Do international SME investment funds kill the rise of local investors?
March 2011
Normally I would welcome every new fund that invests in developing country businesses with open arms. After all finance for businesses in developing countries is hard to come by. Especially young businesses with a lack of track record. Or growing businesses that are constantly strapped for cash to fuel their growth. Every new fund is a new source of finance for the very best entrepreneurs who pass through BiD Network.
New SME funds are appearing at a rate of about 1 a month. Wonderful. At the last count BiD Network had a list of 120 funds that invest below the USD 2 million level. We want more! Or do we?
From the perspective of the entrepreneur I believe he/she is better served by an Angel investor, who was once an entrepreneur, who lives not more than 2 hours away. The Angel investor provides not just money – but also brings experience, mentoring and an understanding of the local context. Limited currency risk, no fat legal documents, no rigid formal procedures. This may be a little romanticized, but its not far from the truth.
It’s tough though, there are extremely few Angel investors in developing countries. The Chinese living in Asia and Africa may be the only exception. The wealthy and the upper middle classes will tend to put their money into real estate or land. Investing in an entrepreneur, with two legs that can run away with your money is an alien and scary proposition.
The Challenge is to find the reputable few who will convince the rest that this type of investing is fun and if managed well can generate returns. If done well, by setting up Business Angel Networks we will be seeing the birth of a risk capital market in developing countries. BiD Network’s partners in Argentina (Fundes), Peru (Invertir), Colombia (UniAndes), Indonesia (www.Mekar.biz) have taken on this challenge and are succeeding.
Then … along comes an SME Investment Fund, often funded in or through the west. Hunts out the best deals. Funds the deals. May even convince the wealthy in a country that the fund is a convenient way to park their money for the good of entrepreneurship. This is good and necessary, but there is a downside. The best deals are no longer available for local investors. Investors who understand why SMEs are important and see potential returns are turned lazy, because they don’t have to invest – the fund does it for them. Gone are the incentives for local investors to stand up and build their own investment vehicles and experience. Local risk capital initiative has no incentive to get started.
Is this a problem? Yes it is. Local risk capital players are as badly needed as the very SMEs we would like to see growing. It is a simple equation of local supply and local demand. Foreigners aren’t needed for the organic growth of businesses.
Is there a solution? Yes. We need more matching funds and sidecar funds. These funds will co-invest with other investors. An investor does 50%, the fund then matches this and does the other 50%. The side-car fund Example will follow the investment made by an angel investor, or a group of angels. It may even be taken a step further to incentivise local banks to finance SMEs. If the criteria are met a matching fund could put in equity to prop a young business’s balance sheet – making it more attractive to banks to provide a loan.
In Indonesia for example, banks are required by law to lend 20% of their assets to SMEs. Do they? No. The banks require more than 100% collateral – so it is no wonder that SMEs won’t borrow. An interesting option though is to set up a fund under the banks. In a separate entity if need be. The 20% bank assets not lent at the end of the year are placed in the fund. The fund can then provide equity or other forms of finance to the SMEs, matching this with Angel money, or even with loans of the very same bank. Finally local investors and local banks have an incentive to let their money flow.
So the question to SME Fund managers is: are you displacing local investors? Can you change your investment practices to actually incentivize the rich in a country to put in some of their own money? Give it a try! You may discover that your money can be stretched a lot further and you suddenly have a network of entrepreneurial angels who may know the market better than you do.
I may be wrong, but the roles may turn. Foreign investors may find themselves queuing up at the airport having to wait for their turn. It’s time for emerging markets to emerge.
Thierry Sanders Jakarta, Indonesia