Thinking About Entrepreneurs in the “Missing” Middle
On a global scale, VCs fund less than 1 percent of entrepreneurial ventures. Let’s assume another 1 percent are subsistence enterprises undertaken by the poorest of the poor at the base of the economic pyramid (BOP) in the least developed countries. There we have the two extremes of a bell curve. What interests me, is what’s happening with the other 98% of entrepreneurial ventures – or the missing middle – and how to address those deserving ventures.
Sramana Mitra’s HBR Network blog makes reference to the “middle of the pyramid” and the need to democratize capitalism. “Too much energy in the business world today,” she writes, “is being spent on high-growth businesses that go after very large business opportunities. All of the startup incubation eco-systems of the world focus on the venture-fundable businesses only.”
Similarly, the international development literature talks about the “missing middle” in developing countries. What characterizes these individuals is that they are too well-off to benefit from poverty alleviation programs, but are still poor and vulnerable.
In my work, when I reconcile the private-sector development (PSD) worlds and the business worlds of technology transfer, I give a lot of thought to the giant mid-section of the bell curve: entrepreneurs at the middle of the pyramid. These ventures include businesses ranging from mom-and-pop retail shops to really great, knowledge intensive, bootstrapped, linear-growth companies.
I think that addressing the needs of the missing middle of the pyramid is essential for these three main reasons:
- Their success would have spillover effects, raising the level of whole communities, just as the rising tide raises all boats.
- Supporting their enterprises is a critical component of a healthy innovation ecosystem.
- The ventures can inspire success on a global scale.
Interestingly enough, I mentored dozens of such companies, largely in the developing world or transition economies. My experience aligns with the observations Josh Lerner makes in his great book published by the Kauffman Foundation called Boulevard of Broken Dreams. Lerner examines various public-sector efforts to foster entrepreneurship in an attempt to identify success factors. The author notes that VC’s main value added goes far beyond money. VC firms make linkages among the portfolio companies with management expertise, markets, financial and legal institutions, specialized consultants, and the like.
Reading his book, I was struck by the fact that I provided exactly the same sorts of qualitative enhancements for my portfolio companies, although I was in technology transfer space. Furthermore, I managed funds providing seed and proof-of-concept support. So, essentially the only difference I can discern between what VCs do and what I did is this: the programs I managed provided grant funding (as opposed to equity investment), and in an order of magnitude much less than VCs.
To blur the lines further, I raised and ran a novel debt-investment fund aimed at moving high-tech enterprises to the next level of sustainability. These companies provided important, life-saving products and services to the marketplace, yet were not deemed innovative enough or have a sufficiently steep growth curve to warrant VC investment. Yet, these companies had tremendous economic development outcomes.
How is this relevant to the missing middle? The companies in my portfolio weren’t at the BOP, benefitting the poorest of the poor. Nor was a single one of the companies I mentored VC-funded, or did they aim to be. The conclusion I’m making is that VC would not address the missing middle with funding for these specific reasons:
VC relies on a system of the rule of law, which protects minority and founder shareholder interests and provides for preferred stock ownership by early stage investors like VC. Such a system may be commonplace in the most developed countries, but it is harder to come by in the developing world and in transition economies where the macroeconomic situation is in greater flux.
VC also relies on exits, a developed marketplace that enables an early-stage investor to recuperate their investment with a significant return on a reasonable time horizon. When capital markets are less developed, the early stage investor has to have the potential to realize an even greater return on investment in order to compensate for market risks.
That said, we can learn from the system of VC and apply lessons to the missing middle. Rather than looking at VC as a causal panacea of economic growth and an innovation ecosystem, it is time to look at what venture capitalists actually do to add value, and from the point of view of private sector development professionals.
In all, there needs to be a recognition and a greater understanding of the multitude of pathways to enterprise development, the myriad types of entrepreneurs and enterprises. At the crux of this issue is scale and scalability, the topic of my next blog post.