The Missing Middle— Part 2
By Mercedes Politi
Welcome back. As mentioned before, Root Capital faces a significant amount of challenges to achieve its goal of filling in the “missing middle” in the developing world. But they have a roadmap of where they are heading and are continually assessing innovative options to stay on that path. Let’s hear more.
Theory of Change
Root Capital’s hope is to succeed and demonstrate to local banks and capital markets that “it’s safe to play”, as Brian mentioned in his presentation. I loved this phrase and thought it was very graphic. By proving that there is not only a social role to increase household and community incomes, but that there is a profit to be made as these companies mature, Root Capital hopes to motivate other players to join in and increase the availability of lending in this segment. This is what I meant at the beginning by saying that Root Capital hopes to disappear. Of course it doesn’t want to disappear altogether, but it hopes to become unnecessary in the markets that it has been involved with for many years, being then able to take on other geographical areas or segments.
A Multi-Fund Structure = Innovation + Scale + Handoff?
So Root Capital is now thinking about how to crowd-in financial sectors, but at the same time promote innovation and expand the scale of its operations in a strategic way. Some of the riskier deals have been turned away over the past years to avoid taking a hit on the repayment rate. Now Root Capital is reconsidering its options.
Does it make sense to have only one portfolio? Perhaps they could have different portfolios with different risk profiles and then companies would graduate to a more secure portfolio as they proved themselves. For example, they could have three funds: the Innovation Fund, the Early Stage Fund, and the Later Stage Fund. This would help Root Capital reflect more precisely the risks of different loans, and differentiate the rates charged to each portfolio, while opening up an opportunity to invest in innovative companies.
Some businesses that Root Capital has worked with for many years don’t need special subsidized rates and could lend at local higher rates. This would be more profitable for Root Capital and also help in the transition towards filling in the “missing middle”, since you could show banks that they are being charged comparable rates. Therefore, a multi-fund model would promote innovation and scalability simultaneously, while setting a stage for handoff to local financial institutions.
The Path Ahead
As mentioned, Root Capital hoped to spur competition and influence financial institutions to copy it. Basically, this has not happened so far. So it’s time to rethink the strategy moving forward. How do you introduce your own competition in a sustainable way? How do you crowd-in the local financial sector? One option is to directly handoff borrowers to local banks as they have proved themselves and can stand higher rates, another option would be to provide banks with advisory services in the identification of successful companies, and then stepping out for the financing piece of the deal. There are probably many other options out there as well.
Overall, Root Capital seems to have done a fantastic job so far and looks to keep innovating and is striving to not forget its original purpose. I’ll certainly be looking out for Root Capital’s next moves, hope you stay tuned as well. You can visit their website at http://www.rootcapital.org to learn more.
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