Signals: LatAm SMBs struggle to access capital. Is that a market opportunity?

Small-to-midsize businesses in Latin America and the Caribbean are flourishing. SMBs account for about one third of the region's GDP, employ roughly 70% of the official labor force and represent one of the fastest-growing segments of the economy. Collectively, LatAm SMBs have grown to $2-$3 trillion in value– a figure that only promises to grow on the back of an increasingly diverse pool of human capital, robust access to financial capital, and an ever-expanding array of technological adoptions.

For over six years, I've been working with Latin American SMBs on creating channels these businesses can leverage to access credit. The market for SMB credit in LatAm is vast; its characteristics vary on a country-to-country basis, but from my perspective the immensity of economic opportunities is clear. 

Given their potential, how come LatAm SMBs still struggle to access credit from capital providers?

First, let us dive into the drivers behind this opportunity and the current tech landscape. 

The availability of human capital, financial capital and technology-enabled productivity are the driving forces of the region. Human capital is projected to grow further: According to the United Nations Economic Commission for Latin America and the Caribbean (ECLAC), interactive demographic indicators show us that Latin America has a few decades of population growth ahead, which means more younger people, more growth, more consumer demand:

Source: Economic Commission for Latin America and the Caribbean 

Women’s labor force participation, another factor crucially correlated with economic growth, is also trending in the right direction. This is not unique to Latin America, but recent positive trends are extremely important given the lack of high-level executive positions held by women in the region. According to a shocking survey published by Statista, the percentage of female CEOs was commonly perceived to be nearly 27% across 27 countries in the region, while the actual number sits at about 3% (numbers don’t need commentary sometimes, do they?). Women’s participation in the labor force tends to be influenced by economic cycles as well as black swan events like the Covid-19 pandemic, but still proves resilient, as seen in the graph below.

Diversity of human capital remains an incredibly powerful driver of economic growth - according to the IDB, more diverse labor fuels innovation, improves productivity, and fosters greater attainment of sustainability goals. Regulatory innovations and policies certainly help the cause - for example, the implementation of childcare policies leads to an increase of women in the labor market by 7-9% on average across the region, consequently increasing GDP by 4-6%. Educating, promoting and supporting women in STEM-related fields could increase GDP by a much higher margin due to higher labor participation, productivity and inclusion. 

I am continuously impressed by the work that LatAm-based tech and manufacturing executives are doing to develop diverse supply chains, build significant ground operations, and leverage technological innovations to scale their businesses in Latin America. There are several important partnerships rising and fostering the progress –for instance, a recent collaboration between Amazon Web Services (AWS) and The City of São Paulo to improve the education of young people in programming, cloud computing and other applicable sciences. Initiatives supported by big tech and other influential institutions will only accelerate progress in the region and increase its talent pool and diversification. This allows investors to remain bullish on the region, and a lot is dictated by the chart below: 

The tech sector’s share of LatAm’s GDP has been growing on average at 65% per year since 2003, while the U.S. has been showing 11% growth per annum in the same period, and China 40%. 

The opportunity for further growth is clear. Despite macroeconomic headwinds and funding volatility in the past couple years, LatAm is demonstrating incredible resilience, entrepreneurial drive, and capacity for technological innovation. The LatAm labor force is quickly acquiring the skills to tackle gaps in a region where over 50% of the national population in several countries still lack access to banking and related financial services.

All developing economies, Latin America included, are more susceptible to major economic slowdowns and downturns. Since the COVID-19 pandemic, the US and global markets and investors have become very cautious due to changing interest rates, consumer anxiety, inflation, FX rate volatility, and micro risks, thus are more punitive in deploying capital. Market data analysis fuels these fears. According to S&P Global Ratings, the corporate default rate in Latin America is forecasted to rise; defaults in Brazil, driven by floating-rate debts, as well as Columbia and Chile face the sharpest deterioration. JP Morgan recently projected defaults reaching 6.6% in the region, up from 5% previously, while forecasting 6% across all the developing markets, up from 5.5%. 

Fraud and geopolitical risks are major challenges globally, but are even more pronounced in developing economies such as Latin America. The SMB space is particularly vulnerable given the manual touchpoints (operational inefficiencies, large volume of paperwork, supply chain inconsistencies, etc.), heavy reliance on cash transactions, government bureaucracy, systemic inefficiencies, and market fragmentation. These factors also leave a lot of room for fraud. Even large institutions like banks, asset managers and non-bank lenders incur major losses from fraudulent transactions, misrepresentations, misdirected funds, theft, etc. The current situation in Ecuador with its ongoing violent clashes and political turmoil is another example of unforeseen circumstances. Of course, local business is hurt as global investors struggle to navigate the changing environment and eventually flee the scene. 

Based on my experience structuring deals in Latam, tech-driven solutions can mitigate these types of risks by leveraging live data and sophisticated models to help businesses make timely risk decisions. As examples, businesses could automate the employment of proper insurance policies (including those insuring against force majeure situations) or instantly verify customers through third party data providers. 

Navigating the nuances of the risks, building sophisticated credit models, pooling live data from various sources, syncing inputs and analyzing outputs in a timely matter, in addition to regular credit analysis, is often difficult, requires specific experience and skills, but thus presents an opportunity for fintechs to approach the market and build their brand recognition. 

SMBs and startups will play a key role in addressing these gaps, but need reliable access to credit markets in order to do so. 

Unfortunately, economic uncertainty is pushing international banks to universally cut back on lending, and tighten their credit boxes in particular for smaller businesses. Adding to this, LatAm's SMBs face several unique, near-term challenges in the global competition for business credit.

According to the studies conducted by the Association for Private Capital Investment in Latin America (LAVCA), interest in the fintech space has exceeded that of any other industry or sector:

The US and global markets depending on the macro environment can prefer different financing options.  Generally, there are several structures SMB’s could get access to capital via: 

Traditional financing usually means a bank loan. Although bank financing could come at favorable rates, collateral requirements can be prohibitively high, and SMBs may struggle to show sufficient track record, sales volume, margin and other financial thresholds for investors to finance their growth. 

Venture capital and private equity’s presence in the Latin American region has been growing, providing alternative sources of financing for SMB’s. However, capital availability largely depends on which country you’re based in – for instance, countries like Brazil, Mexico and Argentina have advanced investment ecosystems, while smaller countries like Ecuador, Guatemala and others don’t benefit from the same offerings. Overall venture capital availability peaked in 2021 and has slowed down since then:

Institutions like Inter-American Development Bank (IDB), the International Finance Corporation (IFC) actively support SMBs in the region through financing programs and other assistance aiming to support them from a technical, operational, expertise standpoints. However, these are usually slow and inefficient processes as well as strict requirements and a limited capacity. 

Crowdfunding and crowdlending platforms like Fondeadora and Cumplo present another source of capital from a more diverse group of investors or lenders. Main disadvantages are the ability to scale and serve diverse range of SMB’s due to small check sizes and time frame of the capital raise process as well as outsize sensitivity to economic slowdowns, as the consumer-heavy profile of investors on these platforms makes this funding more conservative when the economy slows

Fintech startups play a crucial role in providing working capital and liquidity to Latam SMB’s. Digital marketplaces, lenders, and trade finance platforms streamline the loan application process, enable quicker payment reconciliations, and advance funding to drive business growth. Fintechs take advantage of tech-enhanced credit models to speed up the underwriting process and reach a large market, while potentially bringing down costs of capital compared to similar offerings discussed above. 

The right operational tools, sophisticated credit models, advanced technology and great talent pool are key for global investors and fintechs to succeeding in Latin America. From a macro risk perspective, structuring the financing method, securing collateral via innovative tracking tools, monitoring trade and operational process live, while wrapping credit, fraud and political insurance around transactions is where a sophisticated investor can find risk adjusted return. And of course, adding value, supporting SMB’s, growing local presence and contributing to the region’s equality will be beneficial and rewarding for a right investor with fintechs leading the way. 

Fintechs are offering credit investors more inroads to LatAm SMBs, with two developments to look forward to:  

E-invoicing systems have emerged to become a transformative force in Latin America, revolutionizing the way businesses handle transactions and report sales. Countries like Brazil, Mexico, Chile, Argentina and Colombia are at the forefront of the new shift. A large part of the region embraced electronic invoicing for improved transparency, efficiency and regulatory compliance. It’s worth mentioning that e-invoicing has had a slow adoption due to SMB’s sticking to cash transactions - regulation is attempting to change that by enforcing reporting and making the process mandatory. While helping SMB’s to eliminate burdensome paperwork, enable better financial management and obtain real-time visibility, this technology cuts the risk of tax evasion, facilitates growth and trade transparency, thus opening the door to foreign investments. There are several value-add innovations, such as Brazil’s freight-vehicle tracking project, where the goods shipped are monitored in real time and matched to appropriate tax documents, or electronic payroll in Argentina, which eliminates inconsistencies in information, facilitates contributions to social security and verifies personal taxes data. 

The opening of financial data infrastructure to third parties happening in Latin America is transforming the region but so far remains quite fragmented. Mexico and Brazil, for example, are set to roll out and follow a similar regulatory path as Europe, while Argentina and Peru's framework development is less certain. API-driven transformation will lead to payment innovations and added efficiencies which will contribute to the region’s higher inclusion, lower cost and improved user experience. There is a wide range of advantages and applications of having open financial platforms and services including credit scoring, access to credit cards, faster payment systems, insurance, e-commerce and other embedded functionalities.