Building a Center for the Missing Middle

The Missing Middle is becoming a trendy topic for discussion amongst economic development leaders and intellectual forums, and the Missing Middle Initiative is leveraging the growing interest in the space to catalyze private SME finance.

SME Finance is the next wave of capital development after Microfinance, completing the financing food chain in providing capital at each stage of a company’s life.

Organizing thought leaders and champions to speak at global forums has helped tremendously in putting the spotlight on this issue. One of the key goals for the Center of the Missing Middle is to garner the support and knowledge from these individual leaders to address the core challenges of SME Finance with practical solutions.

It is only through the collective wisdom of successes and failures that will drive innovation in private SME finance. The participation of the public adds to the general awareness of the issue, but it is important for the collective mind of the public to move beyond simply asking “What is the Missing Middle?” and “What are its challenges?”, but instead to seek to identify the real solutions people on the ground are using and how they are implementing them.

Asymmetry Information: Information on the Missing Middle (SME Finance Gap) is spread across a number of institutions which produce research reports, and fund information is largely held privately by the investment groups. Before the Missing Middle Initiative, no organized effort aggregated and consolidated the information on this topic. Directories on key champions in the space including funds, intermediaries and intuitions were mainly known only to a small network. The Center seeks to provide a data center for those learning about the space for the first time as well as industry veterans. A communication funnel can be established to easily share updates on the creation of funds, recently made investments, and new research reports.

Informality: SME finance has largely been branded as a social sector, using grants or debt with below market returns. To stimulate interest from private sector capital, funds must establish track records with competitive financial returns and offer an array of investment products. Transforming SME finance to the formal sector requires a common language used among the financial community and the information must be presented in a well defined structure, breaking down the types of funds and asset classes. For the private sector to dedicate capital to this space, it must be presented with clear cases of competitive market rate returns, not only significant social impact. This can only be done with the proper presentation and empirical evidence generated over time. Since the majority of funds in this space are young (3yrs +), many do not yet have results they can point to, but positive early indications can be reported and shared. The sector is at an interesting point in its history as 80% of the SME venture funds were created in the past three years. A track record of 5-7yrs is often required before the private sector with focus on a space or take it seriously, and SME venture funds are only 2-3yrs away from meeting that criteria.

Operational Challenges: SME venture funds face a number of operational challenges including: the need for a strong local presence and network, small total fund sizes which generates little cash flow from management fees for covering operating expenses such as salaries, overhead, and due diligence, and comparatively high transaction costs (it takes roughly the same amount of time and effort to do a $1M investment as it does a $10M investment). The Center provides a core network of funds and proven strategies that have been used to reduce costs and effectively structure funds to improve operational cash flow.

Execution Challenges: As the debt capital market becomes more developed in emerging markets, equity will be the final missing capital segment. This is because equity carries the greatest risk for investors upon liquidation and doesn’t have a natural pre-defined exit similar to debt. Successful equity returns on SME’s in emerging markets are the most challenging as the options for selling a business are not ideal. The Center supports policies that improve the financial infrastructures needed for initial public offerings, access to financing for management buyouts, and strengthening the financial ability for potential domestic strategic buyers.