As practitioners and policymakers increasingly recognize the role of agricultural small- and medium-sized enterprises (agri-SMEs) in developing economies—and seek to finance their growth—they require a sophisticated view of the agri-SME financing landscape. Previous research has identified a persistent smallholder financing gap, while giving a partial accounting of supply and demand of financing for agri-SMEs. But the analysis was incomplete.

In our latest State of the Sector report, we analyze the current state of the agri-SME finance sector, focusing on sub-Saharan Africa and Southeast Asia. In our most recent blog post, we presented a new characterization of agri-SMEs and their finance needs. Part Three of this series looks at how different types of capital and financial service providers are currently striving to meet demand in this market.

An overview of the agri-SME finance market

The agri-SME finance market involves funding flows between three types of actors: capital providers, financial service providers, and agri-SMEs. When a real, articulated demand from an investment-ready SME aligns with an available financial product or capital offering, the market clears. 

As illustrated in the figure below, there are several different kinds of players in this financial market structure. Capital providers, who typically raise capital from the market or public/private donors, fall into five main categories in the agri-SME finance market:

• Overseas development assistance (ODA) and other public/taxpayer-funded institutions
• Philanthropies
• International/development finance institutions, often financed by government or multilateral institutions
• Multilateral development banks chartered by two or more countries
• Other capital providers, including pension and sovereign wealth funds

Financial service providers source funds from capital providers and distribute them to agri-SMEs in the form of different financial products. While capital providers hold power in the form of funding, they rely on financial service providers to achieve their objectives and to understand the local market.

In parallel to these actors are others who play a role in fostering an enabling environment for agri-SME finance, including policymakers, market platforms, and technical assistance providers.

To understand the financing flows in the current market, we look at how capital providers and financial service providers collaborate, deploying subsidies and blended financing to address the challenges of the agri-SME market.

Mapping agri-SME finance flows by channel

Our analysis shows that the current annual supply of finance to the 220,000 agri-SMEs in sub-Saharan Africa and Southeast Asia is estimated at USD 54 billion. With the understanding that estimated amounts probably overlap to a certain extent, we mapped the size of this funding per different channels, as seen in the figure below and described in Part One of this blog series. 

Surprisingly, despite the emergence of numerous social lenders and impact-oriented funds, the bulk of current funding—about USD 40 billion—is supplied by local commercial banks. This is particularly true in Southeast Asia, where banks are supported by a strong enabling environment and policies to lend to creditworthy agri-SME borrowers. 

Key insights about the agri-SME finance gap

The demand and supply mapping in our report reveals a complex market with many different segments of SMEs and types of capital and financial service providers. Here are five key insights from this analysis that should shape strategies to bridge the financing gap:

1. The small “top of the market” is disproportionately served. About 85% of currently available funding is supplied by local commercial banks and impact-oriented funds, which both tend to serve more mature and creditworthy agri-SMEs OR those active in export-oriented value chains. While no global data exists, anecdotally these larger, more mature agri-SMEs represent a very small fraction (<5%) of the market, leaving a huge funding gap.
2. The large “bottom of the market” continues to struggle to become investment ready. Many enterprises won’t develop rapidly enough to raise commercial debt or equity. Often, they do not even have an ambition to do so. The high costs of financing such enterprises requires both capital subsidy and technical assistance—raising questions of sustainability.
3. Where is the equity for the promising “middle of the market”? Many practitioners noted the need for higher equity capitalization of agri-SMEs to help them invest in growth and withstand market shocks. There is, however, a fundamental mismatch between the demand and supply of such funding. 
4. Growth financing is increasing for more disruptive agri-SMEs, but still tough going. In particular, agtech promises disruptive innovation and the potential to address some of the sector’s pain points at scale. Several international funders are now deploying growth financing solutions, hoping to follow the example of successful agtech models such as Rural Taobao in China, and DeHatt and AgroStar in India; but many startups in sub-Saharan Africa are struggling to raise funds.
5. Despite the urgency of climate change, climate finance for agri-SMEs has yet to strongly emerge. Of the USD 580 billion in climate financing in 2020, only 3% went to the agriculture, forestry, and land use sectors (and 4% of that to value chain actors in non-OECD countries). This funding is almost exclusively provided by the public sector, focused on big-ticket initiatives, and disbursed as grants and concessional debt—leaving many missed opportunities that may have dire consequences.

What's next?

In the face of a persistent financing gap in the agri-SME market, we must double down on our approaches to subsidy and blended finance. In the next blog post, we’ll look at how the sector can deploy these approaches to catalyze more private capital investment in the agri-SME market.

Agricultural small- and medium-sized enterprises (agri-SMEs) play a vital role in rural communities, providing employment, livelihoods, markets, and food for local households. Like smallholder farmers, agri-SMEs have historically been thought of as a static, relatively homogenous group. At the most basic level, they are profit-oriented enterprises and cooperatives that are central to global food systems. 

However, this static definition fails to capture the different types and sizes, as well as the dynamic nature of agri-SMEs. As a result of operating within food systems and the unique dynamics of developing economies, agri-SMEs are exposed to multiple challenges, including climate change. Their role changes as markets move through different stages of development, and this has implications for what services they require at any given moment.

In our latest State of the Sector report, we analyze the current state of the agri-SME finance sector, focusing on sub-Saharan Africa and Southeast Asia. Part Two of the report presents a new characterization of agri-SMEs based on their growth pathways and their role in food systems. With this characterization, policymakers and practitioners can better define agri-SMEs and characterize their finance needs.

Six different growth pathways for agri-SMEs

As shown in the figure below, we can sort agri-SMEs into six different categories according to their growth ambitions and potential:

1. High-growth ventures are highly innovative business models serving large, addressable markets with high margins and experiencing a rapid growth trajectory. 
2. Niche ventures are business models that are creating innovative products and services that target niche markets or customer segments.
3. Diversifying enterprises are small, family-run enterprises that have seen minimal growth, but are run by an entrepreneur with a desire to grow, likely through diversification.
4. Dynamic ventures are enterprises in stable “bread and butter” industries that experience moderate, sustained growth by deploying established business models for producing goods and services.
5. Livelihood-sustaining enterprises are small, family-run enterprises that are opportunity-driven and on the path to formalization, though growing incrementally. 
6. Static enterprises are small, family enterprises with no ambition to grow beyond their current status.

To achieve their potential and move along these growth pathways, agri-SMEs need support across five areas: 1) access to finance; 2) access to talent; 3) an ecosystem of support; 4) access to knowledge; and 5) access to markets. Given the persistent financing gap for agri-SMEs—which we estimate to be USD 106 billion in sub-Saharan Africa and Southeast Asia—our analysis focuses on the first area: access to finance.

Understanding different agri-SME investment profiles

The six growth pathways above can help financial service providers better understand the potential investment profiles of different agri-SMEs, including both need for and ability to access finance. 

For example, high-growth ventures and niche ventures develop innovative business models, products, and services. This means that, while they may be riskier and less profitable in their early stages, they can offer more upside as they mature. On the other end of the spectrum, livelihood-sustaining and static enterprises have a narrow path to profitability and high-risk profiles; their financing needs are also smaller in scale. Somewhere in the middle, diversifying enterprises and dynamic ventures have moderate growth potential and risk exposure, with semi-formal structures and governance that may be more attractive to financiers (though some subsidy is likely still required). 

How does this help define the financing needs of different agri-SMEs? While variations in the types of agri-SMEs and opportunities for growth in different markets and value chains exist, we can still use the growth pathways to systematically analyze demand across geographies—and in so doing, establish a new way of linking agri-SME goals with their articulated demand for finance.

What agri-SME goals & pathways tell us about their financing needs

In making the link between individual agri-SME goals and financing needs, it is important to distinguish the specific uses for finance under each goal. Agri-SMEs looking to:

1. Sustain current growth require finance to support day-to-day operations and cash flow cycles in the form of short-term working capital and trade finance.
2. Accelerate the growth to market potential require medium- to long-term investment capital to finance either productivity and cost efficiency investments OR expansion investments.
3. Adapt to changing environment require medium- to long-term investment capital to finance new product/service development AND/OR efforts to build resilience.

With these goals and types of finance defined, we can clearly see in the figures below how agri-SMEs on different growth pathways typically have different needs and ability to afford types of finance. 

The first figure illustrates the foundational link between the types of businesses, their growth goals, and the uses and types of finance needed to realize those goals. However, the types of financing typically change as companies move through early stages of growth through to maturity. Looking at the growth pathways in terms of their orientation to the types of capital in the market and their stage of development (early-stage, growth, maturing) clearly shows where different forms of capital are typically used. 

The second figure shows a more granular, conceptual understanding of agri-SME investment profiles and needs, as well as the types of financial service providers most equipped to meet those needs. With this in mind, we can map current funding flows to see where the market clears and where gaps still remain.

What’s next?

Having established both a sizing and a new way of thinking about the demand for agri-SME finance, our report delves deeper into current efforts to meet this demand. In the next blog post, we’ll look at an overview of the agri-SME finance market, map current agri-SME funding via different channels, and present new insights for how to bridge the persistent agri-SME finance gap.

Over the last several years, the agricultural financing landscape has become increasingly sophisticated, involving a wider variety of actors delivering a more complex menu of services. ISF Advisors has analyzed this evolution through a range of lenses—from the landmark Pathways to Prosperity report on smallholder farmer finance to deep dives into the state of smallholder agri-insurance and the rise of digital platforms.

These reports provide a snapshot of the rural and agricultural finance market, with a focus on smallholder farmers. In Pathways to Prosperity, we estimated the funding gap for smallholder farmers in Latin America, sub-Saharan Africa, and South & Southeast Asia at USD 170 billion. That report also referenced the lending market to agricultural small- and medium-sized enterprises (agri-SMEs), while acknowledging that—at the time—a comprehensive sizing of the demand and supply for agri-SME finance did not exist.

In our latest State of the Sector report, we analyze the current state of the agri-SME finance sector, focusing on sub-Saharan Africa and Southeast Asia. In these emerging markets, new funding structures and specialized financial intermediaries have emerged in recent decades, complementing a financing landscape previously dominated by local banks and government-backed lending programs. This evolution has been guided, in part, by increasingly sophisticated thinking about the use of subsidy, segmentation of agri-SMEs, and holistic investment approaches. But in order to continue evolving, we must develop a clear view of where this finance is and is not flowing.

A USD 106 billion financing gap

More policymakers and practitioners are recognizing the crucial role that agri-SMEs can play in transforming global food systems, reducing poverty, and contributing to smallholder farmers’ climate resilience. However, our analysis shows that agri-SMEs’ access to finance remains severely limited—with huge implications for these development goals. 

We have determined that an estimated 220,000 agri-SMEs in sub-Saharan Africa and Southeast Asia (excluding India) have a total financing need of USD 160 billion. With limited data available, these estimates have been created from the latest self-reported agri-SME surveys and thus represent “articulated demand”—of which only a subset is addressable and met by a source of financing.

Of the total USD 160 billion in demand for agri-SME financing, we estimate that only USD 54 billion (34%) is currently being met through formal finance channels leaving an annual formal financing gap of USD 106 billion. 

Diving deeper into existing agri-SME financing

In our research, we undertook a comparative analysis of the channels through which the existing USD 54 billion in agri-SME finance is flowing. This revealed a complex picture of the market, in which the vast majority of funding—about USD 40 billion—is supplied by local commercial banks. In line with their risk appetite, these banks typically invest in more mature agri-SMEs, primarily in the form of short- to medium-term debt with strong collateral and covenant requirements and relatively high interest rates. While commercial banks use deposits and raise institutional debt to onlend, they also often use risk guarantees from public donors, particularly to lend to agri-SMEs. 

Another USD 6 billion comes from non-bank financial institutions (NBFIs), such as leasing or factoring service providers. This financing typically takes the form of specific products collateralized against tangible assets. NBFIs serve a wider range of agri-SMEs than commercial banks, which has led more donors to recognize their importance in serving underpenetrated markets and to provide them with guarantees and concessional capital.

The next largest tranche of financing is USD 4 billion disbursed by public development banks, which are state-owned financial intermediaries specializing in long-term credit to promote the economic development of different countries or regions. These financial products range from subsidies to concessional and commercial debt, often linked to a state-sponsored development agenda. 

Despite being at the forefront of agri-SME finance innovation, social impact lenders and impact-oriented funds only disburse USD 3 billion per year. These lenders are funded by concessional capital providers and typically pursue a combination of profit and impact returns. Most finance agri-SMEs in export-oriented cash crops (e.g., coffee and cocoa) in the form of working capital or trade finance.

Finally, despite the need for equity to fund the higher-risk growth ambitions of agri-SMEs, private equity and venture capital funds provide only USD 1 billion in (quasi) equity funding per year. Fund partners’ expectations around risk-adjusted returns, ticket size, and investment horizon often do not match up with the investment readiness, scale, and capital strategies of agri-SMEs.

A complex market that struggles to clear

For most practitioners involved in agricultural finance, the USD 106 billion formal financing gap will likely not be surprising. Relative to other sectors, agricultural markets are volatile—with high transaction costs, high risks, and low margins for many of the smaller value chain players. To fully understand the agri-SME financing gap, we looked at the role of subsidy and informal finance in how the market clears. 

As depicted in the figure below, within the estimated USD 54 billion of current agri-SME finance, a small proportion is offered on fully commercial terms (free of any subsidy). Unsurprisingly, it goes to the most profitable agri-SMEs. 

Most agri-SMEs, however, have less revenue and higher risk profiles. Financing these enterprises requires some subsidy to offset costs, hedge against risks, and support capacity building to make them more investment-ready. In this sub-commercial segment, a range of financiers—including commercial banks, NBFIs, social lenders, impact funds, and public development banks—utilize blended finance solutions.

As the graphic shows, this leaves a much bigger segment of the least commercially attractive agri-SMEs. Some of these have access to capital through informal finance channels, including informal lenders and family members. However, the vast majority of this segment remain unserved.

This model demonstrates a complex financing market that struggles to clear. Thus, the large financing gap can be simply understood as a function of three factors:

1. Investment readiness: The fact that many agri-SMEs describe an investment need but do not meet the minimum requirements of investors; 
2. Product availability: Even when agri-SMEs are investment ready, there are not financing products in that market that meet their needs and investment profile; and
3. The volume of capital: Even when agri-SMEs are investment ready and there are matching financial products, there is not enough capital of the right profile to meet demand.

What’s next?

Having established the scale of the financing challenge, we believe there is an urgent need to build on past research and develop more sophisticated and consistent ways of understanding this financing gap. In the full State of the Sector report and in subsequent blog posts, we will present:

1. A new characterization of agri-SME demand for funding to achieve their business growth and adaptation goals;
2. A sizing and characterization of current finance by different types of service providers; and
3. A more sophisticated landscape of approaches to catalyze sub-commercial finance.