Small and medium enterprises (SMEs) are the engine of growth and employment in developed economies, accounting for over 50% of GDP and 60% of employment. In stark contrast, SMEs in emerging and frontier economies struggle to grow and consequently account for a mere 17% of GDP and 30% of employment. The reasons for this are myriad, with factors such as poor infrastructure and imperfect regulatory environments inhibiting the growth of formal private enterprise.
However, much of this can be attributed to a very simple reason – most enterprises require money to make money. Access to finance is cited as the most significant constraint to enterprise growth by SMEs in emerging markets, with theIFC estimating a $1 trillion credit gap . They lack the collateral, financial history, and track record required by traditional lenders, while also generating lower revenue per client.
Given our interest at Ceniarth in helping to address these SME financing hurdles, we are delighted to announce our recent investment in Advance Global Capital (AGC). AGC is a relatively new fund manager that works directly with local financial institutions in emerging markets to channel vital working capital to SMEs. AGC is uniquely focused on factoring and invoice discounting as a means of mitigating credit risk and addressing the SME finance gap.
Invoice Discounting: how does it work?
Many business transactions do not involve immediate payment, delaying re-investment by entrepreneurs. SMEs are often forced by larger buyers to accept payment terms ranging from 30-120 days – and the smaller the supplier, the less leverage they have to demand better terms. AGC unlocks the value of invoices as financeable assets, through local financial institutions, known as “factors”, or directly via invoicing technology platforms, through a process called invoice discounting. In this arrangement a factor purchases approved invoices at a discount and advances funds to the supplier immediately, based on the financial history of the buyer, enabling them to buy more materials and hire more people to grow their business. The full amount of the invoice is then collected from the buyer when it comes due.
Essentially, the counter-party risk is flipped. With a traditional working capital loan, the counter-party would be the SME. By purchasing that SME’s confirmed invoices however, the counter-party is an established business – often a large corporate buyer – with much more information available to underwrite the risk. This is particularly important in emerging markets where credit information is scarce or non-existent. In addition to leveraging the size and information about the buyer, the short duration of the underlying invoices also contributes to creating a financial asset with an extremely low risk profile. A recent survey suggests default rates as low as 0.43% in higher risk EU countries, which compares favourably to other lending modalities.
Important applications in agriculture
Invoice discounting provides an exciting tool to channel much-needed working capital to SMEs working across many sectors that are currently underserved by the financial system in emerging markets. Given our explicit interest in agricultural finance, we are particularly excited about the applications in this sector. Providing financing to aggregators and traders engaged in agricultural supply chains is vital to improving outcomes for smallholder farmers. AGC has partnered with local financial providers like Umati Capital to support SMEs active in multiple agricultural value chains in Kenya, facilitating enhanced market access and swift payment to farmers. In sectors like dairy and horticulture this is having a substantial effect in improving the efficiency of supply chains and enabling SME growth. We are optimistic about the potential for this model to be replicated in agricultural value chains across emerging markets globally, thus providing essential working capital to a sector chronically underserved by traditional financial services.
A model built to scale
Throughout our diligence process, we have been impressed with AGC’s long-term vision to deliver social impact at scale, as well as their early execution toward this goal. They have built a world-class team with experience in both invoice discounting and emerging markets. By partnering with local financial institutions, AGC has focused on the growth of stable domestic financial ecosystems while building a platform to scale across multiple geographies. Their support of partners extends beyond balance sheet funding, encompassing legal, KYC and operational support – in particular, their proprietary, cloud-based software, is optimized for both transactional activity and risk monitoring, thus enabling the financing of invoices as low as $17. By enabling in-market factors to grow their expertise and balance sheets, AGC is contributing positively to the sustainable growth of credit provision in emerging markets globally.
Equally importantly, they are doing so while generating attractive, risk-adjusted returns that exhibit low correlation with other asset classes. As a family office, we focus on funding market-based solutions benefiting underserved communities, in large part because we believe that commercially sustainable approaches to problems like SME credit provision are required to generate impact at scale. Having already funded over 48,000 invoices with more than 1,200 SMEs with zero write-offs, we are excited to partner with AGC as they build upon their impressive early success and continue to grow.