On the Frontiers of Finance: Scaling up Investment in Sustainable Small and Medium Enterprises in Developing Countries

Sustainable SMEs: The Future for Emerging Economies

Small and medium enterprises (SMEs) play a critical and well documented role in both developing and industrialized economies. They drive innovation, spur economic growth, create jobs, and facilitate the provision of goods and services.

Sustainable SMEs are those that manufacture and market environmentally friendly products and/or serve low-income communities and generate additional benefits for society and the environment. Financing such value-added businesses in emerging economies makes sense for both business growth and sustainable development. In developing countries, however, sustainable SMEs face major barriers to growth and success, most notably access to finance and business development support.

Over the past decade, specialized financial intermediaries—generally, those that are international, often with a non-profit organizational structure—have emerged to provide finance and business development support to sustainable SMEs in the developing world. This investment community has grown significantly in recent years, along with the rising interest in green investment, clean technology industries, and market-based approaches to poverty reduction and sustainable development.

On the Frontiers of Finance provides an overview of the current landscape, lending practices, and principal challenges of financial intermediaries providing capital to sustainable SMEs in developing countries. The objective is to help stimulate greater and more effective sustainable SME investment by better understanding how the sector can best be supported and expanded.

Investment Leaders Survey

In 2007, WRI and Boston College, with support from the International Finance Corporation (IFC), gathered together and interviewed 20 leading sustainable SME investment fund managers from Africa, Asia, Eastern Europe, and Latin America. Our discussions focused on challenges, opportunities, best practices, and pathways to sectoral growth, which forms the basis of this report. Section 3 and the appendix are overviews of these funds and their investment models.

In reporting our findings, we have divided the interviewees into two broad categories:

1. Blended Capital Intermediaries—investors with a primary focus on creating positive economic, social, and environmental impact by supporting sustainable SMEs and generating financial returns for investors. These are mostly non-profit entities with an international focus, and tend to be based in the U.S. or Europe;
2. Venture Capital Funds (VC Funds)—investment vehicles that are for-profit, commercial entities that provide market returns. This report examines VC funds in developing countries, those that are tapping into opportunities in green or socially oriented markets, such as cleantech funds.

Our survey revealed the intermediaries face three major challenges: raising funds for what remains an outlying frontier of the finance and development mainstream; justifying to the intermediaries’ investors the high costs of technical assistance for businesses; and finding ways to capture the “added value” of positive social and environmental impacts both cost effectively and consistently across the sector.

Recommendations

• Improve Capital Allocation: Educating commercial investors and grant funders about the business models and performance of SME financial intermediaries, combined with high standards of accounting transparency among the intermediaries would greatly improve the efficiency of the fundraising process. Compiling information about the financial viability and success of different intermediaries and highlighting the growing track record of commercially viable investments is crucial in order to attract further capital to the sector.
• Promote Financial Innovation: Long-term approaches and innovative thinking focused on system-wide barriers are needed to move the sector toward the status of both a recognized investment class and a strategic priority area within the development community. Sector-wide initiatives, angel investor networks and experimentation with social stock exchanges are efforts in the right direction that need to be supported and where successful, replicated and scaled.
• Capture the Triple Bottom Line: As more investors and donors enter the impact investing space, they will focus even more on demonstrable results and measurable effects. Smart, comparable metrics would facilitate the investment decision-making process by providing a clear picture of which intermediaries’ activities are best aligned with the priorities of impact-driven donors and investors. For this reason, comparability is paramount when measuring and communicating impact. Dedicated resources and a collaborative effort among leading intermediaries, investors, donors, and other stakeholders is required to move toward a shared standard methodology for impact measurement and reporting. Over time, aggregate results will help validate and evaluate the efficacy of the enterprise development community’s market-based approach to socioeconomic and environmental issues.

Both development and investment trends are leading major advances in sustainable SME financing. The scale and speed of these advances are not, however, meeting either the demand of local entrepreneurs or the urgency of the social and environmental challenges facing the world. Opportunities to achieve development and environmental goals while delivering financial returns are being missed.

We hope this report will inspire investors, financial intermediaries, the philanthropy and donor community, and enterprise development organizations to increase capital flows and improve capital deployment to sustainable SMEs in developing countries.