Al Hammond

Trending Towards SMEs – Do New Funds Indicate Progress?

Formal, profitable SME financing is gaining momentum in India, as two articles in last week’s Indian financial press indicate:

ICICI Venture mulls 4 specialized funds
New SME Fund to Launch in India

Small and medium sized enterprise investment funds are not new; we’ve discussed the Shell Foundation’s successful African SME fund in the past. Other previous posts have covered the unmet demand for mesofinance. Last week’s announcements by BTS Investment Advisors and ICICI indicate to me that major players in commercial finance have finally begun to understand the need for and potential in SME finance.

It is hard for commercial banks to make small enterprise funding work; they need volume and sizeable transactions for the fees to compete with those charged during traditional equity and loan transactions. Yet funding for SMEs is a tremendous unmet demand–entrepreneurs want to scale their operations and hire more employees, but lack the collateral to do so.

Both BTS and ICICI are taking steps to address this. ICICI is setting up 4 specialized funds–small-cap, mezzanine, equity, and hedge. The article describes how each plans to meet the market demand:

The need for a small-cap fund was felt because ICICI’s current funds are for bigger deals, with an average size of $75 million. The small-cap fund will invest in smaller and emerging companies, which require a fund infusion of between $10 million and $50 million…ICICI also felt the need for a mezzanine fund, which would be a combination of debt and equity. It will protect promoters from losing control over their companies without compromising on growth…As a part of its strategy to become a one-stop shop for investors, ICICI is looking at setting up…an equity fund that invests in other funds. A hedge fund (which will invest for a short period of time) is also being looked into.

BTS, meanwhile, hopes to grow small enterprises by taking an equity stake and eventually bringing successful companies to the IPO stage, an option that has only recently become viable:

While the Indian private equity market is offering a broad range of investment opportunities across various sectors, during the last five years, the M&A market has also started developing concurrently, offering excellent exit options to the VC funds. The availability of exit options in terms of IPOs, secondary sale and through mergers and acquisition has definitely changed the mindset of the global investors on India and hence a large number of global private equity players entered the Indian market during the last three to four years.

These are promising developments, particularly in terms of a shift of perception about where the future lies. But at $10 million per investment, even ICICI’s small cap fund does not get into the mesofinance gap discussed here previously–and it is really small enterprises–those capable of absorbing less than $1 million–that remain virtually unserved.

The good news is that a number of private and public finance agencies are at work on innovative SME funds that can reach even these small?but developmentally critical?firms. We will bring you more details as they become public.