed to better understand high growth SMEs in emerging markets:

  • More insight into why the “missing middle” exists. It is important to understand why many companies don’t go directly from a start-up phase to a sustained growth phase.
  • More insight into non-financial barriers to growth, such identifying good workers; recruiting qualified managers and high-skilled people
  • Specific contributions of SMEs to productivity growth, education, and innovation
  • More efficient ways to do small-scale financing. The deployment of capital to SMEs can come at high transaction costs. There need to be more vehicles to disperse small amounts of capital when financing smaller firms.
  • A way to mobilize money for winners, since there are significant barriers to this. Providing resources to help close this gap is critical for missing middle.
  • More research that connects gazelles with poverty outcomes and examines what the actual development impact of these companies are

Barriers to gathering this information

Although the United States and the European Union have a number of datasets to draw from for research on high growth companies, there is a lack of existing data in many emerging economies. So who does have data? Banks (IFC partner banks), investment funds, other national-level institutions like the tax service, and departments of statistics, have data that can provide some of these answers.

How can business accelerators and funds with existing portfolio companies play a role in clarifying the role of gazelles in emerging markets?

In addition to acting as catalysts and providing support for gazelles, business accelerators and SME financiers are potentially rich sources of data that can help fill the information gaps about gazelles’ role in emerging market economies. These organizations typically have an existing portfolio of companies with relationship histories spanning a few months to over a decade.

For instance, New Ventures, the World Resources Institute’s center for environmental entrepreneurship, has built a portfolio of over 340 environmental small and medium enterprises in six key emerging markets during its twelve years of work. While not all of the portfolio companies are considered “gazelles,” this portfolio combined with peer portfolios, could potentially feed into a global dataset of latent and actual gazelles. Because of its relationships with a wide network of innovative companies, New Ventures and funds like Root Capital and E+Co, are in a unique position to gather information about the types of jobs these companies create/destroy, employee characteristics, innovations, productivity levels, etc.

In addition, examining these companies’ financials over time and in the context of different regulatory frameworks could provide insights about risks and rewards associated with investing in gazelles. This aggregated portfolio dataset could also reveal how these businesses evolve and how local communities participate in their growth. With all of this information, organizations like the IFC would be better positioned to understand how gazelles could help propel a country’s development process.

Rate of Return vs. Impact

At the end of the discussion, Jose Ruisanchez commented that “picking winners” is just one of the many tools to promoting development. Paul Reynolds argued that while there seems to be a strong case for more research on gazelles in emerging economies, we also need to ask some questions about what the objective of gazelles should be: To promote jobs? Grow the economy? Increase the number of citizens who have a productive role in the economy?

For instance, when thinking about sustainable development objectives, is more jobs the most important metric to examine? Ruisanchez expressed that traditionally, what made sense for institutions like the IFC was to have a high economic rate of return (with good development impact). Now there is more discussion about sustainability and net impact. Reynolds pointed out that most growing firms reorganize the economy rather than actually expand/change available goods and services; we need more precise information about firms that are going to grow the economy instead of take jobs away from existing companies. When examining development from this perspective, companies that create the most jobs aren’t necessarily the best in terms of environmental and social impact, so examining development goals more broadly than just job creation is important.

Read more Logan Yonavjak posts here.

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