The missing market

In Nepal, we have commercial banks that provide funds to big enterprises, and we have microfinance institutions that provide funds to small entrepreneurs. In between, there are other financial institutions, segregated by the class structure of Nepal Rasta Bank (NRB), who are catering to the financing needs of entrepreneurs who lie between the above mentioned extremes. Some of the commercial banks have also set up a separate department to cater to the financing needs of small and medium-scale enterprises, so called SME lending; however, their lending via such schemes is miniscule if one compares it to their total lending portfolio.

A bulk of the lending via these financial institutions is on the basis of collateral. Without collateral, there isn’t a good chance of getting loans even if you have a great business plan. If a young enterprising person has a great business idea and needs seed capital to start the business, then there is a slim chance that this person will be able to start the business without providing adequate collateral or initial equity to meet the required debt-to-equity ratio.

And this is where, I believe, there is a huge missing market in terms of our financial system. We don’t have a developed system that provides seed capital to enterprising people. As a result, many innovative business ideas and sound business plans don’t get translated into actual businesses.

One of the ways to bridge this is through venture capital (VC) firms or private equity (PE) funds or other investment funds that invest in new and innovative businesses without seeking any collateral or initial equity from the entrepreneurs. There are two areas where a VC firm or a PE fund can help, either to start a new enterprise by providing seed capital or to expand an existing enterprise by providing necessary funds for expansion.

VC firms or PE funds are necessary as they recognize the concept of sweat equity—value attributed to the creator of an enterprising idea—and fosters innovation and entrepreneurship. If I have a good business plan and if I am able to convince the fund manager of a PE fund that my business plan does indeed make adequate returns, then the PE fund will provide the necessary seed capital to start the business. And they will do that even if I don’t provide any initial equity or put up collateral for a share of a certain percentage in the company. In the process, I get value for my “sweat equity” through the equity sharing structure with the fund.

As of now, we don’t have a proper system in place that recognizes the value of “sweat equity”. Many readers of this column might argue that the Nepali economy hasn’t reached a stage to support the establishment of VC firms of PE funds and these types of investment firms will emerge as the Nepali economy starts to pick up a higher growth rate. Even some of my friends with whom I discuss these ideas feel the same way. However, I beg to disagree with such a viewpoint. There are a couple of reasons for my disagreement.

First, when someone talks about a VC firm or a PE fund, he or she often associates it with either providing seed funding to technological companies (to some extent this is understandable as the growth of major tech firms in Silicon Valley is largely due to VC firms) or the leveraged buyout that engulfed the global financial market during the late 1980s. However, VC firms and PE funds work in areas above and beyond just technology and finance—from agriculture to energy to medicine. It’s just that technology and finance happen to be glorified ones.

Second, again when someone talks about a VC firm or a PE fund, he or she associates its promoters with individuals with a high net worth. Yes, founders of VC firms or PE funds have predominantly been high net worth individuals. However, there is a growing trend of the association of banks (ICICI Venture in India) and development partners (though funds such as Small Enterprise Assistance Fund) to cater to the private financing requirement in developing and emerging economies.

Third, I believe that there is a huge need for VC firms and PE funds in a developing economy like Nepal as they foster innovation and provide employment opportunities. They foster innovation because entrepreneurs are able to translate their business plans into tangible businesses. And when these businesses grow and expand in size, they provide employment. Even though a majority of businesses funded by VC firms or PE funds fail, those who succeed deliver long-term value to the economy.

First published on 24th January in The Kathmandu Post.

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