Impact Voices | October 17, 2023

Tapping the creativity of local fund managers to scale small business finance

Susan de Witt

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Guest Author

Susan de Witt

Small businesses are the growth engine for inclusive and resilient development in Africa. Yet the $330 billion annual financing gap remains stubbornly sticky because few financial institutions and investors are prepared to fund small businesses.

Local fund managers and other capital providers are key to finally unlocking the capital small businesses need. How? By nimbly, creatively and economically identifying the types of financing local businesses truly need, and proving both the financial and impact case for rethinking small business finance.

The Collaborative for Frontier Finance’s most recent research reveals an unprecedented level of experimentation in African small business finance. More than 60 local capital providers, collectively working to mobilize $1.5 billion for small businesses and local ventures in Africa and the Middle East are reengineering financial products and investment terms to fit businesses’ needs; redesigning fund structures to work for small ticket investments; and galvanizing participation from local institutional investors.

Considering many traditional financial institutions are reaching the limit of what they can achieve in the market, there is tremendous opportunity for investors and market builders to track and support the success of alternative models.

Right capital, more impact

Traditional approaches and structures of financing haven’t adequately reached small businesses or enabled them to thrive.

Local fund managers are taking a different approach by embedding flexibility in their funding terms, using a mix of investment instruments, and providing post-investment business support, all while encouraging businesses to double down on local impact. This is not something most banks or digital lending platforms are able to do, yet these approaches are crucial to small business growth.

CFF’s survey finds that 60% of local capital providers’ investment volume is allocated using a variety of self-liquidating instrument including debt but also mezzanine structures, convertible notes and revenue sharing instruments. Almost 90% of managers are using some self-liquidating instrument in their mix.

Amam Ventures in Jordan uses self-liquidating instruments, combining debt and equity with revenue sharing and/or convertible notes, to provide patient, non-dilutive capital and flexible repayment options tailored to the needs of the women founders. The team’s approach is entrepreneur-friendly, offering support beyond just capital and minimizing exit challenges.

“With this type of instrument our performance flows with the performance of the business,” says Amam’s Jenny Atout Ahlzen. “The better the company does, the better we do.”

Moreover, the better a local company does, the more local impact it has. Small businesses are key to local economic resilience and future opportunities, particularly for youth and women.

Sixty percent of the funds in CFF’s network are led by women, compared to 12% in private equity and 5% in venture capital globally. These women are bringing other women investment decision-making, thereby influencing the gender balance in financial services. And they’re giving more women access to finance, boosting women’s long-term economic opportunities and wealth.

Grassroots Business Fund knows the impact opportunity of investing in small businesses in the agriculture sector in particular. The 15-year-old impact investment firm says agri-businesses in its portfolio – once given access to finance – promote gender equity within companies and value chains, enhance climate resilience for their networks of smallholder farmers, and stimulate job growth.

“Agriculture finance is more than just about supplying capital to SMEs,” says GBF’s Lilian Mramba. “It’s a vehicle through which local capital providers can address intersectional impact issues.”

Better fund economics

One obstacle to the flow of small business finance is traditional fund economics, which don’t fit organizations dealing in small ticket sizes. Most traditional closed-ended private equity and venture capital funds are designed for multi-million-dollar investments. That doesn’t work for organizations serving businesses that need $50,000 or $500,000 investments.

Sixty percent of the fund managers in CFF’s network are raising sub-$30 million funds. The sustainability of these smaller funds requires using a variety of strategies to manage cashflow effectively, especially in the early part of a fund’s lifecycle.

Teranga Capital, which invests in local businesses in Senegal, offers an investment readiness programs for early-stage ventures to build pipeline for their core fund while generating additional income. This approach helped with Teranga’s fund economics by augmenting back-office resourcing. It also provided career growth opportunities and talent retention within the organization.

Investing across Sub-Saharan Africa, Unconventional Capital, is set up as an open-ended fund and uses revenue sharing agreements to support economics. By simplifying portfolio management using a bespoke technology platform, they have created efficiencies to enable a high volume of deals. 

Having tested their operator-investor model with support of public monies, Secha Capital are able to transition to a more traditionally sustainable model whilst maintaining a focus on job creation.

Engaging local investors

International development financing institutions played a pivotal role in developing private equity and venture capital in emerging markets by backing new fund managers. They have been largely absent in catalyzing private small business finance funds, however.

Fund managers in CFF’s network expect to raise about $320 million of their targeted $1.5 billion from development finance institutions. Just 4% of it has been secured. By contrast, fund managers expect to raise $250 million from family offices, angel and high net-worth investors, and have reached 36% of that goal.

In total, CFF’s network has secured $260 million, or 17%, of their $1.5 billion target.

To plug their own capital gaps, local capital providers are increasingly turning to local institutional investors. Mirepa Investment Advisors notched half of its $10 million fund goal from local investors, including pension fund managers.

Vakayi Capital in Zimbabwe has also successfully engaged local investors. The value goes beyond money, says Vakayi’s Chai Musoni: local investors have a similar view on perceived and actual risk.

Data transparency drives allocation

Data collection and sharing of the kind that CFF is doing with its member surveys is critical to unlocking small business finance because it teaches capital holders about the real risks, lessons and opportunities in the sector.

“Growing participation in the CFF annual survey provides ongoing insights to investors and serves to showcase how fund managers are innovatively raising, deploying and managing capital,” says Amos Gachiuri of FSDAi, a CFF partner. “More data will serve to reduce risk for investors and provide peer learning among fund managers.”

There is, of course, a key dataset available to development finance institutions—the GEMS database—that likely details such risks and opportunities already. But this data has yet to be made available to the public. Making GEMS public would enable better understanding of where DFI capital is deployed, why certain deployment choices are made, and what constraints exist for deploying capital differently, says Nicholas Colloff of Argidius Foundation. “The goal is to encourage DFIs to collaborate and share data more openly to improve transparency and decision-making in the impact investment space.”

The opportunity at the heart of small business finance sits with a set of capital players who are local, have deep knowledge of their communities and the markets’ business needs – and a willingness and capability to assess and design appropriate financing approaches. It is time for investors and market builders to help them replicate and scale by supporting models and approaches that work.

Susan de Witt is the director for CFF focusing on the Frontier Capital Learning Lab.