From dealflow to a lack of education, this week leaders in social finance addressed some of the key barriers preventing the UK market from flourishing. Last month Antony Bugg-Levine, the chair of the Global Impact Investing Network, told delegates at London’s Critical Mass conference that in the world of social finance there were “hypers, haters and […]Read More ›
Supporting SMEs in Emerging Economies: Impact Investing in Frontier Markets
Growing the SME sector in emerging economies is a key to bolstering economic development. Here is how a brand new private-public partnership does just that.
Why is supporting the SME sector in emerging economies important?
For industrialized countries, SMEs form the foundation of the economy. However, this sector is severely underdeveloped in low-income countries, and SMEs face constraints such as high administrative costs, unrealistic collateral requirements, and weak infrastructure in the country’s financial system. In a World Bank survey where SMEs were asked about the largest hurdles to growth, “financial constraints” was the second largest impediment (whereas larger firms felt this was the fourth largest obstacle). The weak SME sector in low-income countries also negatively impacts GDP, employment, innovation, and resilience in these countries, making economic development difficult.
Supporting SME growth in emerging economies has various benefits. The returns on capital for SMEs can be around 20% to 30% a month, which is much higher than interest rates usually are. Thus, promoting the growth of SMEs has a positive effect on GDP growth, since output, value-added, and profits will increase. The growth of SMEs also increases government revenue from taxation (provided that SMEs are taxed appropriately). Lastly, a strong SME sector helps to diversify the economy in a low-income country, which in turn builds the country’s resilience to global shocks and capital flow fluctuations in particular sectors.
Recognizing the importance of supporting SMEs in the developing world, I wrote a paper in December 2013 recommending DFATD support impact investing and government-backed investment funds in low-income countries as a form of development assistance. In the paper, I also argued that the funds that DFATD supports should have managers who have strong knowledge of the local country context in which they will be investing in order to manage risks. Notable risks associated with investing in SMEs abroad include navigating different property, regulatory, and tax frameworks, as well as working with a different legal and financial system.
Impact Investing in Frontier Markets (INFRONT)
A few months later, I learned through the MaRS Centre for Impact Investing about the INFRONT program which helps address all of these risks, but in a more creative way than I had envisioned.
Impact Investing in Frontier Markets (INFRONT) is a private- public partnership between Mennonite Economic Development Associates (MEDA), Sarona Asset Management (SAM), MaRS Centre for Impact Investing and the Government of Canada to support sustainable development in frontier and emerging markets. Anchored on SAM’s up to $400 million fund-of-funds, the project includes a Social Innovation Grant Fund and a fund manager mentorship program, which is led by MaRS Centre for Impact Investing.
Through INFRONT, experienced North American private equity and venture capital managers mentor promising fund managers in emerging markets. Mentors have over 10 years of experience, and advise mentees over a period of 4-6 months on various aspects of business development. Topics include how to optimize opportunities with investors, structuring of deals and developing strong pitches and presentations for investors.
Instead of training Canadian fund managers to learn how to navigate a foreign country’s legal and financial system to minimize risks, INFRONT helps train high-potential fund managers who are already working and living in emerging markets, and have a strong knowledge of the country context in which they are operating. Through INFRONT, North American mentors only provide advice in areas where the entrepreneurs feel there are gaps that need to be filled. Thus, SME growth is truly owned by the entrepreneurs themselves.
INFRONT: Just the Tip of the Spear
The INFRONT program comes a year after the Canadian government’s announcement last June of a new impact investment project that will run until 2028. In this project, DFATD has committed almost $20 million to MEDA to support the launch of a 15-year investment fund. This fund will leverage up to $400 million in private equity investments, which will help a maximum of 250 SMEs and create over 15,000 new jobs. The project will also help up to 10,000,000 individuals receive better access to products and services, and generate extra revenue for small and medium enterprises (SMEs) in low-income countries.
The INFRONT program will play a crucial role in helping train entrepreneurs in emerging and frontier markets grow their SME sector. Moving forward, INFRONT could extend the mentor-mentee relationship beyond the 4-6 months to encourage knowledge sharing. Other aspects that could be addressed in a prolonged mentor-mentee relationship include how to work in countries with a different property rights regime, working with different regulatory and tax frameworks, and sharing best practices for monitoring and evaluation of investments. Not only will this help develop best practices for a relatively new and rapidly growing sector, but it is also a win-win situation for both parties: the mentor will learn about the financial and legal infrastructure in an emerging economy where he/she may invest in the future, while the mentee will be exposed to the latest trends in monitoring and evaluation for impact investing (such as IRIS, GIIRS, etc.) that may help attract increased investment in the future.
Programs similar to INFRONT have much potential to go further and have exponential impact in emerging economies. With DFATD’s $20 million contribution to Sarona, and a commitment to impact investing until 2028, INFRONT is just the first of many creative initiatives to come.
Editor’s Note: INFRONT is just getting started! Stay tuned to SF.ca for more updates on the program and its progress.