Africa | February 5, 2020

Call No. 12: How local early-stage funders are finding impact alpha in emerging markets

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ImpactAlpha, February 5 – Small and growing businesses are the pillars of local economies, in both developed and developing economies. Startups are engines not only of innovation, but of employment opportunities, creating the vast majority of new jobs.

Yet, small business and startup financing remains a challenge in all but a few global hubs. In emerging markets without strong entrepreneurial ecosystems, even promising businesses fail or merely scrape by without access to the capital they need. The capital gaps are even wider for companies targeting low-income or otherwise disadvantaged customers with high-quality, affordable products and services. 

Providers of both equity and debt capital in Senegal, Kenya and Pakistan joined ImpactAlpha’s Agents of Impact Call No. 12 last week to explore ways to bridge the estimated $5 trillion annual small-business capital gap in emerging and frontier markets. The Call kicked off ImpactAlpha’s deep dive into “capital on the frontier,” in partnership with the Collaborative for Frontier Finance and the Visa Foundation.

Listen to Agents of Impact Call No. 12: Capital on the Frontier

The Collaborative, which looks to support local and global capital providers and field builders to accelerate financing solutions for small and growing businesses, or SGBs, in emerging markets, is backed by Omidyar Network and the MacArthur and Small foundations, as well as Argidius, the World Bank and the development ministries of Australia and the Netherlands. The Visa Foundation, established last year, focuses on helping micro and small enterprises thrive, with a particular emphasis on the empowerment of women.

The unique structures and approaches of the three capital providers, all women, represent just a small slice of the geographic and financial diversity getting deals done, often under the radar of institutional capital sitting in North America and Europe. Adding to the skepticism: The natural wariness and risk-aversion from investors who aren’t always intimately familiar with the the locally-unique and complex contexts in which these capital providers operate.

The early-stage capital providers are “consciously building the market at the early stage,” said Misbah Naqvi of i2i Ventures in Pakistan. “If you don’t do that, then you’re not going to have building the blocks required to get to [later-stage investments] and beyond.”

Naqvi and her co-founder Kalsoom Lakhani have graduated 47 ventures from the Invest 2 Innovate accelerator and have raised more than $1 million toward a planned $15 million fund. 

Everlyne Dioh in Senegal presented WIC Capital, an investment fund backed by a group of 80 women who pool their personal capital to invest in and mentor other women business owners in francophone West Africa. WIC cuts checks of up to $200,000—small sums that go a long way to unlocking growth within local businesses, particularly women-led businesses shut out of most commercial financing.  

And Kenya-based Amanda Cotterman of EquaLife Capital spoke of proving out the opportunity and need for venture debt on the continent with her own funds. “There are so many investors in the venture capital and impact world, and everyone’s competing in an unrealistic manner,” Cotterman observed. 

Dioh, Lakhani, Naqvi and Cotterman were among 30 first-time and early-stage capital providers who convened in Nairobi last month to share their experiences and challenges at the inaugural gathering of the Collaborative for Frontier Finance. ImpactAlpha’s Jessica Pothering attended the convening to make connections and gather material for our ongoing coverage.

“What they’re trying to achieve is paramount to addressing the jobs situation and economic sustainability and resilience of many countries,” said Drew von Glahn, executive director of the collaborative. “Solutions have to come from the local marketplaces, versus the traditional model of large European and U.S. capital providers moving capital from where they sit rather than from the perspective of local players.”

Local fund managers represent a valuable resource for global investors, including development-finance institutions and family offices, who are looking for deals and opportunities in growth markets. Yet such managers face a host of obstacles that the Collaborative is seeking to address. “We asked people to rate issues. Capital ranked number one, two and three in terms of people’s priorities,” von Glahn noted. “They’re all struggling for different reasons to raise capital.”

Alternatives to venture capital

Standard-issue venture capital structures may not be appropriate in local contexts. In Pakistan, for example, where entrepreneurial support networks are scarce and there are few seasoned investors, entrepreneurs often concede large shares of their businesses and get stuck with extractive terms. “We call it vulture capital,” Lakhani said. “We aim to address these issues at the seed up to the Series A level.”

In Kenya, Cotterman is working to prove the need and opportunity for venture debt, which is lacking in Africa. “What’s really needed is equity coupled with debt. Venture debt is usually 10% to 15% of any ecosystem,” she explains. Through her company EquaLife, she’s loaned $750,000 as equipment and inventory financing and other working capital. 

Elsewhere, early-stage investors are experimenting with other creative and flexible capital models, like revenue-based financing or impact-based repayment terms. In Latin America, a number of early-stage capital providers have even been successful leveraging these unique structures to draw investor support. 

Suzanne Biegel, who is heading up the GenderSmart Investing Summit in late April, think more global investors could be interested in backing locally-tailored early-stage vehicles. The challenge is getting hyper-local capital providers in front of a global investor audience.  

“Investors just don’t know what’s out there, and the transaction costs for them of finding them is something we really need to tackle,” she said. 

De-risking first-time managers

Investors often perceive first-time capital providers to be inexperienced and risky. “As a community we really need to dispel that perception,” argued Biegel. “They’ve got the background, they’re just doing it in a new fund or vehicle.”

The founders of i2i Ventures, for example, have an eight-year track record working with Pakistan’s early-stage startups. Cotterman, herself an entrepreneur, brings deep operational expertise alongside capital for her portfolio companies. WIC Capital is a women-led fund whose members have a deep understanding of the challenges women business owners face in the markets where they invest. 

First-time funds are “where the biggest innovation is happening” in the industry, observed Biegel. 

That innovation is also what ensures that the right kind of capital is being deployed for maximum impact. “We have a tendency to assume with best practices that one formula solves everything and can be photocopied around,” said von Glahn. “Best practice is being highly contextual, focusing on needs of the clients, and building on what capital providers are good at.”