Building a Center for the Missing Middle
Building a Center for the Missing Middle solves the three core challenges for SME financing identified by the Missing Middle Initiative launched at the World Economic Forum: legitimizing SME finance for the private sector, aggregating industry information, and developing a blue print for raising, operating, and executing SME Venture Funds.
About You
About You
First Name
J. Skyler
Last Name
Fernandes
Your Organization
South African Chamber of Commerce in America (SACCA)
Country
United States, NY, New York County
About Your Organization
Organization Name
South African Chamber of Commerce in America (SACCA)
Organization Website
Organization Phone
1-617-615-9379
Organization Address
New York, NY
Organization Country
United States, NY, New York County
Organization Type
Non-profit/NGO/Citizen-sector Organization
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Your solution
Name Your solution
Building a Center for the Missing Middle
Describe Your Solution
Building a Center for the Missing Middle solves the three core challenges for SME financing identified by the Missing Middle Initiative launched at the World Economic Forum: legitimizing SME finance for the private sector, aggregating industry information, and developing a blue print for raising, operating, and executing SME Venture Funds.
Country your work focuses on
If multiple countries, please list them here. If your solution targets an entire region, please select it below
Largely Africa, but also other frontier and emerging markets.
Region(s) your solution focuses on:
Africa, East Asia and the Pacific, Europe and Central Asia, Latin America and the Caribbean, Middle East and North Africa, South Asia.
Range of turnover in your target firms, in USD
Less than $1 Million, $1-5 Million.
Average turnover in USD of your target firm
$250-$750K
Number of employees in your target firms
Fewer than 5, 5-24, 25-49.
Average number of employees of your target firm
25
Specify the size, average and range of expected loans or investments in each target firm
The SME Financing Gap, as defined by the Missing Middle Initiative, ranges from $5,000-$2,000,000, which is larger than microfinance, yet smaller than traditional venture capital or institutional financing. Within this missing segment of capital, there are two levels: 1) Micro Venture Capital: $5,000-$500,000, 2) Small Venture Capital: $500,000-$2,000,000.
What stage is your solution in?
Operating for less than a year
Innovation
What makes your innovative solution unique?
The Center for the Missing Middle aims not to reinvent the wheel with a new innovative financing solution, but instead to roll the wheel forward by practical implementation of what we already know works. The goal of the Center is to accelerate the sector beyond purely academic discussions, and focus on establishing SME finance as a legitimate asset class in the eyes of the investor.
The sector is currently viewed largely as a social investment sector, still in its infancy. However, the sector is emerging as a more mature industry with distinct asset classes of capital type (debt, equity, and quasi-equity) and focus (social returns, financial returns, and balanced). With 80% of the SME venture funds being created over the past three years, the sector is on the verge of establishing a track record. There needs to be a Center to harness the energy of new funds entering the space and propel the sector further.
The Center is at the forefront of this industry, using tracking tools to monitor and motivate its development, key to legitimizing the sector and closing the SME finance gap.
Aggregate Data: The Center is taking a leading role in aggregating and organizing information, from key research reports, to a complete list of funds, intermediaries and institutions, and tracking new funds, new investments, and successful exits.
Build a Blueprint for Funds: The Center dives into the core details of how micro and small venture funds can effectively operate financially and structurally. We continue to improve and share a detailed framework for successfully creating, operating, and executing SME venture funds, outlining proven best practices to accelerate the creation of new funds.
Legitimize the Sector: The Center provides a platform for marketing the industry. The proprietary data collected by the Center can be used to better define and legitimize the sector in the eyes of investors by segmenting SME venture funds into a language they can understand and analyze.
How does your proposed innovation leverage public intervention in catalyzing private SME finance?
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.
What barriers does your proposed solution address?
Asymmetry of information, Informality, High transaction costs for financial intermediaries to serve SMEs, Underdeveloped local capital markets (term local currency funding, exit options for SME equity).
If you checked any of these barriers, describe how your solution addresses 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.
Impact
Provide empirical evidence of your proposed solution's success/impact at present. If your project is in the idea phase, please provide evidence that speaks to its potential impact
In order to keep the issue of the Missing Middle at the forefront, grabbing the public's attention, the Missing Middle Initiative has been producing a monthly article series on various aspects of the SME finance challenge. The articles have been spread to as many media outlets as possible such as the Huffington Post and Africa.com to generate the largest impact.
In speaking with many SME funds at different stages, such as fundraising, investing, and divesting, the Initiative has been able to spotlight best practices and share the lessons with other funds at similar stages. This has helped some funds avoid potential pitfalls in how they market themselves to investors.
In collecting and organizing the largest list of SME funds, intermediaries, and institutions focused on this sector, rapid penetration of information has become possible. This intelligent aggregation of data has facilitated specific new relationships to be formed, accelerated the rate of funds being established and SMEs have been increased in their ability to identify potential investors.
In reviewing the key research reports which have covered the Missing Middle, holes have been identified in the research which has led to the new discovery and public revealing of aspects of the issue. Three examples of gaps in information which have recently been filled: 1) Estimating the total asset under management (AUM) of the funds focused on this sector, 2) Providing a detailed account for how micro to small venture funds can financially operate effectively given the fund size and 3) Demystifying the belief that the SME Finance Gap is solely an emerging market issue, but instead largely a numbers issue based on the size of SME funds. Even in developed countries such as the US, raising below $2M is the hardest capital for a company to raise, and often relies heavily on friends and family to fill the gap. The core issue is that the cash flow derived from management fees on small funds and small transactions do not cover basic operational expenses.
How many firms do you expect to reach?
200-300 SME venture funds. According to the 2009 ANDE Impact Report, there are 192 funds investing in emerging market small and growing businesses (SGBs) with about 25 new funds being added each year.
What is the volume of private SME finance you aim to catalyze?
Of the 192 current funds they are raising and investing $7 billion. It is with great hope that in 2yrs the sector will have this $7 billion fully committed, and $10 billion in 4yrs. The Center for the Missing Middle aims to support all SME funds and in particular the SME venture funds focused on higher growth businesses, yielding competitive market rate returns.
What time frame will be required to reach these targets?
2-4yrs
Does your solution seek to have an impact on public policy?
Yes
What would prevent your solution from being a success?
1) Lack of interest from investors to invest in SME venture funds.
2) Lack of wide access to information on funds and SMEs.
3) Lack of actualized results on funds, in terms of both social impact and financial return metrics.
4) Lack of platforms, forums, and media centers to spread awareness.
5) The inability of the sector to break away from largely a social brand, and be seen as an asset class with the potential for financial returns.
This Entry is about (Issues)
Describe the social impact of your innovation. Please include both numbers and stories as evidence of this impact
While it is hard to quantify the social impact for the Center of the Missing Middle, it is the intent of the Center to support SME Funds which invest in SMEs. In turn these SMEs use growth capital to expand and create additional jobs, increasing the GDP for their country, and helping to establish a middle class in their community. Indirect social impact includes an increase in entrepreneurial spirit and optimism.
One of the key social impacts of the Center for the Missing Middle is to direct capital to where it is ready to be invested, not where it is simply needed. Supporting a trade vs. aid strategy, that is focused on true sustainability and scalability.
Sustainability
List all the funding sources that are required for the sustainability of this solution
What is really needed is effort, not money. A small team dedicated on building a Center for the Missing Middle, could fulfill its mission with donations from individuals, corporations, non-profit institutions, and fundraising events.
Demonstrate how your proposed solution has the capacity to graduate from dependence on public finance. What is the time frame?
Focus heavily on holding fundraising events, consulting projects, and possibly longterm committed partnerships. Time frame: 2yrs.
Demonstrate how your proposed solution will survive a potential loss of its largest private funding source
Given a loss in a large private funding source, the Center would implement boot-strap strategies such as bringing on a board of dedicated volunteers, using a virtual office (no overhead), and if possible working with individuals that can share their resources.
Please tell us what kind of partnerships, if any, could be critical to the greater success and sustainability of your innovation
Institutions: Aspen Institute, GIIN, The Center for International Development at Harvard University, World Bank, IDC.
Intermediaries: Endeavor, Echoing Green, SevenFund, Ashoka.
Networks of SME Investors: OMIDYAR, OPIC.
Financial Research: Dalburg, Goldman Sachs, J P Morgan, Milken Institute, Brookings Institute.
Global Platforms & Forums: G-20, TED, Clinton Global Initiative (CGI), World Economic Forum (WEF).
Are there non-financial issues that could threaten the sustainability of your proposed solution?
Lack of time, dedication, and manpower.
Please tell us if your proposed solution aims to scale up through a high growth sector, expand immediately to multiple sectors, and/or scale up geographically
SME venture funds are gaining momentum, and are focused on investing in mid-high growth businesses. SME venture funds range from debt, equity to quasi-equity, and are beginning to break ground across the continent in Africa as well as other frontier and emerging markets.
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Comments
This is a great, well thought out concept.
It was surprising to learn that 80% of SME finance has been scaled up in the last 3-4 years, which means that this emerging trend needs the support of transparent and committed institutions to help monitor, motivate and track SME investment funds.
I wonder what type of tracking tools the Missing Middle will implement or develop to easily monitor the movements of SME investments, and also how transparent this process will be. I think that this type of initiative will be key to supporting and legitimatizing the steps needed to close the gap of the "Missing Middle".
Good luck!
Hi Bahiyah,
This is a great question and one which our team has put in a lot of time thinking about. The Center of the Missing Middle plans to track the sector in a number of ways, but mainly focused on the details of SME funds and investments.
SME Funds:
The Center seeks to first organize the current status of funds in space, and then track their changes. To easily monitor SME funds, they will be organized and sortable by:
- Current Stage of Fund: Fundraising, Investing, Fully-Invested
- Total Fund Size:
- Range of Investment Size: fits roughly within $5K to $2M.
- Capital Type: Debt, Equity, Quasi-Equity, Mix
- Targeted Company Stage: Start up, Early stage, Mid stage, Late stage
- Industry Focus:
- Geographic Focus: Continent, region, country
- Core Mission: Social Impact, Financial Return, Balanced
- Website:
By tracking the above:
- Potential investors in SME funds will be able to quickly identify the funds in fundraising mode.
- It will be easier to track the percent of funds which graduate from pure fundraising to investing.
- More comprehensive data on total assets under management by sector, geography, and stage.
Investments:
The Center also seeks to track:
- New SME investments made by SME funds.
- SMEs currently raising capital.
- Successful SME exits: IPOs, M&A, Management Buyouts.
- Average returns on SME investments.
Hi J. Skyler:
This, I feel, is important information that should be embedded into your entry! I would suggest outlining this information in one of the larger sections 1- What makes this solution unique or 2- Solutions addressing the barriers- just outline these points in an area that will allow you expound and explain your tracking methodology.
Great approach!!
This is a fantastic idea that could really help close the gap in the SME finance sector.
Creating a Center for the "Missing Middle" seems like a very logical first step towards making SME financing into a legitimate and well-understood asset class.
Great proposal. Building a Center for the "Missing Middle" is definitely something that is vital to the future of this space.
Also, I read your article on the Huffington Post and would recommend that everyone read your article and send it to friends who could be interested in the topic:
http://www.huffingtonpost.com/j-skyler-fernandes/investing-in-africa-def...
Thanks Jenna for your support. The article you found is the first article in a series, which the Missing Middle Initiative is producing to track some of the key learnings our team is making and continuing to put a spot light on the sector.
To view the 2nd article in the series: The Evolution of the Missing Middle Landscape, click here: http://www.africa.com/blog/blog,the_evolution_of_the_missing_middle_land...
The 3rd article will focus on the operational challenges and solutions for SME venture funds, and should be coming out soon.
Best regards,
J. Skyler Fernandes
What are some of the big challenges for creating an SME venture fund?
What's holding back the creation of funds? Is it lack of private sector capital that investors are willing to devote to the space or something else?
Thanks Jenna.
At the Center for the Missing Middle, we are finding there are two key challenges for SME venture funds: Operational and execution issues.
For operational challenges, one of the biggest hurdles is making an SME venture fund of $10-30M operationally profitable. Funds must find strategies to increase the cash flow and/or decrease operating expenses in order to make funds like these possible. A fund manager must be able to profitably operate the fund, before they can focus on making investments and yielding a return. A traditional management fee of 2% for funds of these sizes are not enough to cover basic operational expenses such as salaries, overhead, and due diligence. However, there are number of funds which have found solutions to these issues, and which the Center is sharing in a blue print for how to successfully operate an SME venture fund.
These operational challenges must first be solved before private sector investors are willing and able to dedicate capital to a fund. If you get a commitment from an investor to start a $30 million fund, but you don't have the strategy in place to make the fund operationally profitable, you will not have the resources to make good investments. You need to able to offer competitive salaries, working capital to conduct in-depth due diligence and pay for lawyers to check and draft documents. In addressing your question, "Is it the lack of private sector capital that investors are willing to devote to the space", the answer is there are operational challenges that need to be overcome before private sector is able to dedicate capital to this space.
In looking at the challenges for operating an SME venture fund, you can see that it is more of a numbers issue, than an emerging market or regional issue. Execution challenges, such as raising a fund, making investments, and realizing a return on investments vary much more based on local markets.
Capital must go where it is ready to be invested, not just where it is needed. Some countries have laws that make it much easier to establish an investment fund and make investments than others. These are crucial points when deciding where you seek to establish the holding company, what countries you will be investing in, and the sources for where the capital is coming from.
When investment managers decide to create a fund, they must specify in detail the focus of the fund. What industries are they going to focus on, what type of capital will they be investing, and what will be the mission - social returns, financial returns, or a mixture. Once this has been outlined, marketing the fund to investors is the real execution challenge. A balanced fund model can be a good solution in raising a fund, as you can likely get the interest of both social investors and return focused investors, which increase your target market base of potential sources of capital. It also means you will likely be measuring your success based on both social and financial metrics, but the returns being sought are likely less aggressive or challenging to achieve.
A challenge which is both an execution and operational issue is having the right team and network on the ground to source the best investment opportunities and structure the best deals. You must have a local presence in the region you are investing, and be in close contact with those you invest in. At the end of the day, investment are made in people, not ideas, and you can only judge and help develop a business if you can look them in the face.
This is spot on, Skyler!
Very best,
Magatte
Really interesting proposal!
I understand that The Center is utilizing collected data and such to legitimize this time of investment, but are there other incentives to investors? Why would they stray from their original investments?
Great question Yon. The early investors in SME venture funds were and still are largely philanthropic organizations, foundations, wealthy families and individuals, and government entities. This happened mainly because these type of investors often don't make investments for the financial returns, and are more focused on the social impact it can create. Those that went in with the intent to make a profit, did so knowing that this was a very infant market, and they might lose it all in trying to be pioneer, but someone had to try.
Only in the past few years, have the minds of investors begun to come around to the idea that investing in Missing Middle funds could yield competitive market rate returns. You asked "why would investors stray from their original investments" and and begin investing in this sector. I think it's important to note that sector of SME venture funds are beginning to bucket themselves into three big categories: Socially focused funds, return focused funds, and balanced funds (a mix of trying to generate both social and financial returns).
In order for return focused investors to begin dedicating capital to this space, the sector needs to establish a track record that shows it is a viable asset class, able to yield certain returns with certain products. Once a strong grouping of SME venture funds have proven they can hit competitive market rate returns, the private sector will be more likely to add this asset class into the diversification of their portfolio.
Another incentive is that the balanced funds, those which seek actively seek to generate both a social impact and a financial return, provide a great opportunity for fund managers to promote the philosophy of "doing well by doing good".
The sector will continue to mature, and as it does, it will break down into various asset classes of type (debt, equity, and quasi-equity), focus (Social, Returns, balanced), and a number of other characteristics and investment criteria. As this happens, all types of investors will be able to easily identify the type of investment products in this sector that make sense for their portfolio.
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