What developing countries lack in resources, access and formal institutions, their entrepreneurs compensate for with clever and effective business activity. Constraints often breed creativity. But underdeveloped capital markets, geographical barriers and little regulatory support make scaling up operations nearly impossible for most of these entrepreneurs.
Bringing local SMEs to scale is the trillion-dollar question at the heart of private-sector development. It was also the subject of a recent day-long conference, part of the 2009 Global Entrepreneurship Week, held at the International Finance Corporation headquarters in Washington, DC.
As U.S. Secretary of State Hillary Clinton put it in her video address to the attendees: “[The developed world] can't afford to leave out anyone who has an idea, a dream, an invention or innovation, and the desire to work hard.”
The issue is that many SMEs with the potential to make meaningful impacts are stuck in a financing limbo. They have outgrown microfinance but are still deemed too risky for funding from commercial banks, government sources and development organizations.
There is an asset class that is starting to fill this gap in traditional financing. It has been dubbed “patient” or “humanistic” capital. But whatever the moniker, it requires a social mission backed by investors who value good business as much as they do profits.
The strategy takes a Darwinian approach. Venture capital fund managers with a double-bottom-line mission select local SMEs that are already outperforming their peers and achieving impressive socio-economic impacts.
The funds then inject these fledgling businesses with enough capital, contacts and management advice to expand their services to a broader consumer base and therefore more low-income communities.
For instance, Harvard Professor Michael Chu, whose $75 million IGNIA Fund embraces this concept, invests in young growth companies whose core business is delivering commercial solutions to unmet needs at the base of the pyramid (BoP).
With their management expertise, technical prowess and cash, VC funds are likely the best vehicles for scaling up businesses in the developing world.
They can spot best-in-class SMEs from the rest, and they remain focused and incentivized enough during a young company’s growth cycle to make the smart decisions that another kind of financier might miss. Or not have the authority to make.
If some of the companies in their portfolio are successful, a fund demonstrates to other investors there is money in serving low-income communities. That can ultimately help create new industries.
At the IFC conference, Michael Fairbanks, co-founder of the SEVEN Fund, gave a keynote and highlighted his work with the Pioneers of Prosperity program. The program employs a similar “lead by example” idea but uses an award process instead of investing equity.
Granted, some pitfalls remain. Teresa Barger, CEO of Cartica Capital and a panelist at the conference, admitted that the core tension still lies in the misaligned objectives inherent in all VC activity: VC managers generally want control, maximized ROI and then timely exits while entrepreneurs pursue their vision and seek longevity.
That is surely a concern. But if a firm’s management team and its financial backers can get on board to achieve the same social goals, any boardroom wrangling might just seem like details.
