A dynamic approach to understanding demand in agri-SME finance

Agricultural small- and medium-sized enterprises (agri-SMEs) play a vital role in rural communities, providing employment, livelihoods, markets, and food for local households. Like smallholder farmers, agri-SMEs have historically been thought of as a static, relatively homogenous group. At the most basic level, they are profit-oriented enterprises and cooperatives that are central to global food systems.

However, this static definition fails to capture the different types and sizes, as well as the dynamic nature of agri-SMEs. As a result of operating within food systems and the unique dynamics of developing economies, agri-SMEs are exposed to multiple challenges, including climate change. Their role changes as markets move through different stages of development, and this has implications for what services they require at any given moment.

In our latest State of the Sector report, we analyze the current state of the agri-SME finance sector, focusing on sub-Saharan Africa and Southeast Asia. Part Two of the report presents a new characterization of agri-SMEs based on their growth pathways and their role in food systems. With this characterization, policymakers and practitioners can better define agri-SMEs and characterize their finance needs.

Six different growth pathways for agri-SMEs

As shown in the figure below, we can sort agri-SMEs into six different categories according to their growth ambitions and potential:

1. High-growth ventures are highly innovative business models serving large, addressable markets with high margins and experiencing a rapid growth trajectory.

2. Niche ventures are business models that are creating innovative products and services that target niche markets or customer segments.

3. Diversifying enterprises are small, family-run enterprises that have seen minimal growth, but are run by an entrepreneur with a desire to grow, likely through diversification.

4. Dynamic ventures are enterprises in stable “bread and butter” industries that experience moderate, sustained growth by deploying established business models for producing goods and services.

5. Livelihood-sustaining enterprises are small, family-run enterprises that are opportunity-driven and on the path to formalization, though growing incrementally.

6. Static enterprises are small, family enterprises with no ambition to grow beyond their current status.

To achieve their potential and move along these growth pathways, agri-SMEs need support across five areas: 1) access to finance; 2) access to talent; 3) an ecosystem of support; 4) access to knowledge; and 5) access to markets. Given the persistent financing gap for agri-SMEs—which we estimate to be USD 106 billion in sub-Saharan Africa and Southeast Asia—our analysis focuses on the first area: access to finance.

Understanding different agri-SME investment profiles

The six growth pathways above can help financial service providers better understand the potential investment profiles of different agri-SMEs, including both need for and ability to access finance.

For example, high-growth ventures and niche ventures develop innovative business models, products, and services. This means that, while they may be riskier and less profitable in their early stages, they can offer more upside as they mature. On the other end of the spectrum, livelihood-sustaining and static enterprises have a narrow path to profitability and high-risk profiles; their financing needs are also smaller in scale. Somewhere in the middle, diversifying enterprises and dynamic ventures have moderate growth potential and risk exposure, with semi-formal structures and governance that may be more attractive to financiers (though some subsidy is likely still required).

How does this help define the financing needs of different agri-SMEs? While variations in the types of agri-SMEs and opportunities for growth in different markets and value chains exist, we can still use the growth pathways to systematically analyze demand across geographies—and in so doing, establish a new way of linking agri-SME goals with their articulated demand for finance.

What agri-SME goals & pathways tell us about their financing needs

In making the link between individual agri-SME goals and financing needs, it is important to distinguish the specific uses for finance under each goal. Agri-SMEs looking to:

1. Sustain current growth require finance to support day-to-day operations and cash flow cycles in the form of short-term working capital and trade finance.

2. Accelerate the growth to market potential require medium- to long-term investment capital to finance either productivity and cost efficiency investments OR expansion investments.

3. Adapt to changing environment require medium- to long-term investment capital to finance new product/service development AND/OR efforts to build resilience.

With these goals and types of finance defined, we can clearly see in the figures below how agri-SMEs on different growth pathways typically have different needs and ability to afford types of finance.

The first figure illustrates the foundational link between the types of businesses, their growth goals, and the uses and types of finance needed to realize those goals. However, the types of financing typically change as companies move through early stages of growth through to maturity. Looking at the growth pathways in terms of their orientation to the types of capital in the market and their stage of development (early-stage, growth, maturing) clearly shows where different forms of capital are typically used.

The second figure shows a more granular, conceptual understanding of agri-SME investment profiles and needs, as well as the types of financial service providers most equipped to meet those needs. With this in mind, we can map current funding flows to see where the market clears and where gaps still remain.

What’s next?

Having established both a sizing and a new way of thinking about the demand for agri-SME finance, our report delves deeper into current efforts to meet this demand. In the next blog post, we’ll look at an overview of the agri-SME finance market, map current agri-SME funding via different channels, and present new insights for how to bridge the persistent agri-SME finance gap.

This article was originally published by ISF Advisors.