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NEW IDEAS FROM THE WORLD BANK OF SMALL AND MEDIUM ENTERPRISES World Bank Group SME Department Vol. 2, No. 1 March 2001 A thriving SME sector is crucial to spurring growth and reducing poverty in developing and transition economies. But financial institutions often avoid SMEs, sensing—understandably—that the transaction costs of financing them will be excessively high. What SMEs need is not to be left without access to capital, but approached on a new model that combines early-stage equity investment and performance-enhancing technical assistance, writes Bert van der Vaart, CEO of Small Enterprise Assistance Funds (SEAF). This US- and Dutch-based NGO manages a network of 14 commercially driven investment funds worldwide with total assets of $140 million, and has developed a unique “equity plus assistance” approach to SME investing. Small and medium sized enterprises (SMEs) Sare widely credited with generating the highest rates of revenue and employment growth in virtually all economies. In transition and developing countries open to foreign direct investment, they also tend to pay disproportionately more in taxes and social security contributions than either their larger and smaller counterparts. Larger enterprises, especially multinationals, often find a way to reduce their tax obligations through transfer pricing, royalty payments, and negotiated tax holidays. Microenterprises, on the other hand, often fall in the informal sector, neither paying taxes nor making social security contributions. Yet if SMEs constitute a critical dimension of growth and development and are often well positioned to achieve high revenue and profit growth, why have private and public financing institutions alike tended to avoid investing in them? The reasons are multiple and, for the most part, understandable. For private investors, the amount of work required to invest relatively small sums into several SMEs seems unattractive compared to the work needed to support fewer investment