The Future of CDC

Evidence from Grofin


This submission of evidence details the support that GroFin has received over six years from CDC. GroFin is pioneering a scale-able and replicable business model to address the finance needs of the ‘missing middle’.

The challenge: supporting the ‘missing middle’

The ‘missing middle’ is the space between Microfinance and Private Equity and refers to a target market that requires from US$50,000 to US$1,5 million in finance to start or grow a business. This underserved market not only suffers from the lack of access to capital, but is also deficient in the skills required to sustain a business. This problem is particularly acute in Africa and other developing countries. Failure rates for small businesses are widely publicised the world over, with between 60% and 90% failing before they reach their third year.

A lack of finance, entrepreneurial and management skills and the high failure rates of small and medium enterprises (SMEs) has a significant negative economic and social impact in the developing world. No country can truly experience economic growth and wealth creation without the existence of a strong SME sector acting as a key job creator and provider. The social and economic benefits that flow from a strong SME sector are well known and documented in OECD countries that have sufficiently nurtured this sector However, a historic lack of institutional support for the ‘missing middle’ has contributed to the absence of a thriving, sustainable SME sector in Africa and other developing nations.

As with Microfinance and Private Equity, a new asset class must be developed to effectively address the needs of this segment. This emerging asset class is known as Growth Finance. With the assistance of CDC and others, GroFin continues to play a key role in the establishment and promotion of this new asset class, which is of critical development importance.

A cause aligned to CDC objectives

The support that GroFin has received from CDC since 2004 is evidence of an initiative that is directly aligned to the CDC objective :

- To invest in the creation and growth of viable private businesses in poorer developing countries;

- To contribute to economic growth for the benefit of the poor; and;

- And to mobilise private investment in these markets both directly and by demonstrating profitable investments.

CDC’s support for GroFin and growth finance

In the following paragraphs, more detail will be given in support of this statement detailing the contribution CDC has made to date and why we believe CDC should continue to support initiatives such as GroFin and growth finance funds.

GroFin was established to address the need that exists in the market for the development of an SME focused value add financier model that addresses the finance and business support needs of small (not micro) businesses and entrepreneurs. The GroFin business model was conceptualised and brought to market by Jurie Willemse, founder of GroFin, with the support of the Shell Foundation in 2003. Shell Foundation supports the development of commercially scale-able, replicable and sustainable models that addresses key development challenges.

GroFin acts as a financier and support provider to entrepreneurs, increasing the ability of SME's to succeed with a solution that extends beyond finance. Their support lies in the provision of access to GroFin’s expertise for the duration of the finance relationship. This solution-based approach is necessary to address the high failure rate that keeps commercial investors and financiers from serving the needs of this enterprise segment.

GroFin and Shell Foundation approached CDC in 2004 to explore a possible partnership in pioneering a new solution for the ‘missing middle’. Prior to GroFin’s inception, the market experienced a void of solid, scalable business models that can effectively address the needs of these entrepreneurs in nearly all developing countries. For a long period of time, banks with the assistance of IFIs, DFIs and others, tried to address the needs but with no success, as secured bank finance without business support could not address the market need. Private Equity was already well developed, but lacks the ability to serve the $2m market segment. Microfinance, although flexible and development orientated, is restricted to supporting individuals and small entities. Venture Capital offers the seed funding so desperately needed by start-up businesses lacking a track record, but is confined to an early stage, high growth business models that can easily be scaled. The market needed a new solution and the key was in developing a new intermediary model able to effectively serve the needs of entrepreneurs and channel large sums of monies from investors.

GroFin set itself the goal of developing into a focused value add financier for entrepreneurs that need between $50,000 and $1 million in start up and growth finance. As a viability-based financier, it makes decisions to invest on the basis of the entrepreneurial ability and viability of the business plan, and thus overcomes the constraints of insufficient track record and collateral that most entrepreneurs face at this stage of their business development. The model effectively overcomes the constraints that other financiers face in serving this substantial market segment.

The aim was to develop the business model over a period of 10 years to a point where it can successfully demonstrate the ability to deliver positive returns to investors. In so doing, a new asset class will be developed that will gradually attract commercial investors. This will unlock major capital and, through the replication of the business model, will address the issues that restrict SME development through a sustainable commercial model. It goes without saying that to pioneer a model that will have a global impact is no small task and can only be achieved through committed and knowledgeable partners. CDC’s partnership with GroFin began in 2004, with the establishment the pilot GroFin East Africa Fund (GEAF). Understanding the market and the need to address the missing middle sector CDC was interested in the new ground breaking venture and, after value adding due diligence, committed $3m as an anchor investor to the fund. CDC played a leading role, together with FMO, GroFin and Shell Foundation to bring a group together that committed $25 m in capital and $18 m in co-finance to establish the model in East Africa. This group included four commercial banks, four foundations, five DFIs and GroFin. It was a clear demonstration of how a diverse group with a common interest of solving the ‘missing middle’ challenge can work together in a pilot fund to establish a new finance model.

CDC not only committed capital to the pioneering fund, but also made available expert advice that proved to be invaluable over the past six years. CDC has a wealth of experience derived from decades of development finance activity, which proved extremely valuable in the development of the GroFin business model. CDC is also respected in DFI circles as a result of their professional and successful approach in mobilising development finance. When they lend their support as an anchor investor, the finance community appreciate the value of the fund and the fund manager. This is owing to the widespread knowledge that their decision to participate in a fund is based on the stringent business and development criteria which is recognised by all in the industry.

The GEAF pilot fund proved the concept of growth finance and the GroFin business model sufficiently to attract more support. Today, the business has more than 100 staff in nine developing countries, eight of which are in sub-Sahara Africa. GroFin is now the biggest growth finance organisation, with more than $260 million under management and has assumed a pioneering role in commercialising a new asset class that is of major developmental importance. CDC played a large part in this and, apart from their anchor investor role in the GEAF, also played an anchor investor role in the GroFin Africa Fund (GAF), a pan African fund for growth finance currently investing in seven countries. CDC chairs the advisory committee of this fund and continues to play a lead role among investors to ensure that a new asset class is born similarly to how micro finance was developed over the past 30 years.

No positive economic returns have yet been gained for the benefit of investors, as Growth Finance is still at an early stage of development. All indications from results to date however, point to positive returns that over time will improve to the extent where it will draw in private investors. CDC’s investment in GroFin funds and growth finance as an asset class is financially additional, i.e. it plays an ever important role in creating a new paradigm as far as sustainable SME development and resulting job creation goes.

5. CDC’s positive impact on the SME sector

In addition to its contribution to GroFin funds, CDC is acting as a catalyst for the sector; over time attracting (crowding-in) private investors by demonstrating that profitable and responsible investments can be made in very challenging business environments in developing countries. Very few organisations exist that are prepared to put their scarce capital toward addressing a significant development opportunity that, if correctly addressed, will draw in billions of dollars of private capital in the near future. CDC is doing just that for the growth finance sector.

CDC’s total capital commitment of US$ 33 million of which US$ 9 648 400 have been drawn down has already resulted in the start-up and growth of approaching 200 businesses, sustainably employing 4,878 people. These numbers speak for themselves when it comes to questioning the impact of development finance and the resulting development returns derived from successfully executed initiatives.

The results to date, the development of the new business model, as well as the economic and development results achieved through the investments made, has also been recognised internationally. GroFin was awarded the Africa Investor Award in support of the millennium development goals in both 2007 and 2008. In 2010, GroFin received the UN World Business and Development Award. The awards, launched by the International Chamber of Commerce in 2000 and now run in partnership with the United Nations Development Programme and the International Business Leaders Forum, is one of the central events in 2010 to recognise the contributions of the private sector to development. It places particular emphasis on recognizing those private companies that have successfully promoted the Millennium Development Goals (MDGs).

What has been achieved to date cannot be done without the collaborative efforts of several organisations. We experienced CDC as an innovative leader among the IFI and DFI community. This community would be much poorer without a CDC that values partnerships and subsequently the developing world, and specifically Africa, would lose a key contributor to poverty reduction.

What has been achieved to date cannot be done through direct investment. No DFI has the ability to do small transactions in volume and nor should they do it and thus crowd out specialized service providers. The best way to achieve significant results at the broad end of the pyramid is through support of initiatives such as GroFin and GroFin funds. Direct investment has its place, but inevitably means that only bigger investments can be supported and thus effectively results in single private equity investments that ignore the largest part of the market that lack access to finance. The focus must be broadened to include more than Private Equity and CDC has already started to do this with investments such as GroFin. As this segment grows more and more opportunities will arise to channel more capital towards it in support of CDC objectives.

With CDC capital so invested, harvested and reinvested effectively, a growing development accelerator is created that generates sustainable employment and thus lasting economic growth and wealth creation. Through its investment and support of GroFin and GroFin funds, CDC has contributed to economic development and poverty reduction in eight poor countries