Designing a Due Diligence Process for the Informal Sector
Earlier this year, we announced that we were expanding our work and launched Balloon Capital, our Micro Venture Capital arm. What this means is that, building on the work of our 1,300 Balloon ICS and Citi Volunteer Africa volunteers, we’ll be helping more experienced entrepreneurs in Kenya and Uganda to take their businesses to the next level through ongoing business support coupled with innovative equity investment.
In this post, we caught up with Eva Stolz, who is working as part of our Balloon Growth Team in Uganda. Eva is a consultant from Bain & Company, a world-leading management consultancy and strategy firm. For the past 12 weeks, she’s been working with a number of entrepreneurs who have previously been part of the Balloon ICS programme, and who received further support as part of our Volunteer Africa partnership with Citi. The ultimate aim of Eva’s work in Uganda is to assess entrepreneurs’ suitability for further investment by Balloon Capital, our Micro Venture Capital business.
Eva has predominantly been working with two entrepreneurs – Sam, whose bakery business was the recipient of a loan at the end of this year’s Volunteer Africa programme; and Charles, who is an ambitious agri-vet entrepreneur who also worked with our Citi volunteers. A large part of her work has been performing due diligence on the businesses – a process which, in the corporate world, involves verifying the information given to potential investors by the business owners. In the developing world, though, we’ve had to innovate a process of due diligence that accounts for the way that informal sector businesses operate, and the uncertainties this brings.
For Balloon, when we’re considering making investments in informal sector businesses, there are three things we look to consider: the entrepreneur, the market, and the business itself.
In previous posts, we’ve discussed using psychometric testing in entrepreneur selection on our Balloon ICS programme. We’ve built on this knowledge and experience to ensure that we build a strong understanding of the entrepreneur, their background and their motivations. We try to ensure that entrepreneurs are looking for a partnership for their next stage of growth, but also that they’re willing to work hard to drive that growth themselves. We look for entrepreneurs with vision, and with knowledge and experience in their particular business sector. A learning mindset is important, as we will continue to work with entrepreneurs and hope to expand their skill and knowledge base. Finally, we try to assess an entrepreneur’s trustworthiness by looking at things like how open they are in our discussions with them and at their previous loan repayment rate.
When considering making an investment in an informal sector business, of any size, we need to understand more about the market in which they operate. We try to assess how attractive the market is, to make sure that we support businesses with the ability to grow. It’s important that we get a handle on the competition in the market, so that we know it’s not too crowded, or that the competition is too undifferentiated. We corroborate this information by visiting customers and suppliers, a vital part of our due diligence process.
This is where we get to grips with the information the entrepreneur has told us about their business and their plans for the future. As we’ve written previously, financial record-keeping is one area where we know that informal sector entrepreneurs struggle. It’s therefore been important for Eva to scrutinise the financial records entrepreneurs do have to ensure that the business is in good financial health. It’s important, also, for us to get a sense of how well the entrepreneur will be able to continue keeping financial records in the future. Eva also spoke to the entrepreneurs about how they would use any future investment or finance from Balloon, ascertaining whether it’s a concrete plan, or just pie-in-the-sky thinking.
Working out a due diligence process for the informal sector has been challenging. The commercial environment in emerging markets is different in so many ways than that in developed economies that a lot of our assumptions had to be adjusted. Access to reliable information, credit scoring, audited accounts – all of the things that are available easily in, for example, the UK, just aren’t available as readily. The process, therefore, is part detective work and part intuition. Decisions are made based on the best information and data we can gather, tempered by our own expertise and experience (the aggregated data from all the programmes we’ve run) and then decided by intuition.
We’re now poised to make our first investment with Balloon Capital, thanks to the work of Eva and the due diligence process she helped to create. Keep checking the blog for more updates as the continue to develop, or subscribe using the form below to get updates delivered direct to your inbox.