Dead Aid to Igniting Spark
Future role of the third sector and blended finance in impact investing
Social enterprise and impact investing are du jour. An intoxicating combination of financial returns and doing good - what isn’t there to like. However, for many, the promised potential of this sector has a hollow ring. Consider ZanaAfrica, a wonderful social enterprise which manufactures high-quality sanitary pads that are affordable to these women and girls. 65% of girls in Kenya cannot regularly access sanitary pads to manage their periods - it’s a real tragedy. Given their life-changing mission and sustainable business model, you’d think it would be easy for them to raise impact investment capital but it isn’t. They are often faced with a stark choice between maintaining their social impact or profit-maximising to meet the high cost of working capital. As a result they struggle to realise their full potential.
We believe that for social enterprise and impact investing to play a significant role in addressing the Sustainable Development Goals (SDGs) the void between financial return and social impact must be bridged.
Starved of Oxygen
Investment is critical to support small and medium enterprise (SME) growth. SMEs create ~80% of formal employment opportunities in frontier and emerging markets, however they face an estimated US$930 billion financing gap in appropriate capital they need to grow. For example, Kenya, one of the two target countries, has a US$6.2 billion credit gap. In 2017, 70% of FDI was directed to only five companies, with 64% of SMEs struggling to access credit. The credit that is available is unaffordable for most SMEs, with interest rates typically between 20 – 25%.
Establishing a profitable enterprise in an emerging economy is challenging and is even more difficult when combined with also achieving social impact. These enterprises are considered too risky for commercial banks; with growth profiles not aligned to venture capital expectations; and too small for most private equity growth funds.
Impact investment can begin to fill this gap, financing impactful SMEs that generate jobs and provide essential goods and services contributing to inclusive economic growth. Over the past decade there has been significant flows of capital towards impact investing, however most of this capital is seeking similar market-rate returns and short time horizons as commercial capital.
Without access to finance these enterprises die.
From Dead Aid to Igniting Spark
Development aid and the third sector have come under fire in recent years. ‘Dead Aid’ by economist Damisa Moyo laid out how aid had created dependency, distorted markets, enabled corruption and failed to deliver economic growth. Many of those accusations are justified but it risks ‘throwing out the baby with the bath water’. Instead of acting as a form of ‘social welfare’ this capital can play a vital, catalytic role in economic and social development.
Foundations, Philanthropists and NGOs (third-sector) have mandates to address the SDGs and are looking for more effective ways to utilise their concessional capital and expertise to achieve their aims. Thus their risk-return appetite is a better match for needs/ reality of SMEs in sub-Saharan Africa. Worldwide, the third-sector hold total assets of US$1.5 trillion, with an annual expenditure of US$150 billion. However, the third sector has been slow to leverage their capabilities and move towards impact investing with less than 8% having explored impact investing approaches.
Fanning the flames of Blended Finance
Impact enterprises are ideal investment targets for mobilised third-sector impact capital to create substantial additionality – generating significant social impact alongside financial returns. Incorporating third-sector capital provides the opportunity to ‘de-risk’ these investments by structuring multi-tiered return requirements and can thus leverage finance from more commercial sources – including local banks and other debt providers. The private sector understands that the USD930 billion financing gap for SMEs is an investment opportunity. A recent GIIN report on private debt impact funds identified US$10.9 billion with a growing investor appetite (15% CAGR between 2012 and 2016).
The potential of blended finance is enormous but there are very few examples of successful models in the SME sector. Some of the market barriers that must be addressed to move forward includes:
Lack of evidence base of ‘oxen’ as a viable and impactful market segment.
Funders (concessional and commercial) and projects remain too distant from each other, and have misaligned expectations, in terms of risk-return and impact.
There are limited examples of blended finance partnerships with significant tenure and successful track-record.
Third sector lack experience and expertise in impact investing and thus inability to leverage their resources (financial and technical).
Lack of incentive and innovation in the private sector to create appropriate financial products (credit requirements, cost, type and nature).
Insufficient coordination, partnerships and learning among investors and with other ecosystem players prevents scaling.
Evolve or Die!
The third sector is under significant pressure to justify its existence in an era of diminishing resources. Now is a critical opportunity for the third sector to re-envision its mandate and re-purpose its capital. The void between impact and return must be bridged - we have only 10 years left.