Shareholder loan funds for SMEs in developing markets: USAID Technical Brief no. 8, 2009
| Funding agency(ies) | USAID | |
|---|---|---|
| Date completed | January 2009 |
- Description
Authored by: Tom Gibson
In most developing markets the majority of viable small and medium enterprises (SMEs) tend to remain small, slow-growing and largely self-financing. Abundant expansion opportunities languish across the sectors due less to the absence of able entrepreneurs than to the absence of adequate expansion financing. Particularly in the current credit climate, the majority of SMEs in developing markets are simply unappealing candidates for the long-term, cash-flow based financing that growth-oriented SMEs should have.
Commercial banks, whose core lending practices incur minimal risk, have little incentive to use depositors' funds to make loans to SMEs, particularly to those offering less than full collateral coverage and inadequate documentation. Leasing companies in developing markets are equally risk-averse, preferring to lease only a narrow range of easily remarketed assets. The relatively rare venture capital intermediaries targeting SMEs finance only a miniscule percentage of potentially successful SMEs.
There are other ingredients in the mix of reasons for which financial sectors deny the SMEs the financing they need. However, the principal problem is an uncomplicated matter of risk and return. Lending to SMEs beyond the short-term presents too much risk for commercial bankers and too little return for venture capitalists.
Imagine an entrepreneur with the ability to put $500,000 to good use to realize an expansion opportunity and all of the local economic benefits that come with it. Then, imagine that the entrepreneur knocks on three doors: the commercial bank's, the leasing company's, and the venture capitalist's. Being politely turned away from all three for self-apparent reasons, where does the entrepreneur knock next? This paper outlines a new type of financial intermediary not currently in the market and calls it a 'Fourth Door Fund.'
Shareholder Loan Funds for SMEs in Developing Markets