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Emerging markets: LCPs shake up small business finance
Small businesses in emerging markets have long been recognised as crucial drivers of inclusive growth and resilience in the face of economic challenges. However, access to financing has remained a persistent obstacle for these enterprises.
In response, an innovative asset class of nonbank financial players, known as local capital providers (LCPs), is emerging in Africa and the Middle East, demonstrating the potential to bridge the financing gap for small businesses with ticket sizes ranging from $100 000 to $1 million.
The latest survey findings from the Collaborative for Frontier Finance (CFF), authored by Dr Susan de Witt, Drew von Glahn, and Zee de Gersigny, shed light on the unique characteristics and strategies of LCPs.
The survey focuses on 60 LCPs collectively targeting a capital raise of $1.46 billion to support small businesses. These LCPs have already financed over 1 200 enterprises, making a significant impact in their markets. Key survey findings include:
Diverse fund managers
The survey revealed that 60% of these locally-based fund managers are women-led, reflecting a growing trend of diversity in fund management teams. All the funds surveyed reported against the 2x criteria, emphasising their commitment to achieving positive social and environmental impact alongside financial returns.
LCPs use innovative investment instruments
A significant 60% of LCPs employ a combination of self-liquidating and equity investment tools. Notably, there’s a growing preference for self-liquidating models, driven by concerns related to exit strategies. These innovative approaches are essential for providing appropriate capital to small businesses in challenging markets.
Managing cash flow
Many LCPs, approximately 60%, are raising funds that are sub $30 million in size. To manage cash flow effectively during the initial stages of fund life, they utilize instrument selection, innovative fee structures, and strategic alliances.
Diverse funding sources
While 35% of current funding raised comes from high net worth individuals, fund of funds and domestic institutional LP contributions are on the rise year-on-year. This diversification of funding sources indicates growing confidence in the LCP model.
Impact aligned with UN SDGs
All fund managers in the survey reported alignment with the United Nations Sustainable Development Goals (SDGs), underlining the importance of impact investing. They utilise tools like the 2x criteria and IRIS+ to ensure their investments contribute to positive social and environmental outcomes.
Focus on agriculture
Agriculture dominates the sector focus of these funds, with 55% of funds reporting a significant allocation to this sector. Given that agriculture employs a significant portion of the population in Africa, this emphasis aligns with local economic priorities.
Accelerators and ecosystem support
Half of the fund managers surveyed have their own accelerators, which play a vital role in sourcing deals and providing ongoing support to portfolio companies. This ecosystem approach contributes to the success of LCPs.
Tailored investment tenors
The majority of LCPs target investments with a tenor of 4-7 years, matching global market norms. This aligns with the needs of small businesses at various stages of growth.
Follow-on investments
LCPs recognise the importance of follow-on investments, with most permitting them. This is critical for supporting businesses in their early stages of capital raising and enabling them to scale.
The findings of this survey highlight the significant impact LCPs are making in addressing the financing needs of small businesses in Africa and the Middle East. However, it also underscores the importance of support and investment capital from development institutions, institutional investors, and national small business finance programs to ensure the continued growth and resilience of the small enterprise ecosystem in these regions.
Local capital providers are pioneering innovative solutions to the financing challenges faced by small businesses in challenging markets. Their efforts have the potential to transform the landscape of small business finance in Africa and the Middle East, contributing to sustainable economic growth and social development.
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