Small business owners often lack the collateral required by banks for loans. But many small and growing businesses do have another valuable asset: cashflow.
A pilot project in Nicaragua is testing an innovative loan structure that relies on companies' cashflow to unlock financing for small- and medium-sized enterprises. The test of the new Variable Payment Obligation, or VPO, is aimed at helping women business owners in particular, who often lack fixed assets or loan guarantors. As a result, women entrepreneurs receive only 16-18 percent of financing for “SGBs” — small and growing businesses — in emerging markets.
Over the next two years, the first 30 to 40 companies will receive five-year loans of $25,000 to $30,000 at an annual interest rate of 18 percent, including both program fees and interest. Typical loan recipients are women-led or women-owned small- to medium-sized enterprises with annual sales of $100,000 to $250,000. The goal of the program is to facilitate SGB lending by local banks and third-party investors.
“The most exciting part of the initiative is the holistic approach to addressing the needs of women-owned and women-led businesses by tackling challenges on both demand and supply sides,” says Laurie Spengler, President and CEO of Enclude, the advisory firm that helped establish the pilot project in partnership with USAID’s PACE Initiative.
The pilot program, which the partnership hopes to scale across Latin America, is a new example of how public, philanthropic, and private actors are engineering market forces with the goal of closing persistent capital gaps stifling individuals, businesses, and economies.
The program's partners include the Miller Center for Social Entrepreneurship and Agora Partnerships, both business accelerator programs, Banco de America Central in Nicaragua, a local commercial bank, and the Swiss-based Argidius Foundation, a philanthropy.
SGBs have long been considered the “engine of growth”, playing a key role in job creation and long-term economic growth. But the “growing” part of small-and-growing has often been stymied by lack of access to commercial bank loans. The costs of evaluating large numbers of smaller loans causes banks to cater to larger and more established enterprises. Collateral requirements and rigid repayment schedules bar businesses that lack sufficient assets or enough early cash flow to cover loan payments.
Women entrepreneurs, with fewer assets and higher hurdles, in particular struggle to access the “fuel,” or capital, they need to grow. The VPO partnership is designed to increase access to finance for SGBs by demonstrating a number of key concepts:
- A traditional commercial bank can expand financial access to smaller businesses by lending primarily based on cash flow rather than collateral;
- Small and growing businesses can obtain financing with payment terms that are clearly linked to cash flow and/or revenue;
- Impact investors and other third-party investors can invest alongside local banks; and
- Capacity-building increases the borrowers' potential growth, readiness for investment, and reduces risk for lenders and third-party investors.
According to Enclude, the partnership was structured to ensure that all partners have “skin in the game.” A key partner is Banco de America Central in Nicaragua, a local commercial bank, which will gain access to new credit methodologies and expanded market opportunities that allow lending to clients previously deemed as too risky. As those customers become ready for follow-on funding, they can become customers for the bank's traditional products.
It took more than a year to put all the pieces together, according to Maria Denise Duarte and Kira Lopez, who manage the program for Agora Partnerships, a social enterprise accelerator serving Latin America. The first step was the building of a trusted relationship with Banco de America Central's management team. Since 2013, Enclude had been working closely with the bank's then-new small and mid-sized business arm to help the bank increase its share in this growing market.
The program targets companies in the manufacturing and production sectors that are well-integrated in the supply chain and require substantial capital injection for capital expenditure to ensure further growth.
Agora conducts due diligence, pre-screens potential recipients and provides recommendations to the Bank. Once the beneficiaries are selected by the bank, over the next five years, Agora will continue to work closely with the companies to support business growth and ensure loan repayment. These services are key to minimizing transaction costs and lending risk for the bank. USAID and a Swiss-based Argidius Foundation paved the way for the partnership by funding operational costs.
Santa Clara University’s Miller Center for Social Entrepreneurship helped structure the product early on based on Professor John Kohler’s innovative “Demand Dividend” model. Agora and the Miller Center are developing a capacity-building program for enterprises to analyze cash flow, boost managerial and accounting skills, provide sales and marketing training and develop operating plans.
By year four of the program, companies in need of additional growth capital should be able to complete refinancing with BAC and receive a commercial loan without the program’s support.
Next up: Replicating the pilot in other countries in Latin America through BAC’s network of local commercial banks. A third phase of the project may be an online platform for companies in the program to allow for easy deal access to third-party investors.