Private Equity and Venture Capital in SMEs in Developing

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Policy Research Working Paper 6827, This paper discusses the constraints for private equity small and medium enterprises in emerging markets to. financing of small and medium enterprises in developing raise private equity capital Technical assistance provides. economies In addition to capital private equity funding that allows private equity funds to extend their. investors bring knowledge and expertise to the companies reach to smaller companies Technical assistance can. in which they invest Through active participation on the mitigate some level of risk and increase the probability of. board of directors or in partnership with management successful investments by funding targeted operational. private equity investors equip companies with critical improvements of investee companies Dedicated technical. improvements in governance financial accounting access assistance facilities financed by third parties such as. to markets technology and other drivers of business development finance institutions governments or other. success Although private equity investors could help to parties have emerged to fill this critical need The paper. create deepen and expand growth of small and medium discusses the provision of investment capital twinned. enterprises in developing economies the vast majority with technical assistance which is now more accepted by. of private equity in such markets targets larger or more limited partners and general partners or fund managers. established enterprises Technical assistance when and is becoming more of a market model for private. partnered with private equity can unlock more investor equity finance focused on small and medium enterprises. commitments and considerably enhance the ability of. This paper is a product of the Non Bank Financial Institutions Unit Capital Markets Practice It is part of a larger effort by. the World Bank to provide open access to its research and make a contribution to development policy discussions around. the world Policy Research Working Papers are also posted on the Web at http econ worldbank org The authors may be. contacted at sdivakaran worldbank org, The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development. issues An objective of the series is to get the findings out quickly even if the presentations are less than fully polished The papers carry the. names of the authors and should be cited accordingly The findings interpretations and conclusions expressed in this paper are entirely those. of the authors They do not necessarily represent the views of the International Bank for Reconstruction and Development World Bank and. its affiliated organizations or those of the Executive Directors of the World Bank or the governments they represent. Produced by the Research Support Team, Private Equity and Venture Capital in SMEs in Developing Countries The. Role for Technical Assistance, Shanthi Divakaran Patrick J McGinnis and Masood Shariff. Key Words Private Equity Venture Capital Small and Medium Enterprises Technical. Assistance,JEL Classification G24 G23,Sector Board Classification Capital Markets.
Shanthi Divakaran Senior Financial Sector Specialist World Bank Patrick McGinnis Consultant World. Bank Masood Shariff Consultant World Bank The authors are grateful for the comments and input received. from Randa Akeel Senior Economist World Bank Mahesh Kotecha President Structured Credit International. Corp SCIC and Ravi Gupta Consultant World Bank The authors are also grateful for the research assistance of. Sevara Atamuratova Research Analyst World Bank and document support from Marilyn Benjamin Program. Assistant World Bank and Katherine Delos Reyes Program Assistant World Bank. List of Abbreviations, AECID Agencia Espa ola de Cooperaci n Internacional. AFD Agence Fran aise de D veloppement,AfDB African Development Bank. BIO Belgian Development Corporation,CAF Corporaci n Andino de Fomento. CDC Commonwealth Development Corp,CI Conservation International. DFI Development Finance Institution, EBRD European Bank for Reconstruction and Development.
EIB European Investment Bank,EU European Union,FdeF Fondo de Fondos. Finnfund Finnish Fund for Industrial Development Cooperation. FMO Financieringsmaatschappij voor Ontwikkelingslanden. FOMIN Fondo Multilateral de Inversiones Multilateral Investment Fund. GBMF Gordon and Betty Moore Foundation,GDP Gross Domestic Product. GP General Partner Fund Manager,HNW High Net Worth Individual or Investor. IADB Inter American Development Bank,IC Investment Committee. IFC International Finance Corporation,IPO Initial Public Offering.
IRR Internal Rate of Return,LAVCA Latin America Venture Capital Association. LP Limited Partner, Norfund Norwegian Investment Fund for Developing Countries. OPIC Overseas Private Investment Corporation,PE Private Equity. SEDF Soros Economic Development Fund,SIFEM Swiss Investment Fund for Emerging Markets. SME Small and Medium Enterprise,TA Technical Assistance.
TAF Technical Assistance Facility or Fund,USAID U S Agency for International Development. VC Venture Capital, A Introduction Private Equity Venture Capital and Technical. Assistance, Private equity PE refers to an asset class in which investors purchase the illiquid equity or. equity like securities of operating companies This equity is not publicly traded but instead held in. private hands In exchange for their capital PE firms take ownership stakes that range from a. concentrated minority through to majority ownership in a company PE investors typically hold these. securities for a period of three to seven years with the expectation of generating attractive risk adjusted. financial returns upon exiting the investment For more details on the PE industry refer to Annex 1. Like PE firms VC firms also invest in the private securities of operating companies VC firms are. known for investing in early stage companies that are typically riskier in nature than the investments. made by their PE counterparts See the life cycle of financing for a typical company in Table 1 Often. VC firms invest in companies in sectors that are related to technology or innovation although they may. also back businesses in other verticals In developed markets VCs also source ideas and build new. companies from proprietary networks of proven entrepreneurs This seeding of investment ideas into the. market is less common in developing markets but will likely become more common as these markets. become more robust,Table 1 Typical Stages of Financing a Company. Company stage Uses of financing Typical sources of financing Financing stage. Concept Idea is created Assess prove business feasibility Personal savings Seed capital. initial business model is and qualify for start up capital Microcredit. conceptualized but there is Develop business plan Friends Family. limited management in place Conduct market research Angel investorsa. no product ready and no Build and test prototype Seed stage VC firms. track record File patents Grants, Product development Converting concept into product Bootstrap financing Start up capital.
Business model investigated Develop product Angel investors. product prototype in place Conduct initial marketing Microcredit. but needs to be finalized and Establish product facility VC firms seed series A. introduced to market investor b,Recruit key management. Initial revenue Have proven Expand sales and distribution Microcredit Early stage. product delivered proof of Improve productivity Angel investors. concept but cash flow is Enhance team and operations VC firms. Established company Working capital Cash flow based financing line Growth equity debt. Sustained positive cash flow Trade credit factoring leasing of credit working capital financing. customer base is growing Expansion grow sales and short term unsecured financing. and the business is viable assets ramp up existing long term debt. operations capital Asset based financing accounts,expenditures launch new receivable inventory. products or enter new markets equipment real estate. Suppliers trade credit,Factoring Leasing,Private growth equity. Corporate Strong To support growth Private equity Private equity debt. sales revenue stable cash Finance acquisition Initial public offering financing public. flows management buyout Mezzanine financing equity. Optimize capital structure Corporate debt,Provide exit path for existing. investors or owners,Source Authors research, a Angels refer to established entrepreneurs or HNWs who may be interested in financing startups for reasons that are not just.
financial e g altruistic, b A series A investor participates in a first round of funding for a startup. PE and VC firms are investment managers that typically raise fixed pools of capital that are then. invested in a diversified set of companies often across many industries Both PE and VC firms source. deals by working with a network of intermediaries 1 developing business linkages and competencies in. specific sectors and by scouring a given market for investment opportunities Apart from providing. financing PE funds typically take a capital plus approach in that they help the companies in their. portfolios to enhance management capacity improve market focus and presence strengthen governance. and manage growth Although PE investment styles may vary considerably many firms seek financial. returns by supporting and financing the growth of the companies in their portfolios As such these firms. are widely linked to job creation 2, PE and VC funds usually employ a partnership structure A fund management company or. general partner GP raises capital from a limited number of qualified investors that become limited. partners LPs of a fund Typically LPs consist of pension funds insurance companies foundations. endowments high net worth individuals HNWs sovereign wealth funds or development finance. institutions DFIs The fund manager receives two types of compensation from the investors First the. fund charges a management fee approximately 2 percent of the capital in the fund to cover operating. expenses Additionally the GP receives a share of the gains generated on its investments typically 20. percent of profits which is known as carried interest Carried interest seeks to align the incentives of the. GP with those of the LP investors in the fund See Figure 1 for a typical PE structure and business model. Figure 1 Standard PE Business Model, Source European Private Equity and Capital Association. Such intermediaries include accelerators incubators accounting firms advisory and consulting firms investment advisors. investment banks lawyers business associations and banks. IFC Job Study www ifc org, Within the VC and angel investor network incubators and accelerators are intermediaries that. help companies to grow by providing a combination of capital mentorship technical support. infrastructure and other critical resources Their ultimate goal is to prepare companies for growth and. eventual investment from VC firms Unlike VC firms however incubators and accelerators are not funds. per se and generally provide only small amounts of financing Often the capital invested by such. intermediaries is start up capital and is less than 25 000 50 000 Rather than providing significant cash. these intermediaries invest largely through in kind contributions such as workspace basic. infrastructure advice technical resources mentorship sector expertise and other types of capacity. In developing countries technical assistance TA has proven to be an important tool for fund. managers and investors in the PE and VC industries In such markets entrepreneurs and the businesses. that they manage are held back by deficiencies in business training and operational expertise These. challenges are not limited to start up businesses but can also be seen in established small and medium. enterprises SMEs or family owned businesses in a wide variety of industries Such capacity gaps often. translate into missed opportunities and broadly impede the ability of businesses to access financing. Moreover TA can improve critical business functions such as governance and financial planning which. are essential for attracting new sources of capital In the context of this report TA refers to a set of. services provided to the types of companies in which PE and VC funds invest also known as portfolio. companies or investee companies Such services build skills or capacity for the investee companies in. diverse areas such as finance management technology and strategic planning. Technical assistance can considerably enhance the effectiveness of fund managers investments. in SMEs TA mitigates risk and increases the probability that investments will perform successfully by. funding targeted operational improvements within these companies Although this type of capacity. building creates value for companies independent of their size it can be most impactful for smaller. businesses that inherently lack the resources to make such investments on their own Thus in this context. TA provides funding that allows funds to extend their reach to smaller and less sophisticated companies. For a detailed definition of the SME segment refer to Annex 1. B Private Equity Venture Capital and SMEs in Emerging Markets. Despite the vast number of SMEs operating in developing countries the overall market for risk. A Introduction Private Equity Venture Capital and Technical Assistance Private equity PE refers to an asset class in which investors purchase the illiquid equity or equity like securities of operating compan This equity is ies not publicly traded but instead held in private hands In exchange for their capital PE firms

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