By Genevieve Edens Sep. 1, 2015
What good is a business plan if you can't get the financing to implement it? This is a question that we've heard many Aspen Network of Development Entrepreneurs (ANDE) members ask. Our members help hundreds of promising small businesses—led by entrepreneurs who have the ambition and passion to grow their ventures—plan for growth, but they continue to struggle over early-stage financing.
In 2013 and 2014, the Entrepreneurship Database program at Emory University, with support from the Kauffman Foundation and Argidius Foundation, collected data from more than 2,300 ventures (of which over 1,300 operate in emerging markets) applying for entry into one of 20 impact-focused acceleration programs. These ventures were typically very early-stage—only a year old, with revenues just over $10,000. Most were actively seeking formal financing (often the goal of participation in acceleration programs), but across the board—whether the entrepreneurs were interested in debt, equity, or grant funding—they sought small amounts, around $40,000 to $50,000 in the next year.
This illustrates a central challenge for entrepreneurs, who typically don’t have the track record or collateral to access bank credit, and also struggle to find investors willing to offer very small amounts of capital.
This challenge isn’t new. Many have written about the social enterprise “pioneer gap.” On one hand, impact investors tend to target companies that are already established and poised for scale. On the other, many promising, early-stage ventures need funding to test and refine their models, but can’t access financing.
The good news is that ANDE is seeing encouraging signs that the small and growing business (SGB) sector is addressing this gap. Our annual “State of the SGB Sector” report tracks investment vehicles that make deals between $20,000 and $2 million, and among this group, we have seen a decrease of $100,000 in the minimum deal size that investors will consider—down to a median of $250,000 in the past five years. In 2014, Latin America in particular saw a surge in early-stage investments. The number of deals below $500,000 tripled in 2014 compared to 2013, and of those, almost a third were seed investments of $100,000 or less.
Closing the Gap
One possible explanation for the increase in seed funding is the explosion of accelerators globally. Accelerators typically work with a cohort of enterprises, and offer mentorship and networking opportunities, often along with a small amount of funding in the range of $20,000 in exchange for a stake of around five percent equity.
One academic study found that there was an association between the arrival of an accelerator in one metropolitan area and an annual increase of more than 100 percent in the number of seed-stage deals, and (over a 10 year period) nearly 10 times the amount of total amount of capital available for seed funding. The arrival of an accelerator was also associated with additional investors moving into the seed stage.
But does that same effect hold true for accelerators that focus on enterprises in emerging markets? Certainly, the arrival of 500 Startups and NXTP Labs into Latin America could have spurred the jump in seed-stage investment. But we don’t know very much about accelerators in the global south, especially those focused beyond tech on impact-related sectors, such as health, water, and energy.
In the effort to learn more, ANDE and Emory University’s Social Enterprise @ Goizueta, an academic center at the Goizueta Business School, recently announced the launch of the Global Accelerator Learning Initiative (GALI), a partnership that will help answer that question. Created by U.S. Global Development Lab at the U.S. Agency for International Development, Omidyar Network, The Lemelson Foundation, and the Argidius Foundation, GALI aims to analyze the efficacy of accelerator programs and share insight about the entrepreneurs who participate in these programs.
We have seen that investing at the seed stage takes the kind of strong non-financial support that acceleration programs offer. Over the past year, many ANDE members have been experimenting with partnership models to deliver both the finance and the capacity development support necessary to serve early-stage entrepreneurs. Here are three different examples of the innovations our members have been experimenting with to serve this market segment.
Social Enterprise in India: The Artha Venture Challenge
The Artha Venture Challenge (AVC) is a partnership between the Artha Platform, an online community that supports impact investments through networking and shared due-diligence, and the social enterprise incubator Villgro. AVC selects promising social enterprises to receive incubation services and a $50,000 equity investment from Artha structured as match funding alongside additional co-investors. Since its launch in 2013, AVC has worked with 24 businesses and deployed $600,000 in seed-stage investments.
Acceptance into the program does not guarantee investment; each deal still requires deep due diligence, which can be more complex in the case of co-investments. Sometimes the type of capital that Artha can provide isn’t right for the venture at its current stage, and the investment isn’t a guarantee. Nonetheless, AVC has seen that even without a seed investment, non-financial support that Villgro provides (such as exposure to new networks and business model support) can propel the venture to a higher level of operations and impact.
Food Processors in Tanzania: The Opportunity Fund
Since 2012, Partners in Food Solutions and Technoserve have been collaborating to support food processors throughout sub-Saharan Africa, providing these enterprises with strategic advice, financial planning, and technical knowledge to expand. While more established enterprises could apply for financing from partner Root Capital, early-stage ventures with credit needs below $50,000 had few options. Working together with Root Capital, they launched a pilot—the Opportunity Fund—to provide loans of less than $50,000 to early-stage businesses in this underserved market.
To do this, TechnoServe first identified a pipeline of investment-ready clients in Tanzania, conducting pre-due diligence assessments of their operational and managerial health. Credit is not always the solution, so Technoserve identified businesses that were at the right stage to receive financing.
Root Capital then adapted its standard due diligence requirements to accommodate these early-stage rural businesses. For example, in lieu of requiring three years of audited financial statements (which these businesses did not have), the lender asked for bank account records. The local Root Capital loan officer then visited each client and reviewed the financial models that TechnoServe had assisted each business in developing, while also learning more about the client’s operations and sales, and the social and environmental impact of their commercial activities.
Earlier this year, two sunflower-oil processors received loans of $27,000 and $50,000 to support capital expenditures and working capital needs. Face-to-face relationships were critical in enabling these transactions to take place, and TechnoServe's business advisors laid the foundation for Root Capital to efficiently serve these high-impact enterprises. It’s one example of how organizations can collaborate to overcome the costly and complex challenge of delivering financial services to SGBs.
Rural Entrepreneurs in Mexico: El Buen Socio
El Buen Socio has developed a model that also recognizes the importance of face-to-face relationships in lending to this segment. El Buen Socio provides loans of $15,000 on average to very early-stage ventures typically set up as income-generating projects by conservation and community development nonprofits, such as sustainable vegetable farms, honey production, or silvopastoral systems. These ventures are too large for microfinance loans, but too small and informal to access traditional bank financing.
El Buen Socio partners with nonprofits already established in these rural, indigenous communities. Their partners suggest a pipeline of projects they believe are ready for external investment, and entrepreneurs then work with El Buen Socio to develop a cash flow model and help them understand whether a loan is right for them.
Since its founding in 2013, El Buen Socio has funded 33 ventures, with a repayment rate of around 90 percent. For loans where the term is complete, 50 percent of clients are repeat customers. The second loan has funded further expansion—for example, entry into export markets or vertical expansion along the value chain.
El Buen Socio operates with a hybrid model. Its for-profit arm manages lending operations, while its nonprofit arm provides financial training. It relies heavily on its NGO partners as a de-risking mechanism. Trusted partners based in the field provide critical pipeline development, origination, and loan monitoring services.
Continuing to fill the finance gap for early-stage enterprises will require creative solutions and collaboration across organizations. Ultimately, we think it will take a coordinated effort across an entire ecosystem of stakeholders that support entrepreneurs. The financing gap is just one piece of that puzzle, but we are making significant strides to close it using accelerator models and new partnerships.