It is a cool morning as I hop out of the car in northern Quito, the beautiful capital of Ecuador. Quito is nestled on the Eastern slopes of Pichincha in the Andes mountains nearly 3,000 meters above sea level. We’re in an industrial district of the city and stroll through an open metal gate up a long sloping hill to a collection of buildings, the hum of machines in our ears. We’re soon greeted by one of the factory owners who, along with his wife, had immigrated from Colombia some years ago and now operate their two businesses side by side. He smiled broadly and soon launched into an energetic tour of his small plastic outerwear factory where he makes rain gear and fishing waders, among other products. The tour concluded with hot drinks in our hands after we visited his wife’s adjacent tea infusion business, where women were busy packaging recently dried Ecuadorean fruit and spices. Deetken Impact began supporting micro, small, and medium sized enterprises (MSMEs) in Latin America over a decade ago, and has continually looked for innovative approaches that make access to finance more inclusive. The business owners hosting us that morning are clients of Pragmatiqus, a new business based in Quito that is increasing the availability of credit to small and medium sized businesses (SMEs) in Ecuador through micro-factoring.
What is Micro-factoring?
Factoring is a type of business loan that makes cash available to companies when they need it. Unlike most loans where the borrower pays interest on the loan, in a Pragmatiqus factor operation the lender buys invoices at a discount from the borrower, and is repaid with the full amount of the invoice when it is paid by the third party. For example, suppose a building contractor buys $10,000 worth of lumber from a hardware store on 90 days credit and the hardware store issues an invoice to the contractor for the amount due. In a factor operation, Pragmatiqus would buy the invoice from the hardware store at a discount, say for $9,400, providing the hardware store with the cash today rather than 3 months from now. In 90 days when the building contractor pays the $10,000 invoice to the hardware store, the hardware store in turn pays Pragmatiqus the full $10,000, earning them $600. The product is referred to as ‘micro’ factoring because Pragmatiqus is willing to accept hundreds of small invoices rather than one large invoice for a single factoring operation.
The Social Impact of Micro-factoring
The two small businesses we were visiting employed between them over 20 individuals. Over two thirds of Pragmatiqus’ clients are small and medium sized businesses like these ones. 1 While SMEs generate over half of the GDP in high-income countries like Canada, they produce less than a quarter of Ecuador’s GDP. 2 3 Part of the reason for this lower productivity is limited access to credit. Just 15% of total financing goes to SMEs in Ecuador, compared to the OECD average of 25%. 4 High collateral requirements, lack of information, high fees, and lack of flexibility are among the reasons for the low levels observed in Ecuador. 5
Pragmatiqus is managing risk and overcoming these shortcomings to provide SMEs in Ecuador with a much-needed source of credit. A comparison with standard loans is instructive. Business loans are often made based on potential future sales; Pragmatiqus’ factors are made based on sales that have already been made, reducing risk. Business loans often require collateral; Pragmatiqus factors are made based on invoices, promissory notes (legally binding commitments to pay), and post-dated cheques, the combination of which mitigates risk while increasing access. Together, the financial and social impact characteristics of Pragmatiqus’ business caught our attention. Supporting innovative businesses like Pragmatiqus to reduce the barriers that SMEs face in emerging markets is what Deetken Impact is all about.
- Using two common definitions to classify businesses: (1) Based on Assets: Very Small up to 100K; Small between 100k and 3M; Medium between 3M and 15M; and large for companies with assets greater than 15M. (2) Based on number of employees: very small for between 1 and 9; small for between 10 and 49; medium for between 50 and 249; large for 250+.
- Ardic, Oya Pinar, Nataliya Mylenko, and Valentina Saltane (2011). “Small and Medium Enterprises: A Cross-Country Analysis with a New Data Set.” The World Bank Policy Research Working Paper 5538.
- Ayyagari, Meghana, et al. (2003). “Small and Medium Enterprises across the Globe: A New Database”. The World Bank Working Paper 3127.
- OECD-ECLAC (2012). Latin American Economic Outlook 2013: Small and Medium Enterprise Policies for Structural Change, OECD, Paris.
- Avendaño, Rolando, Niels Boehm, and Elisa Calza. “Why scarce small and medium enterprise financing hinders growth in Latin America: A role for public policies” VOX CEPR’s Policy Portal, 27 January 2013. http://voxeu.org/article/small-and- medium-enterprise-financing- and-growth- evidence-latin- america