Key Drivers for Success and Challenges for the Development of an Entrepreneurial Ecosystem

2 September 2015

CJ Fonzi, with Amanda Dawes Ibanez, Senior Project Manager
Dalberg

Entrepreneurial activity thrives where it has a strong supporting ecosystem. Venture capital and other forms of appropriate financing are necessary, but not sufficient in building a vibrant small and growing business (SGB) sector. Academics and practitioners have largely coalesced around the components of the ecosystem that must be present in order for a robust pipeline of investable SGBs to emerge in developing markets. The challenges in developing entrepreneurial ecosystems vary dramatically from market to market; however, our research and interviews with thought leaders have surfaced seven key themes as the most salient across entrepreneurial ecosystems.

Management talent is a binding constraint to the scale-up of entrepreneurial enterprises. SGBs are unable to attract talent because they fail to provide the salaries, security and status that government and large corporation jobs offer. SGBs are also reluctant to hire talented managers because of contractual risks and high search costs, and because they place insufficient value on them. Finally, stringent immigration laws prevent some countries from bringing in foreign talent that can both lift SGBs and train the next generation of managers.
The largest gaps in funding for SGBs are at the seed-stage; more angel investors are needed. Seed-stage funding has increased during the last ten years, but it is still the biggest financial need for entrepreneurs, slowing entrepreneurial activity, stifling entrepreneurial ecosystems and limiting the number of SGBs that reach a Series A or B round.
Banks cannot be ignored, and have a significant role to play in developing vibrant entrepreneurial ecosystems. Venture capital is unlikely to completely satisfy entrepreneurs’ need for capital. In the United States, for example, less than 1% of companies, and less than 2% of gazelles[1] have raised venture capital. There are signs that banks are beginning to service more SGBs, but lack of access to bank loans for asset finance and working capital remains a strong obstacle limiting their growth.
Blended finance is gaining momentum and creating an opportunity to innovate new financing mechanisms. Over the last few years, foundations and bi- and multi-lateral donors have dedicated significant resources to blended finance mechanisms to attract private capital. At the 2015 Global Entrepreneurship Summit, Convergence—an online transaction platform to facilitate blended finance—was announced, suggesting that donors’ new investment funds will increasingly make use of grants and concessional finance.
Continued research and innovation is necessary to understand what works in business development services (BDS), in both content and organizational structure. While there are examples of financially sustainable acceleration programs, and forthcoming research shows some indication that BDS may accelerate business growth, investors point out the need to understand what works in BDS and how it can be provided without philanthropic subsidy.
Many SGBs, especially impact enterprises, need support in prepping markets before they can scale. For example, for solar-powered lanterns, pre-competitive efforts such as developing consumer awareness and advocating for equal access to energy subsidies could spur entrepreneurial activity within the entire sector. However, these efforts go beyond what any individual SGB could be expected to fund.
There are underexplored opportunities to spur the growth of entrepreneurship with policy. Policy constraints hold back would-be entrepreneurs from starting businesses and keep informal enterprises from formalizing and seeking to scale. Common bottlenecks are administrative burdens, stringent labor market laws and limited bankruptcy protection. Proactive policy can also play a role in incentivizing entrepreneurship by, for example, revising government procurement processes to allow SGBs to participate.

[1] Gazelles are enterprises with ten or more employees, which have been employers for a period of up to five years, and have had an average annualized growth in employees greater than 20% a year over a three-year period (“Entrepreneurship at a glance”, OECD, 2014).

Research