How do we connect fledgling enterprises with angel investors?

This article was originally published on The World Bank’s Private Sector Development blog.

There has been a lot of discussion around the topic of SMEs and job creation.  While SMEs can foster innovation, help diversify an economy, spread economic activity beyond the main urban hubs, give opportunities to women and youth and much more, their role in creating jobs – in the current economic environment – is key.

Interesting work by the Kauffman Foundation (see graph below) shows than virtually all new net job creation in the U.S. economy has been generated by firms that are less than five years-old and which, almost by definition, are more than likely to be small.  Although there is a huge amount of job churn in this class of enterprise (which are new and therefore probably small), the “net” impact is powerful.  A small subset of these firms are “gazelles” – or very fast growing enterprises – which grow from 5 to 500 employees in a five-year period, generating impressive results.

From the Kauffman Foundation’s Entrepreneurship Policy Digest

Similar studies in Canada, some European countries, and even in India point to similar outcomes.  These are the types of firms we would like to support in emerging markets to truly generate job creation.

The evidence is variable between countries, contradictory, disputed by some researchers, and its transferability to developing countries is often questioned despite the Indian research.

But let’s assume for a moment that most job growth in emerging markets really does come from new (and small) firms, some of which race off to become high performing gazelles.
What are the implications of this for the World Bank Group?

First, commercial banks are highly unlikely to finance this class of operation.  New, small, unknown and with very little track record – they are not the company profile that most banks like to engage with.

If banks won’t engage with these enterprises, even though they may be the companies most likely to create the highest number of jobs, what is the solution?   Many of our interventions in these emerging markets are confined to lines of credit through the established banking system, which brings into question whether we really are supporting SMEs that generate jobs.

The World Bank Group increasingly is beginning to experiment with co-investment vehicles with “Angel Financiers.”  “Angels” and “Bands of Angels” are high net-worth individuals generally with considerable business experience who are prepared to invest their own money, often in tandem with other Angels, and provide other services such as mentoring, to support these fledgling companies.

This type of extremely high risk financing is very much pre-bank and pre-Venture Capital.  The deals can be small and the risks are extremely high.  Yet, this type of financing has increased sharply since the 2008 Global Recession and now vies in terms of size with Venture Capital within the United States.  It has also grown rapidly in Canada, United Kingdom, Europe, Australia, and in some parts of the developing world such as India.  It is attracted by that one sweet deal that can make 10, 20 or 30 times return on capital (to compensate for the losses on those investments which inevitably fail).

The World Bank Group is supporting projects in Lebanon, India and Croatia – and an upcoming project in Morocco – as a way of expanding the financing continuum down to those entrepreneurs with “just an idea,” some of whom will hopefully become galloping gazelles creating many new jobs.  These projects have developed in different ways, but one established approach is to provide co-investment vehicles – investing 50-50 alongside Angel Investors (so that the angel also has “skin in the game”), while relying on the angel investors’ business savvy to identify and mentor a “good deal.”

The fastest growing and wealthiest companies in Silicon Valley are now referred to as “unicorns.”  This is a now widely used term to describe companies valued at more than $1 billion.  It is estimated that there are now well over 50 firms that qualify as unicorns in the United States and over a hundred worldwide.

While the creation of Unicorns may be a star gazer’s dream for many (but not all) of our client countries, there is a desperate need to provide a continuum of financing at each and every stage of enterprise development to ensure that, possibly, one day, such high growth companies will emerge.

Meanwhile, we need to focus on connecting with Angels in support of our Gazelles because, unless we do so, we may NOT generate the needed jobs in developing countries, and those mythical unicorns will never be able to emerge.

Publication does not imply endorsement of views by the World Economic Forum.

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Author: Simon Bell is the Global Lead for SME Finance, in the Finance and Markets Global Practice.

Image: A vendor hands change back to a customer at her market stall with price tags marked in Cuban pesos in Havana. REUTERS/Desmond Boylan.