Investing in SMEs in frontier markets is one of the most important ways to drive sustainable economic growth. Yet it remains among the most challenging approaches for Development Finance Institutions, or DFIs.
In Africa, 80% of SMEs lack access to adequate finance, which holds back entrepreneurship, job creation and inclusive development. The estimated SME finance gap now stands at $330 billion, and this shortfall is the widest in frontier markets.
In its new report, “Reaching small and growing businesses in frontier markets,” ARIA highlights the critical role that locally managed SME funds can play in addressing this gap. (Disclosure: The ARIA initiative is funded by BII, FMO and Proparco.) It challenges DFIs and impact investors to move beyond traditional private equity structures and find new ways to support and channel capital into local funds.
Many of the barriers and recommendations highlighted in the report cannot currently be addressed through DFI investment alone. Ticket sizes are often too small; the perceived risk of emerging fund managers remains high; and macroeconomic volatility, currency risk, security and liquidity constraints add further challenges.
What we have learned
Recognizing these challenges, the Dutch entrepreneurial development bank FMO has made market creation a strategic priority to address barriers that limit DFI investment in underserved markets. Our market creation approach enables us to go beyond the traditional DFI boundaries, leveraging patient and risk-tolerant forms of capital to catalyze the types of opportunities identified in the ARIA report. We seek to be highly additional — backing efforts that wouldn’t happen without our support — by collaborating with a range of partners and taking a systemic approach to tackling barriers that can unlock DFI investment.
Here we share some key insights that shape our market creation ambition, along with early examples of how this is translating into action:
1. Catalytic capital and knowledge should target scalable, replicable models.
Funding for market creation is scarce and must be directed where it can have the greatest catalytic effect. This means supporting models that can be scaled and replicated to create a demonstration effect on the market. As highlighted in the ARIA report, identifying approaches that can unlock pools of local and international capital is essential. And sharing knowledge from these early models on what works and what needs to be improved — as our pioneering partners Investisseurs et Partenaires and the Collaborative for Frontier Finance do in the report — is vital to ensure that market creation efforts can scale, replicate and deliver sustained impact.
Ci-Gaba offers one case study of an effective approach. A pioneering fund-of-funds, it mobilizes local institutional capital for SME investing across West Africa. In Ghana, for example, the pension industry is approximately $6 billion. While regulation allows for 25% to be allocated to alternative assets, currently less than 1% is. Ci-Gaba uses catalytic capital to help de-risk and crowd in institutional investors that can provide long-term, local currency investment for local SME-focused fund managers.
2. Financial and non-financial tools need to reflect local market realities.
Unlocking investment opportunities in frontier markets requires developing the right financial tools, and this requires more than just money. SMEs need flexible, risk-bearing financial products that can support early-stage enterprise growth. Equally critical is tailored non-financial support to strengthen performance, market access and investment readiness. Such early-stage capital and support are best delivered via intermediaries that are agile, cost-efficient, deeply embedded in the local context and able to pull in DFI capital at the right time.
For example, the Village Capital Africa Ecosystem Catalyst Facility, funded by FMO and the Netherlands Enterprise Agency, is designed to strengthen the entrepreneurial ecosystem by supporting entrepreneur support organizations in Africa. These organizations play a critical role in preparing SMEs for investment by providing business development services, mentorship and access to networks. The facility provides flexible funding and capacity-building support to these organizations, enabling them to deliver high-quality, context-specific programs that improve investment readiness and long-term sustainability for local enterprises. This approach demonstrates how ecosystem-level interventions, alongside direct investment, are essential for market creation and for building pipelines of investable businesses that can attract DFI and private capital at scale.
In addition to providing flexible funding, DFIs need to adapt their instruments and expectations to working in growing but riskier frontier markets. Deal-making often involves high transaction costs, as ticket sizes are typically small, but business development and due diligence costs are high. By aligning tools, timelines and expectations with conditions on the ground, DFIs can play a more effective role in building a pipeline of investable opportunities within the boundaries of current mandates.
For example, FMO is set to invest €13 million into Investisseurs et Partenaires’s IPDEV initiative, leveraging a first-loss feature to unlock additional capital and attract new investors. This smart de-risking mechanism amplifies IPDEV2’s ability to launch and scale locally managed investment funds across Africa. By anchoring these funds, FMO empowers grassroots teams who can disburse smaller tickets and benefit from local presence, financing underserved SMEs and fostering inclusive growth and resilient entrepreneurial ecosystems in fragile markets. It’s a bold step toward sustainable market creation and financial inclusion.
3. Building partnerships can bridge the gap between DFIs and local markets.
DFIs typically lack a local presence in frontier markets, which limits their ability to source and support potential investment opportunities. In these challenging environments, where local knowledge is limited and transaction costs are high, strategic partnerships can bridge the gap and unlock investments.
For example, platforms like ARIA are redefining how market creation happens in frontier markets. Funded by FMO, BII and Proparco, ARIA operates as a catalytic ecosystem builder. It provides DFIs with an on-the-ground presence in Ethiopia, DRC, Sierra Leone, Liberia, Benin, Togo and Guinea to source and promote deal pipeline. ARIA then works to advance deals through technical assistance and transaction advisory support. To date, ARIA has referred more than 200 deals to 16 DFIs, supporting investment committee approval for over $120 million of investment into frontier markets.
With a long time horizon, ARIA is also engaging in ecosystem development initiatives that address more systemic barriers to investment. For example, in Ethiopia, ARIA has engaged with financial institutions to design and implement capacity building for local financial institutions on ESG — a barrier to investment identified by DFIs actively engaging in the country.
ARIA’s model shows that market creation is not just about deploying capital, but also building the enabling environment and partnerships that allow local enterprises to thrive and scale. The platform’s work highlights the importance of a collaborative approach to drive sustainable, inclusive growth in frontier markets.
Market creation is a long-term journey. The insights shared here reflect early lessons from our work with pioneering partners like IPDEV and ARIA. As we continue to explore and refine new approaches, we remain committed to learning, adapting and sharing what works and what doesn’t.
Claire Nyambori is a technical assistance officer; Katie Mountain is the ARIA lead; and Alexander Burtenshaw is the MEL lead at FMO.
Guest posts on ImpactAlpha represent the opinions of their authors and do not necessarily reflect the views of ImpactAlpha.
