Growing Up: Why Innovative Finance is Key to Scaling and Replicating MSMEs

This blog was co-authored by Aline Krämer, co-founder and director at Endeva.

Micro, Small, and Medium Enterprises (MSMEs) drive job creation and economic diversification, and are critical for development. Unfortunately, small companies too often stay small. Despite great business models, they do not grow to be medium-sized or larger and are unable to replicate their success in other markets due to poor infrastructure, lack of skilled people or suitable business partners, ineffective regulatory environments, and other market challenges.

“Multiplying Impact: Supporting the Replication of Inclusive Busines...” the latest report by Berlin-based Endeva, which will officially launch in November, takes a critical look at the challenges entrepreneurs and companies of all sizes face when replicating. It further provides recommendations how various actors – such as development partners, investors, or civil society organizations – can support replicating businesses in realizing their full potential to deliver impact. The report identified three main areas in which such support is needed: information and knowledge, people and partners, and financing. In the over three dozen interviews with companies, intermediaries, and experts on the topic of replication carried out for this report, financing was the area most mentioned as a challenge.

Catherine Adelmann, Founder and CEO of Fosera, a solar lighting MSME based in Berlin that both produces and sells its products in low-income markets, said that one of her greatest challenges is to cover working capital needs, especially for Fosera’s local assembly lines. The problem for Catherine and other MSMEs is accessing the right kind of financing that allows them to scale or replicate. According to the IFC and McKinsey[1], the total unmet need for credit by all formal and informal MSMEs in emerging markets is in the range of $2.1 trillion to $2.5 trillion.

There is clearly a need for specialized finance products, but investors see the risk as being too high: instable political environments, unregistered collateral, poor physical infrastructure that hampers business as usual, as well as an overall lack of readiness on the part of the MSMEs to receive investment are just some of the roadblocks preventing MSMEs from accessing finance. Moreover, MSMEs that are ready to grow and replicate often require smaller ticket sizes that may range from US $250,000-1 million with longer repayment windows of up to 10-15 years that simply don’t pay off for investors when due diligence and transaction costs are taken into account.

How, then, can we get MSMEs the financing they need? Partnerships and engaging with new players are undoubtedly crucial. Investors cannot always be expected to take on the risk themselves, reasonably enough. However, they can work with other organizations and fellow investors to reduce risk and make their investments much more sound. The Deutsche Investitions- und Entwicklungsgesellschaft (DEG) a subsidiary of KfW, has created a special scaling program, “Up-Scaling,” for SMEs in developing and emerging markets that provides up to 50% of an enterprise’s financing needs up to 500,000 euro as long as co-investors cover at least 25% of the firm’s equity needs.

Other organizations have found online-based solutions to foster collaboration between investors. For example, bidx connects entrepreneurs, investors, and mentors in their online portal with the aim to start, grow, and finance MSMEs. Since 2011, bidx has grown and started over 100 businesses that have created over 500 direct jobs every year.

Another way to fill the financing gap is to bring in new players. Multinational corporations, for example, are seeing great value in investing in smaller organizations through “Corporate Impact Venturing.” For example, GSK, along with other public and private partners, helped implement One Family Health, which operates as franchise network of ‘Health Posts’ across Rwanda. These Health Posts have treated over 180,000 low-income patients since they were established in 2012.

Also, diaspora communities can play a role: They often have the commitment, skills and also the financial resources to act as financing partners for inclusive businesses. For example, Overseas Private Investment Corporation (OPIC), a U.S. development-finance institution, is partnering with diaspora communities to make investments in Africa.

MSMEs, especially the ‘homegrown’ ones from developing markets themselves, can really hedge their innovative business models for widespread impact. Understanding their needs and the most efficient way to deliver targeted support will go a very long way in helping them realize this potential.

[1] Stein, Peer, Tony Goland, and Robert Schiff. “Two trillion and counting: Assessing the credit gap for micro, small, and medium-size enterprises in the developing world.” IFC and McKinsey & Company. 2010.