Smaller businesses are a powerful source of employment and growth in fast-growing economies such as South Africa, Nigeria or Brazil. Yet a lack of working capital stops local retailers, merchants and entrepreneurs from achieving their true potential. Banks are reluctant to lend because trade is transacted offline, offering little visibility on cashflows and profits. So how can we solve the problem and unleash growth across these markets? 

Lack of working capital is a near-universal issue for businesses in developing markets. Usually entirely cash-based, these retailers and merchants are reliant on making multiple stock runs each week because they cannot secure credit to buy additional stock, even if they see rising customer demand.

With these essential purchases entirely income-dependent, their business is constrained by how much stock they can gather in one go. Distributors won’t extend credit lines because they too have cash constraints preventing them from taking on more stock.

Similarly, there is no opportunity to scale. Few local business owners can save enough money to make capex purchases that they know would transform their stock carrying or sales capabilities. Bank loans are inaccessible, and it’s easy to understand their reluctance to lend. In Peru, for example, 57.9% of SMEs do not keep a record of their cash flows and 80% do not prepare a financing plan for their activities. There is simply not the data available on which to make a lending decision. Even if these are cash generative businesses with prospects for growth, which lender has the time or inclination to root around for the evidence they need to make a decision?

A multi-trillion dollar problem

The World Bank estimates that 65 million enterprises, or 40% of formal micro, small and medium businesses in developing countries, have an unmet financing need of $5.2 trillion annually. Escaping this loop would be a powerful way to generate economic growth in developing markets.

The African Private Equity and Venture Capital Association (AVCA) has long identified this problem. “African markets face a chronic lack of working capital to catalyse private sector growth. The poor availability of working capital results from several factors:  a low savings rate, lack of well-structured capital markets and a crowding out of the private sector due to high government borrowing.

Traditional sources of working capital for small businesses such as asset and invoice financing are not common in African markets. And if they are, they are hard to obtain and expensive – up to 20% higher, says the AVCA. Microfinance fills some of the hole, but only for those companies that can prove their creditworthiness. In Kenya, for example, the financing gap for micro, small and medium enterprises is estimated at $19 billion.

This is not just an Africa problem. In Peru, 99.5% of enterprises qualify as SMEs and they employ 89.4% of the private sector workforce. On average, these businesses paid 15.8% more than large companies for loans in 2020, according to the Central Reserve Bank. This prices all but the most risk-hardy businesses out of the market.

The need to digitise trading history

This is a vast, untapped global growth opportunity. With working capital, local retailers, merchants, and entrepreneurs can thrive. Whenever we’ve worked with these business owners – in markets as diverse as Argentina and South Africa – we’ve found no shortage of ambition for growth, nor any shortage of local demand. But the lack of access to credit and working capital is a consistent constraint. Some merchants routinely make 2-3 hour journeys for stock replenishment multiple times in a single week because they cannot afford to make bigger orders. They can’t benefit from bulk discounts and can’t meet customer needs effectively by offering more product range or more competitive pricing. All in all, it’s a time-consuming, expensive, and unsustainable way to do business.

At the heart of this problem is a data issue. These businesses need to provide trading histories and visibility on cash flow for banks and other lenders to decide on their creditworthiness. In the offline world, this is impossible. However, once purchasing and sales data is online, it’s easy. The question is how best to digitise these businesses, given their reliance on cash for buying and selling.

Well, the answer is two-fold. Firstly, allow merchants to start ordering products digitally via their phones. And secondly, create ways for them to ‘upload’ physical cash to these digital accounts.

By partnering with financial institutions across large parts of Latin America and Africa, we’ve been able to solve these problems and allow 10,000s of merchants to build up a digital trading profile. Merchants can carry out all trading digitally via a simple smartphone app and ‘upload’ their physical cash at nearby deposit outlets or ATMs.

Fair finance, sustainable lending

From a lending perspective, the impact is transformative. Banks can aggregate this with data they already hold and make decisions accordingly. It’s the missing piece of the puzzle – crucial to bringing down the cost of lending to these local businesses.

And we’re working hard to integrate these lending solutions into our technology. By the end of 2022, any retailer or distributor using the RedCloud app to build up their digital trading history will be able to access working capital loans or credit.

This type of finance/technology partnership can have a profound impact on businesses in developed markets. It’s not only about giving local retailers and merchants the chance to invest in their future. By providing them with rich trading data, they can gain stronger insight into purchasing and sales trends, helping them better anticipate emerging customer needs, behaviours, and trends.

There’s no doubt that merchants need access to far better lending terms than those available via conventional channels. But this has to be done safely and sustainably, which is why digitisation is so vital in helping entrepreneurs invest in the equipment and stock they need to grow their businesses. Once banks and financial institutions see that they’re backing winners, the growth potential is boundless.