Emerging markets equal tremendous innovation, incredibly creative entrepreneurs and a vast array of business ideas for potential startups! Reading these lines a newcomer to the field might think this whole combination sounds more like an NGO-Let’s save the world type of fantasy than a possible reality. At least that’s what I thought until a few weeks ago. During the Seedstars summit – which aims to promote, connect and invest in emerging market startups – I met some of the brightest and most innovative minds you can find in these fast-growing economies.
Funds to start a business in these economies are hard to find due to a variety of factors such as a certain lack of awareness from potential investors – both public and private – or financial exclusion from the traditional banking/financial system. But as in more mature ecosystems every startup needs access to capital, whether for funding product development, for initial rollout efforts, acquiring inventory, or simply to grow and thrive, so how can entrepreneurs in developing countries solve this problem? Here are four alternative ways to bank loans and venture capital (VC) to fund startups in emerging markets and foster a functioning entrepreneurial ecosystem…
1. Business angels or angel investors
Most entrepreneurs think of bank loans as the primary source of money, only to find out that banks are really the least likely benefactors for startups not only due to the high rates they “offer” but also because as soon as they enter your capital they will try to directly influence your development and management process.
Another type of primary source of money could be a business angel, a former entrepreneur who has launched and developed several successful business ventures and who is willing to provide starting or growth capital as well as mentorship and only playing an indirect advisory role. Plus, angels are also usually less risk averse than VCs or banks hence more keen to invest in early-stage companies.
Although business angels can be key facilitators for a new business, as any other investment method this first one isn’t without some risks as angels can also withdraw their money at any time, if for example the return on investment is too lengthy.
2. Family and/or friends financing
This second method might be the easiest and maybe less risky one as your friends and family are the first people who should believe in you, without waiting to see if your idea works, or waiting until you have real customers and revenue.
However borrowing money from close relatives does not prevent you from being cautious! If this family-based method is the chosen one, you should never forget that these commitments should nonetheless be positioned in writing as so-called bridge-loans or interim financing, which convert to equity at a rate determined by later investors.
Crowdfunding is a real solution to support the rise of developing countries by allowing entrepreneurs – via the use of new technologies – to complete transactions swiftly without needing any central facilitator such customary financial institutions.
By using crowdfunding to raise money to develop a business venture entrepreneurs can pool small investments from a relatively large number of investors coming from their country/region but also from anywhere in the world. Usually investors put money on a specific project simply because it’s of interest to them making of crowdfunding a sensible alternative to the traditional investor system (VC or financial institutions).
However, crowdfunding as any other investment method isn’t without some risks. The type of platform used will depend on the type of project as well as its capital needs. Thus it’s key to pay careful attention to the fine prints and know the ins and outs of each platform making sure the appropriate one has been selected.
4. Peer-to-peer lending
Peer-to-peer (P2P) lending is a process whereby a group of people comes together to lend money to each other based on a shared affiliation such as ethnicity, religion or even gender, without the involvement of standard financial institutions. P2P lending is therefore an ideal solution for borrowers/entrepreneurs whose project might not have gotten approved by traditional financial intermediaries.
Since P2P lending generally operates online it is also cheaper and faster than traditional funding methods. Another advantage of this method for borrowers is the better rates than those offered by banks. As for the lenders, it can be higher returns than obtainable from a savings account or other classic investments.
The risk of this last method is the financial power lying in the hands of lender. As they are effectively subject to higher risk of loss they can charge their loans with higher interest rates than banks or institutional loans.
Family-based, business angels, crowdfunding or P2P lending, these four alternative methods can all be a solution for providing entrepreneurs with starting capital.