4.4.3 Understand the challenges of using loan guarantees in your context before you start
After five years of operating the loan fund, PROBIDE has identified several challenges to loan guarantees for youth entrepreneurs. The first involved streamlining the business plan and evaluation process to include a simple, reduced business plan format that could be filled out online on a rolling basis. This way, the banks were able to manage a steady flow of one to two projects per week versus 50-100 all at once. The reduced business plan also saved time in evaluating the businesses.
The second challenge was geographic where 64 percent of the youth businesses financed were located outside of Lima. As a result, PROBIDE used local contacts as regional coordinators to closely monitor these businesses. This system however was costly.
Thirdly, PROBIDE found it difficult to incentivize private companies to contribute to the guarantee fund since there is little benefit to doing so. Finally, the guarantee fund presented sustainability concerns. During the project PROBIDE had the advantage of using pro bono advice and overhead costs from the university. Moving forward PROBIDE will need to ensure the university sees enough value - i.e. reputation, potential to expand advisory service role, etc.- in providing this type of pro bono service.
In Uruguay, the IDB took a different approach than PROBIDE to funding youth-owned enterprises. The unique context in Uruguay – a government commitment to investing in research and development in the software industry- encouraged the IDB to develop a seed capital fund to support technology-focused high growth potential businesses. The target market was more educated, all with university degrees, and mostly focused on software and technology. These market characteristics required larger loan sizes and longer terms. Rather than a guarantee fund, which would be more expensive and less likely to generate interest from investors due to the elevated risk associated with the larger loan size (average US$40,000), the IDB partnered with a venture capital fund company who created a seven-year convertible loan with US$1.1 million in seed capital. Loan sizes range from US$20,000 to 50,000, have a three-year grace period on the principal, and require 10 percent quarterly interest payments. Entrepreneurs have the option to defer payment or to prepay without a penalty. The number of businesses funded is much smaller than PROBIDE, 20 firms have been financed since 2007. These businesses, however, have created an average of 8.5 jobs each while the PROBIDE businesses have created an average of 4.1 jobs each. Two of the loans have since been converted into equity and seven firms have obtained a second round of financing, totaling US$3 million investment from the venture capital fund and business angels. This model is particularly attractive to venture capitalists because it allows them to potentially double their expected earnings.