The Other Investment Universe — Micro-businesses and New Capital Opportunities
The unrealised potential of micro-businesses
One thing every politician agrees on, regardless of political flavour, nationality or portfolio, is that “small businesses are the backbone of the economy.”
There’s a good reason for that; micro-businesses make up over half the world’s economy and over half of global employment. It’s impossible to know the exact numbers, because the majority of micro-businesses are informal, but in many developing countries it’s estimated that micro-businesses make up more than 70% of the economy. There are around 25 million registered small businesses in Europe, nearly 30 million in the USA, with an average of about one microbusiness for every 20 people. However, estimates predict that in Africa, there’s a microbusiness for every 10 people — around 100 million in sub-Saharan Africa today, and with Africa’s population growing by over a million by 2050, that’s an estimated 200 million business opportunities
Micro-businesses are more likely to work away from an office — agriculture, retail, construction, catering and logistics — and the vast majority of micro-businesses in developing economies don’t own a PC. Most lack access to banking and many don’t have formal identity. The World Bank estimates that there are around 450 million microbusinesses in developing countries, about 350 million without access to banking.
Keeping it in the family
Microbusinesses are likely to be intergenerational — even today, agriculture and craftsmanship runs in the family, with commercial operations and skills being passed from mother to daughter and from father to son. Families of microbusiness owners are likely to form part or all of the workforce, often unpaid, with the kids and spouses helping out in different capacities. Children in developing economies are frequently pulled out of school to help with struggling businesses — 11% of school age children globally are engaged in labour rather than in school, from as young as 5, and the majority of them are girls. The entrepreneurs we’ve talked to agree they’d keep their girls in school, if their businesses were more successful.
The Funding Challenge
The main barrier to growth for micro-businesses everywhere is difficulty in attracting funding. Most financing for small businesses comes from bank debt or informal lending, however banks find it hard to lend to micro-businesses due to the complexity of assessing credit risk and sectoral risk. This complexity also makes the cost of borrowing extremely high for small businesses with bank accounts, while those without formal records need to resort to local lenders — who charge an average of 40% interest and up to 600% in some developing countries where the sector is less regulated, meaning that many simply can’t grow because they can’t afford it.
This is a challenge for individual businesses, but at a macro level it looks more like systemic failure — in global capital markets, there’s $73 trillion invested in equity markets, $100 trillion in bonds and yet less than $4 trillion invested in debt AND equity for small businesses, including microfinance loans. A vanishingly small amount from venture capitalists goes to a tiny number of high growth potential businesses, usually in the tech sector, and concentrated in technology centres, leaving whole sectors and regions ignored.
And yet, despite the headline high failure rate in microbusinesses, many represent a great investment opportunity. We work with entrepreneurs who are building businesses despite a lack of access to capital, education, electricity, healthcare or running water. In the groups we’re supporting in Niger, their community lending circles have a less than 2% default rate, which would be attractive to any lender (the average agricultural lending default rate 2014–18 in Denmark was 3%). Women micro-entrepreneurs build sustainable businesses because they have the long-term interests of the community at heart — they each support between 5 and 15 family members, so they make long-term decisions about applying capital.
Farida and Lars — Entrepreneurs With Fantastic Growth Potential
Farida makes food products from peanuts with her community savings group in Niger. There’s enormous demand from the market and she can’t make enough to meet it. She needs a $40 peanut processing machine to expand her business, but the group hasn’t saved enough to lend her the money. Lars runs a small construction firm in Denmark building sustainable homes. He’d love to expand his business if he could get access to affordable capital, because he’s turning away both private and large scale customers.
Farida and Lars share many characteristics loved by investors — they’re hard-working, dedicated, creative, working in growth markets, committed to their businesses and with the skills to grow the business effectively. Lars and Farida wouldn’t consider seeking investment independently, even if they know about capital markets — and the administration cost would wipe out investors’ profits using traditional investment approaches.
Crowdfunding, SME Bonds and STOs
Crowdfunding platforms have been attempting to open out the small business investment market for some time, and many such as Kickstarter have been successful in helping innovative startups to take off, while NGO led microfinance peer to peer lending platforms have had some success in developing economies. But they still face the challenges of scale, and many peer to peer lending and financing platforms suffer from high fees, lack of transparency, low returns to investors and the occasional high profile failure. However, emerging technology has seen the birth of a new generation of lending platforms, while new investment instruments offer to revolutionise the way that small businesses are financed.
Waking up Sleeping Capital
Blockchain regulations for securities are emerging in many countries, most recently in Luxembourg. This movement will help to unlock trillion of dollars in sleeping savings to cash starved SMEs.
BitBond is a German peer to peer lending platform encouraging investors to take a stake in SMEs by creating bond instruments backing affordable lending to small businesses globally. It’s been authorised by the German BaFin to issue the first German Security Token Offering (STO), which went on sale on 11th March 2019. The STO is based on the Stellar blockchain, offering a fixed 4% return, with an additional variable coupon each year, maturing after 10 years. This means that global investors can now easily participate in directly benefiting small businesses. STOs are fully regulated securities, protecting investors from the well-documented risks of ICOs (Initial Coin Offerings) made popular in the rush of 2017/18, and rightly criticised for the proliferation of scams and unsound ideas.
Security Tokens are the next step in releasing sleeping savings — many in zero or near zero interest accounts — and capital into companies which today can’t get their hands on growth capital. Global savings today are at US$7 trillion annually; releasing some of this capital will help fuel growth of SMEs, reducing failure rates and creating jobs.
Channeling Capital to Developing Countries
Micro-businesses in developing economies usually belong to communities and associations of businesses with more or less formal organisation structures. Like Farida’s lending group, which is part of a 600,000-strong network in Niger, communities of businesses organise themselves around leadership and distribution channels — primary producers will collaborate via collection centres such as milk or grain processors, or form associations of nomadic herders who meet to trade and engage in social activities. Releasing additional capital to these business communities can result in not just better outcomes for individual businesses, but for the whole community, where they collaborate on projects such as health, education, infrastructure and energy as their businesses grow.
With the growth of digital communications, rapid adoption of mobile technology and the increasing availability of digital solutions for mobile money and microfinance, it’s now possible to tap into these communities thanks to audit tools like those developed by hiveonline, for investors to realise a range of investments in hundreds of millions of potential target businesses, using investment vehicles such as sustainable STOs and through platforms like BitBond.
Meanwhile, businesses like Lars’s also belong to trade associations and guilds. We’re working at hiveonline to help entrepreneurs like Lars build reputation based on what they do — and just like Farida, this means new opportunities for investors to see the full value chain, and to make sound investment choices based on businesses that have a great track record of delivery.
Investing in Sustainability
Legal clarity around security tokens is a step towards innovating and modernising capital market instruments that lowers the costs of fundraising for small businesses. It’s also relevant that both Farida and Lars are also committed to creating greater sustainability in their communities — because this is also something that more and more consumers care about, and while we’re opening up access to capital for sustainable small businesses, we also know investors make more money when they invest in sustainability.
Opening Both Ends of the Investment Pipeline
Technology has emerged which can address some of the big investment headaches — traceability and auditability at scale, and regulation is catching up to make these investments practical and scalable, allowing for democratisation of investment in small businesses.
We think the opportunity to invest sustainably provides a key incentive for unlocking sleeping capital and enabling ordinary investors to participate in building sustainable business communities everywhere. That’s true, not just for headline projects like large-scale clean technology, but cricially in ground-level community projects, where microbusinesses are the heartbeat of the economy and supporting the future sustainability of their environments. This is opening out a new universe for investors and unlocking 7 trillion USD of sleeping capital.
Sofie Blakstad is the CEO and Founder of hiveonline, the financial trust platform for micro-businesses and author of Fintech Revolution: Universal Inclusion in the New Financial Ecosystem
