Frogtek is a social enterprise that helps small shopkeepers in Mexico and Colombia increase sales with the use of mobile apps. Its products offer significant potential to boost income at the bottom of the pyramid, but there’s a catch. Few micro-sized customers can afford to buy the hardware—in this case, tablet computers and barcode scanners—needed to run the apps that will help their businesses grow. Similar cash flow problems frustrate entrepreneurs throughout the developing world.
A solution to this 21st-century problem is emerging from a financial tradition that dates back centuries. “Factoring,” one of the oldest transactions in merchant banking, involves purchasing accounts receivable at discount. The concept has been retooled to meet the unique needs of startups in emerging markets where working capital is in short supply.
Invested Development, a Boston-based impact investment management firm, has launched the Impact Factoring Fund, a first-of-its-kind product. The fund is intended to give young companies access to the cash they need to scale up operations. Investors, meanwhile, can expect a return of 6 to 8 percent along with double-bottom-line benefits of supporting entrepreneurs in the developing world.
“Accounts receivable purchasing is useful for the kind of companies we’re supporting,” explains Alex Bashian, senior investment manager of Invested Development. Factoring enables companies to grow without saddling them with debt. “That’s assuming they could even raise a loan,” he adds, “which is either very costly in these markets or not available at all.”
Businesses most likely to benefit from factoring, Bashian says, “sell physical goods, are trying to dramatically increase growth, and have some sort of payment lag.” Sellers of fair-trade clothing, for instance, face a delay between buying inventory and earning revenue from the sale of merchandise. Technology startups like Frogtek, selling more expensive products, often have to resort to providing credit to customers who have no other options for financing.
Most of the early applicants for this new financial product will likely come from Invested Development’s portfolio of mobile technology and energy enterprises or be referred by trusted networks. “Working knowledge is essential” Bashian says, as a strategy to mitigate default risk. A careful vetting process, considering applicants’ financial statements, growth projections, operations, and management team, may take several months.
Bashian walks through what happens after a match is made: “Once we agree that capital is needed and we understand their sales cycle, we choose an initial first purchase point—say, 30 percent of their accounts. Then they would begin to repay us monthly or quarterly. If things are going well, after a few months we would purchase another percentage of accounts receivable, maybe 40 or 50 percent.” After 18 months to two years, the cycle would reverse. The fund would purchase fewer and fewer of the available receivables, eventually unwinding its position. After about four years, the enterprise should be experiencing positive cash flow and accelerated sales. “At that point, we hope they will attract commercial rate lenders,” Bashian says.
Impact Factoring Fund had raised $1 million in seed funding by early spring with the goal of $10 million to $15 million for its first fund, which will likely focus on sub-Saharan Africa. Future funds will serve a ready pipeline of enterprises poised to grow in India and Latin America.
Morgan Simon, CEO and cofounder of Toniic, an impact investor network, gives Invested Development credit “for exploring the best ways to support their entrepreneurs. Buyouts are not likely in these markets, and thus we need to adjust our strategies to return capital accordingly,” she says. The new fund offers a mechanism for impact investors to meet both social and financial objectives. “We look to impact investing to add more value than it extracts” from a community, Simon says. The best investment will benefit investors, entrepreneurs, and, ultimately, beneficiaries. And the Impact Factoring Fund, Simon explains, “is structured in a way to accomplish that triple win.”
Read more stories by Suzie Boss.