A Missing Middle?

Back in November 2023, I had the opportunity to attend the FLII CA&C conference in Honduras, a great space to learn about the investment environment in Central America. One strange thing that stood out to me was that out of the hundreds of participants, entrepreneurs and investors, there really wasn’t any presence of medium-sized firms or funds targeting this range (say of revenues greater than $1 million, for example). Virtually everyone was at the micro or small scale. I began asking participants, entrepreneurs and funders alike, why this was the case. Most responded with the known answer that there’s a “missing middle”. But is there really?

Some people will say that there certainly exists a missing middle in developing countries, a notion made popular by James Tybout (2000) and Anne Krueger (2009). Others will point out that this is a misconception based on how the data was constructed, see Hsieh and Olken’s paper titled The Missing “Missing Middle”. This question is important to Bahlam because this is where we operate. We are in the latter camp and firmly believe that there is not a missing middle in Central America. Sure, this group is smaller than other firms (think about the large amount of informal work that exists in C.A.), but to say it doesn’t exist is wrong. For example, Bahlam has built, through our network, a proprietary database of around 500 firms that have estimated annual income above $4 million. From this database we have identified 32 highly promising opportunities to invest in (you can read more about our sectors and approach here).

As to why there wasn’t much representation and interest from medium-sized firms in the conference, I cannot say for certain. Some might argue that it is because these firms have access to cheaper capital when compared to their smaller counterparts. This isn’t true either, we know of several medium-sized firms who can’t get finance at a rate lower than 18% (see our blog about the challenges of finance in C.A.). What I can say with certainty, though, is that it is at least as important to focus on supporting medium-sized firms than it is helping others. Here’s a few reasons why:

  • The financial returns are higher: even if they can sometimes face higher barriers to growth than smaller firms, the returns are greater. If over 8 years you were to triple the yearly revenues of a small company, say from $250k to $750k, the returns of tripling a medium company is much greater, say from $5 to $15 million. This is what we managed to accomplish with one of our investments.
  • The social impact from medium-sized firms on jobs is bigger: Bahlam managed to increase the number of full-time employees in one of its investments from 30 to 80. Smaller firms might grow from 2 to 10 or 15 employees, great for the economy, but not comparable to the impact of a medium-sized one. We increased our number of full-time employees by 60, and these are well-paid jobs averaging $1,200 per month (significant for a country like Honduras) and this number does not include the salaries of the CEO or other high paid managers.
  • They are safer to invest in: It is one thing to open a business in Central America, it is quite another to successfully operate it. Medium-sized firms in these countries have figured out how to operate and survive the challenging business environment, making it more likely that they won’t fail. What they need is the resources and capabilities to grow, and this is why a dedicated manager with a differentiated strategy, such as Bahlam Capital, is needed.
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