Opinion: Funding is failing emerging market SMEs – as impact investors, we can change that | The Magazine for Social Enterprise

Around the world, small and medium-sized enterprises, or SMEs, are the economic engine that drives jobs and supports communities. However, when it comes to accessing capital and growth financing, they are often overlooked in favor of larger companies that are viewed as a better investment opportunity. The situation is acute in emerging markets and especially in Africa.

SMEs in Africa account for up to 70% of employment and 40% of GDP across the continent. However, only one in five of these companies has access to financing from local banks. Meanwhile, private equity funds can often be too large to meet the needs of smaller companies. Additionally, they are often provided by funds and investors with international – rather than local – views and goals. As the world faces the threat of another global economic downturn, there is a risk of another crisis for small businesses already struggling to find financing.

The Covid-19 pandemic marked a turning point for governments and investors. It highlighted the growing inequality in opportunities and wealth between developed and emerging economies. It spurred debate and action to rebuild fairer economies that benefit all people and the planet. That’s why the UK Presidency of the G7 asked us to lead their Impact Taskforce last year. A key objective was to focus on key leverage points to increase capital flow into investments that can have positive social and environmental benefits, particularly in emerging markets that are at risk of being left behind.

To implement the recommendations of the G7 Impact Taskforce, we at the Global Steering Group for Impact Investment have worked together with the World Economic Forum, the expert group Collaborative for Frontier Finance and other partners. Our goal is to improve SME financing in countries like Ghana, Zambia and South Africa. Together, we have looked at ways to direct more investment into this important segment to help create more resilient economies that can provide better livelihoods for more people.

Plenty of capital

It may come as a surprise, but there is plenty of untapped capital in African markets. Own private pension funds in Ghana control about two-thirds of the country’s US$5.5 billion in pension assets and are growing at a rate of about 30% per year. But while the industry is allowed to invest up to 15% of assets in alternatives, data from the Ghana National Pension Funds Authority shows that only 0.03% is actually invested in private wealth. Even in South Africa, where pension funds invested $8.9 billion in private equity and venture capital in 2021, many funds are well below their allowable limits. The problem was not so much the availability of capital as the lack of the right types of locally-led financing structures that can meet the needs of SMEs.

There is no one-size-fits-all approach, but a range of options depending on each country’s needs. However, the goal is the same – to encourage domestic institutions to make more investments in small and growing companies, while attracting more international investors with a growing appetite to invest in Impact.

The problem was not so much the availability of capital as the lack of locally-led financing structures capable of meeting the needs of SMEs

In Ghana, our local partners have started structuring a fund of funds model that can attract investment from domestic institutional investors as well as international development finance institutions and impact investors. This fund then invests with local financiers (or in other words, impact venture capital and private equity funds), who in turn finance SMEs in the amounts they need – typically in the $50,000 to $500,000 range, which by is missed by many larger funds. This investment can be debt, equity or mezzanine financing, as long as it focuses on impact goals. Crucially, local financiers are led by local talent with intimate knowledge of local markets, rather than international investors with more of a helicopter view.

In countries like Zambia, where SMEs are smaller and financing options less developed, the government has a loan guarantee scheme. For pension funds, whose primary concern is capital protection, such structures can reduce the risk of their investments and allow lenders to channel money into SMEs through loans and other debt. Investors with a higher risk appetite can provide the guarantee, providing investors with impact returns and companies with growth capital. The loan guarantee program our partners are developing with the Central Bank in Zambia will initially target smallholder farmers in the country, who produce 80% of the domestic food supply. If they can improve their resilience thanks to adequate financing, this in turn has a positive impact on food security and poverty reduction.

Skills and talent required

As always, there are challenges in developing new forms of financing for SMEs. Fund of funds (and other schemes) structures need to be carefully considered to incentivize managers and provide de-risking mechanisms to attract new types of local and international investors. Additionally, there are a limited number of individuals with the experience and expertise to set up and operate such impact investment vehicles in Africa and other emerging markets.

The pioneering work in Ghana and Zambia is an example of how other countries can empower smaller businesses

But that is changing. The growing flow of capital into the SME space in Africa will drive innovation, catalyze the creation of new investment patterns and drive the development of skills and talent. If we want more resilient economies, where people have better livelihoods, we need to focus more on SMEs and creating the ecosystems that can help them thrive and contribute to the Sustainable Development Goals.

The pioneering efforts in Ghana and Zambia are examples of how other countries across Africa, as well as Asia and Latin America, can empower smaller businesses. They show how domestic investors and managers can unlock essential investments for small companies and thereby attract even more impact investments from international investors.

To create fair economies and just societies in emerging markets, we need to focus on the small businesses at their heart. It’s time to get involved.

Explore this topic further at Joining Forces: Growing Impact in Africa & Beyond, a side event co-hosted by GSG at the Finance in Common Summit on October 18 in Abidjan, Cote d’Ivoire. Also, Part 2 of the GSG Impact Summit Series will be held online on September 22nd on Boosting Capital Flows in Emerging Markets, with a panel discussion on boosting investments in SMEs.

The detailed insights into how funds of funds can help improve SME financing can be read here.

  • Krisztina Tora is Chief Market Development Director of the Global Steering Group for Impact Investment.

Cover Photo: View of Accra, Ghana (Photo by Muntaka Chasant, CC BY-SA 4.0)

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