Small Foundation » Emerald Africa: Lessons from backing early-stage digital lenders in sub-Saharan Africa

By Alex Simuyandi, Principal, Emerald Africa

Emerald Africa was established within Small Foundation to provide loans to early-stage digital lenders – agtechs and fintechs – working across Africa, with the goal of understanding the challenges they face, the impact they create, and whether it would be viable to do this at scale. Three and a half years and 18 loans to 9 companies later, we have learnt a great deal, and we’re pleased to share those lessons here, because they are shaping Emerald Africa’s next phase.

The need for more working capital for African SMEs is well-documented. The International Finance Corporation (IFC) estimates the SME financing gap in sub-Saharan Africa at $331 billion. This lack of capital hinders the ability of these companies to both survive and thrive. In 2020, Small Foundation noticed a trend of emerging working capital providers using digital technology to lower costs and increase their reach into underserved communities. The digital lenders were helping to address the shortage of working capital for SMEs, but Small Foundation discovered the support needs of these lenders were also significant.

Small Foundation assessed that a critical funding gap they faced was shortly after they had managed a commercial pilot but hadn’t yet proven the scalability of their model to investors. They lacked the balance sheet to scale up their lending operations.

We structured the pilot to provide loans to these lenders, targeting ventures that were looking for between $50,000 and $250,000 to boost their balance sheet lending activities. We were open to a range of business models, with two emphases: they must be digital-first lenders, and, at a portfolio level, our focus would be on those financing ag and rural SMEs.

Now, three and half years on since the pilot was initiated, we have made 18 loans into 9 companies. As we plan our future steps, we want to use this inflection point to share the lessons that we have learnt so far.

There is a strong pipeline with promising business models and dedicated entrepreneurs attempting to address the working capital gap. We reviewed over 500 businesses during the pilot and have a promising set of companies that we believe are currently investable. These founders recognise the business opportunities to address the challenge of working capital to SMEs; the ecosystem needs to continue to work to support those with potential so they can graduate from start-ups into growth ventures, scaling their impact as they do so.
The lack of appropriate capital is real. Despite positive trends in the African private credit space, very little of it is reaching earlier stage business models that require debt to prosper. Of the loans we made, we were the first institutional debt capital to 67% of the portfolio. Recent research from FMO highlights a gap in funding for digital lenders from $1m to $5m. Our portfolio demonstrated that the lack of funding starts much earlier. By not funding this earlier stage, we risk a diminished pipeline for those investors – equity and debt – that have capital to deploy at larger ticket sizes.
The debt we provided was highly catalytic in two ways. First, during the lifetime of our loans our portfolio companies raised approximately $1 of debt and $1 of equity for each dollar of debt we invested. As our loans had a relatively short tenor (up to twelve months) this represents a demonstration of their ability to swiftly raise further funds. Secondly, our funding contributed to a significant amount of lending to SMEs. During the pilot period, our portfolio companies provided over $43m of loans to SMEs. The velocity of finance moving through the SMEs and their supply chain shows how an initial loan can multiply its impact in a relatively short period of time.
Impact was tangible for clients and their customers. Aside from the volume of capital being deployed, we also wanted to know how it was being used and who the recipients were. Small Foundation undertook an evaluation of the impact of the pilot, reviewing the nine client companies themselves and impact studies completed by the clients. They also commissioned three studies with 60dB on select portfolio companies to understand their impact on customers. These studies showed that a significant proportion of the underlying loans were being made to SMEs that hadn’t accessed formal financing before, and were able to establish positive end-customer benefits in terms of income and quality of life. Even with an evaluation at such an early stage, there were signals of greater resilience for SMEs, some highlighting they had not downsized during hard times and others showing modest employment growth.
Finally, we believe that the data from the pilot points to the opportunity for a viable larger facility to focus on this segment. Repayments have, overall, been reliable; pipeline is strong and the impact has shown underserved SMEs accessing finance for the first time. In addition, we have worked with Vula to streamline our investment process and portfolio management systems so that we can deploy capital in the most efficient and effective way possible.

From our experience, it is clear that if we are to successfully address the working capital gap, we need different parts of the ecosystem to play their part.

We need more working capital providers, which means flourishing venture builders, incubators and accelerators
We need angel investors and early-stage VCs to take a chance on founders
We need follow on funders – both debt and equity – to get these businesses to scale so they can reach the customers and have a wider ecosystem impact.

At Emerald Africa, we believe that we can play our role in the ecosystem by supporting early-stage lenders so they can prove their ability to have impact at scale and attract further funding. This is why we are launching a fund: to build on our learnings, support innovative business models and scale the impact our investments can have on this underserved market. We are delighted that Small Foundation will be the anchor investor in our fund, and are excited about incorporating the lessons from our pilot into this next phase, which will help the next cohort of digital lenders make a dent in the financing gap in sub-Saharan Africa.