James Militzer

Start Small, Stay Small: Can better finance help Latin America’s microenterprises take the next step?

According to a recent World Bank report, “a massive 60 percent of Latin America employees work for businesses with five or fewer employees.” And while the region generates a high number of new businesses, these companies grow much more slowly than their counterparts in other middle-income regions. In short, in the words of World Bank economist Augusto de la Torre, Latin American companies “tend to start small, and stay small.”

Part of the problem, according to George Petty, is that the region lacks finance for the much-discussed “missing middle” – making it hard for microenterprises to grow into the kind of dynamic, stable, small and mid-sized firms that generate much of the employment in higher-income countries. Petty is managing director of Venture South International, a company which lends to micro, small and medium-sized enterprises through subsidiary companies in Colombia and the Philippines. We spoke with him at the recent Sustainatopia conference, at which he was moderating a panel on impact investing in Latin America.

Asked why the region’s businesses are struggling to access appropriate finance, he mentioned several factors. “In one respect, microfinance has been so successful because it’s been very specific loan products, and very easily replicable. And once you get up to larger loan sizes – $5,000, $10,000, $20,000 – you’re really looking at businesses which need more specifically catered loan products. And the microfinance lenders haven’t really grown up into the space of microfinance very much.

“In terms of the banks – on paper, they can lend into this space, and they should be lending into this place. But my feeling is there are a couple of barriers to that. First of all, the central bank requirements are quite onerous, and the reporting requirements the banks have to the central banks, in terms of their guarantee requirements for the loans they make, are quite complicated. And often the small businesses can’t meet all the guarantee requirements that the banks require. Beyond that, I think it’s frankly just more profitable for the banks to be lending at higher levels. And I think there’s a sort of lack of interest – they have to get their hands dirty, they have to get out of their air conditioned office and go off and meet the clients. What we’re doing is choosing the hands-on microfinance approach, where you’re meeting your clients in their place of work, in their home, getting to know their neighbors – but we’re using bank loan products.”

This approach provides a needed product to businesses, but it isn’t always easy for lenders. “It can be a tough space to start off in,” Petty said. “You really need to know your clients, because each of these businesses are quite different, and often their financing requirements are different. And once you do that you can be profitable, but you have to have the scale – and by scale, I mean over a $5 million portfolio – to really make it worthwhile to do. And getting there is the trick.”

In spite of the challenges, he sees Latin America as a promising region for both business lending and impact investing. “There’s enormous wealth there, but you’re looking at 30, 40 – even 60 percent poverty in most of the countries, though it varies by country. So the need is self-evident, and there are a lot of excititng things going on.” But even so, he said, the region is sometimes overlooked in the global development and impact investing community. “I think there’s a little bit of an impression from some of the government agencies that there’s less need, because the region is more economically advanced than, say, Africa. So there’s not $10, $15, $20 million deals which are happening – many of them remain quite small. But they’re happening. And what’s exciting about it is that the ecosystem is developing. You’re getting the financing from a company like mine, but you’re also getting the small businesses – whether they’re organic soap producers or fair trade coffee or whatnot. And you get the feeling that a critical mass is developing to be able to grow the space further.”

Petty discusses the hot spots (and dead zones) for impact investing in the region, and the opportunities available for both lenders and investors, in the video below, part 3 of our Impact Investing Insights series.

You can view the other posts and video interviews in the series here:

Part 1: A Small Drop in a Large Bucket: The World Economic Forum’s Abigail Noble, on why impact investing needs to go mainstream

Part 2: Pay for Success: Can social impact bonds provide the fabled “win-win-win”?

James Militzer is the editor of NextBillion Financial Innovation.

business development, impact investing, lending, microfinance