DP13698 Micro-equity for Microenterprises

Author(s): Suresh De Mel, David J. McKenzie, Christopher Woodruff
Publication Date: April 2019
Keyword(s): alternative financing, Contract Enforcement In Transition, micro-equity, Microenterprises, Microfinance
JEL(s): G21, O12, O16
Programme Areas: Development Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13698

Many microenterprises in developing countries have high returns to capital, but also face risky revenue streams. In principle, equity offers several advantages over debt when financing investments of this nature, but the use of equity in practice has been largely limited to investments in much larger firms. We develop a model contract to make self-liquidating, quasi-equity investments in microenterprises. Our contract has three key parameters that can be used to shift risk between the entrepreneur and the investor, resulting in a continuum of contracts ranging from a debt-like contract that shifts little risk from the entrepreneur to a pure revenue-sharing contract in which the investor absorbs much more of the risk. We discuss implementation choices, and then provide lessons from a proof-of-concept carried out by an investment partner, KGC Equity, which made nine investments averaging $3,800 in Sri Lankan microenterprises. This pilot demonstrates that our contract structure can work in practice, but also highlights the difficulties of micro-equity investments in an environment with weak contract enforcement.