Derek Newberry

SMEs Are What’s Next

“What poor countries need most is not more microbusinesses. They need more small-to-medium-sized enterprises, the kind that are bigger than a fruit stand but smaller than a Fortune 1000 corporation.”

investThese were the words of James Surowiecki last month in his New Yorker piece What Microloans Miss. Now another mass media hit for the SME cause – the Miami Herald interviewed Root Capital founder Willy Foote this week about the basics of his enterprise development organization.Root Capital identifies and supports SMEs in countries where the private sector is dominated by micro-enterprises and large corporations. This structure represents a dearth of businesses in the investment range of roughly $100,000 – $3 million – the infamous “missing middle”

Willy, a key player in this space, believes that providing success stories of SME finance can help set off a rising tide of investment in this sector – very similar to the New Ventures approach. In his words: “…we can really do what microfinance did. That is, show local financial institutions that this is an asset class they can penetrate profitably.”

Reading this, it occurred to me that this is already happening – take the case of Brazil, where in the past several years, a number of funds have sprung up focusing on SMEs in environmental sectors, including Axial Par, the Stratus VCIII fund, Rio Bravo Investimentos and a new fund to be launched soon by Rio Bravo veteran Luiz Maia.

I called Andre Carvalho for comment this morning – he is the Director of New Ventures Brazil and an expert on SME trends in that country:

“We have increasing participation of VC funds in the Brazilian economy, more seed funds in just the last year and a half and more angel investors. So this market is warming up. The interesting thing is that these investors are not generally focusing on sustainability as a priority, at least not at first. But they see a good business, with a solid revenue model, and it also happens to have sustainability benefits; then they really get it.”

As Andre explains, and as we’ve always believed, investors are not coming into this space because they have some philanthropic focus on SMEs or sustainability. Of the four funds I mentioned earlier, only Axial Par is an explicit sustainability fund the way Verde Ventures or EcoEnterprises are. The rest are just mainstream investors that are seeing the potential returns of startup and expansion stage companies in environmental sectors.

The SME success stories being supported and promoted by Root Capital, New Ventures, and our many colleagues in this space are catching on in regional investment communities like Brazil’s. Publications like the New Yorker and the Miami Herald are taking note of the benefits of this sector. Microfinance is nestling into the mainstream and becoming less over-exposed. And SMEs are what’s next.