International Investment Funds, Part 3: Sizing the Market
In parts 1 and 2 of this three-part miniseries on funds, we went over a segmentation published by the Food and Agriculture Organization of the United Nations (FAO) and my own, simplified segmentation. Here in the final part, we try to get a better idea of the market these funds are trying to serve. Some questions:
- On a percentage basis, do we need more or less subsidy to bridge the remaining finance gap?
- Should we be focusing on the total financing gap or the addressable demand?
- How can we get the data we need to answer these questions?
Sizing the market
We have talked a little bit about the supply side, i.e., investors providing capital, so now let’s talk a little bit about the demand side, i.e., the small- and medium-sized enterprises (SMEs) that are looking for capital. As an example, we will look at this market analysis in Africa done by Aceli Africa (see page 6).
Aceli has a target of mobilizing $600 million over five years. That is about 1% of the estimated $65 billion financing gap for agricultural SMEs in Africa. Aceli has raised over $60 million in donor funding to date. Assuming the same (roughly) 10% cost, does that mean we need to spend $6.5 billion to completely eliminate the $65 billion financing gap?
First of all, $6.5 billion sounds like a huge amount of money, because it is, but just as a reference point (or banana), we can compare it to the “about $20 billion per year in government budget outlays in recent years,” for U.S. farm programs. Second, I don’t think $6.5 billion would be enough.
We already have technical assistance (TA) to help SMEs become investment ready, guarantees to help banks reduce their risk and blended finance investment funds to increase affordability. Why does the gap persist?
There is a group of SMEs out there that are probably investment ready, but because of the perception of risk and information asymmetry, they are not able to access financing. I would estimate this group making up only 10% or less of the financing gap, i.e., could be solved by matchmaking activities like the African Green Revolution Forum (AGRF) deal room.
If Aceli had more donor funding, they would likely be able to mobilize more capital but the amount would be limited because of the “diminishing development returns” on incremental subsidy (when we talk about economies of scale, we find we are often confronted with it’s opposite, diminishing returns). First, you have to think about the environment they operate in. Their model only works if you have a competitive lending environment to begin with. You also need to be able to collect the data. The segment they are targeting are SMEs that are investment ready but may have more risk and lower returns than other lending opportunities banks have. Assuming Aceli had unlimited donor funding, I would estimate that they would only be able to address another 10% of the financing gap.
So what about the remaining 80%? A portion of SMEs in this group could use TA, but that TA would not likely make them investment ready anytime soon. TA could help the SMEs build capacity or improve operations, but they would still likely need years to build up a track record to make them investment ready.
We don’t have the data, and one of my main questions is how can we get the data? The purpose of me making these guesses is to spark a discussion rather than to attempt to achieve any accuracy. My main point is that it often sounds like we just need more capital, or lenders just need to take more risk, to address the financing gap. In the same vein, SMEs are often put into one of two buckets, investment ready (e.g., the problem is information asymmetry or just the perception of risk rather than real risk) or that they can become investment ready quickly (e.g., through TA). This reminds me of the belief in microfinance that everyone could be an entrepreneur when “the reality is more complicated.”
I often hear things like “shifting only 1% of the trillions could fill the gap,” but even if that money became available, first, how would we channel all of it to where it needs to go, and, second, are there enough financeable businesses to take it? Should we focus on generating more evidence on what works with donor subsidy and being able to better measure the positive social impact that investors and governments should be willing to pay for? What do you think?