Alternative Financing Models and Innovation Capacity of MSMEs in Kenya: A Post-COVID Analysis

Abstract

Micro, Small, and Medium Enterprises (MSMEs) form the backbone of Kenya’s economy, yet their innovation capacity has historically been constrained by limited access to traditional financing mechanisms. The COVID-19 pandemic amplified these challenges, creating liquidity shocks and reduced lending, while simultaneously highlighting the need for adaptive financing strategies. This study examined the effect of alternative financing models on the innovation capacity of MSMEs in Kenya in the post-COVID period. Specifically, it explored the influence of digital credit platforms, crowdfunding, cooperative financing, venture capital, and green financing on product, process, and market innovation. A mixed-methods design was employed, drawing on panel data from 2014 to 2023 complemented by survey responses from 312 MSMEs across key urban centers. Panel regression results indicated that digital credit platforms and cooperative financing had the strongest positive effect on innovation, enabling MSMEs to invest in process improvements and product diversification. Crowdfunding and venture capital were also significant, though constrained by regulatory and awareness challenges, while green financing exhibited emerging potential particularly in manufacturing and service sectors pursuing sustainability. The study concludes that alternative financing models provide viable pathways for MSMEs to enhance their innovation capacity by reducing dependency on collateral-based lending, fostering flexibility, and facilitating resilience in dynamic environments. Based on these findings, it is recommended that policymakers strengthen the regulatory environment for crowdfunding and venture capital, while financial institutions scale up accessible digital credit solutions tailored for MSMEs. Cooperative societies should be incentivized to expand innovation-linked financing, and government should introduce tax incentives or guarantee schemes for green financing to encourage broader uptake. For MSMEs, adopting blended financing approaches that combine traditional and alternative sources is advised to ensure sustainable innovation capacity and competitiveness. Overall, the study demonstrates that alternative financing models are critical enablers of post-COVID recovery and long-term enterprise growth in Kenya, providing practical lessons for emerging markets facing similar challenges.