Background
Ninety percent of today’s firms globally are Micro/SMEs*. A third of them are one-person companies while a fifth are family sized^ – this means that close to 55% are Micro/SMEs (MSMEs) whose owners work for their own companies. They are the fastest-growing firms in the past decade.
With MSMEs accounting for 55% of employment vs 30% by large enterprises, the “labour force” for a nation’s growth and productivity is no longer working for large firms; they work for themselves. These are small manufacturers, software engineers, consultants, influencers, content creators, photographers, marketers, accountants, AI and data analysts – the list of micro firms goes on. Many of them are young and talented, deciding not to enter the “workforce” but to earn income on their own. Just as many are older, wiser, and also as talented, stepping out of full-time employment to do things differently. The post-Covid wave of “lying flat”, “quietly quitting”, or the “great resignation”, while not yet exacerbating the situation, is nonetheless fuelling the micro-firm phenomenon.
While some may be able to generate a decent income for themselves, many do not have the skills to build business equity and become viable businesses. Our universities and college systems have taught business for corporate employment or for venture funding. Learning business to be in business is a holistic, practical capability across all business functions of marketing, accounting and finance, HR, strategic management. Many micro-firm owners lack such a capability. There is also a dearth of capital for such businesses; most of these funds are channeled towards viable, profitable companies or venture-led firms. Micro firms are therefore left behind, lacking the resources and knowledge that would allow them to progress to the next stage.
Yet, the data shows that 1 in 5 micro firms do become scalable firms. And according to a McKinsey report, raising MSMEs to top-quartile levels relative to large companies is equivalent to 5% of GDP in advanced economies and 10% in emerging economies. From a capital perspective, what kind of funding could be deployed for MSMEs to grow and become profitable, high-value businesses?
What is Equity-Building Capital (EBC)?
At Innovorsa, we have coined the term “Equity Building Capital” (EBC) to conceptualize a form of capital investment for small businesses that have the potential to become high-yield business assets.
Such an aspiration is an aligned goal for both the micro-firm founder and the investor. For micro-firm owners, building equity in their businesses can help secure their futures. Since they are not automatically contributing to pensions nor does their income go into a mortgage, there is a genuine concern for their future financial security. Building business equity could enable them to eventually sell their business and realise the value of the equity they have built. Depending on the business, micro-firm owners could also build a legacy for their future generations if they prefer to pass down their firm instead of selling it.
For our investors, EBC funds provide a stable return with the potential to exit at different milestones. EBC funds are designed as a hybrid of debt and equity financing, with investments in micro firms that are already profitable in that the firm’s owner has already, to some extent, monetized their own skills and capabilities. We expect EBC funds to achieve a consistent dividend income of an average of 8-12%, with the ability to exit investments and distribute profits among investors within 4 to 6 years of investing. Exits could be designed as buybacks, buyouts by investors or carry holders.
Overall, we believe that EBC investment is a good fit for investors who desire dividend-based returns and business owners who are looking to grow the value of their businesses.
How EBC works
To ensure the success of EBC, providing capital alone is insufficient. EBC funds are designed to be deployed with the provision of non-core business services.
We already provide business incubation and transformation services to our investees and family office businesses in 5 countries. Over the past 10 years, we have codified many business practices with digital tools that enable the businesses to focus on value while our team supports them with managed services (Accounting, IT, HR etc) and technology. More importantly, we are able to digitalize some of their capabilities to enable the scalability of their businesses. Extending this service to be incorporated into a fund is a natural progression.
EBC v VC
Data from Carta shows that more than half of startups founded between 2017 and 2023 that had raised more than $1 million went out of business in 2023. Worse, startup closures in the first quarter of 2024 were much greater than in each quarter of 2023.
The Venture Capital (VC) model for financing businesses is high risk because investments are often not grounded on business fundamentals but on “taking bets”, with a formulaic method that often incentivises growth rather than building a viable business. With the rising cost of capital, a different model for financing innovative businesses is much needed.
EBC invests in profitable micro firms because it targets business owners who have used their own resources to build their businesses in order to sustain themselves. As EBC fund managers, we would work with a business owner to grow the value of their business from the baseline of an already-profitable firm to translate the owner-operator capability into the firm’s equity value and support the firm in its growth. EBC-funded firms could, of course, be VC funded as they grow.
Conclusion
EBC Funds offer a unique opportunity to invest in a carefully curated portfolio of profitable micro firms. By leveraging our expertise in identifying and nurturing high-potential micro firms, we aim to deliver consistent returns and long-term value to our investors.
*Future Readiness of SMEs: Mobilizing the SME Sector to Drive Widespread Sustainability and Prosperity | World Economic Forum (weforum.org)
^The power of small: Unlocking the potential of SMEs - InfoStories (ilo.org)
