Farm subsidies are not unique to Africa. Agriculture in the US, Europe, and nearly everywhere else depends on government support and incentives.
In Africa, where the agriculture sector faces a $75 billion financing gap, impact investors have an instrumental role to play in making subsidies work better for the small farms and businesses that grow and process a majority of the continent’s food. The key: targeting limited concessionary capital to the operating needs of agri-food businesses and the funds that support them.
New research on agri-finance funds in Africa finds that concessional financing is often used to crowd in commercial capital by reducing risks and enhancing returns for senior investors, “rather than to pass along some benefits to the underlying investee,” according to ISF Advisors, which surveyed 18 funds in Africa about their business models, capital stacks and experiences with investors for “Concessional capital for agri-SME funds“. This slant in blended-finance structuring could make long-term capital mobilization for the sector even more difficult.
Case in point: Finance in Motion’s Eco.business Fund, an open-ended debt fund for microfinance institutions and other agri-business lenders, is made up of concessional debt and equity tranches that buffer losses and enhance the upside of the senior debt and equity tranches. It has raised $20 million in junior debt against $6 million in senior, and $68 million in junior equity against $30 million in senior.
The fund operates in the relatively low-risk wholesale debt sphere of agribusiness finance, financing intermediaries, versus higher-risk direct lending and equity strategies.
Yet the high ratio of concessional to senior financing underscores the misalignment of investors’ real versus perceived risks. Intermediary lenders surveyed, like Finance in Motion, estimate about 2% losses, while direct lenders estimate about 2% to 3% losses. Their funds offer senior investor protections of 15x to 20x those amounts.“Senior investors are indexing to the worst case scenario, not to the average scenario,” ISF Advisors’ Dan Zook tells ImpactAlpha.
The result is inefficient use of a scarce resource. “Directly linking the size of the junior tranche to the economics of the fund would reduce the chances of overcommitting concessional capital,” the ISF report recommends.
Impact intent
That’s not to say that there aren’t merits to structuring funds to bring more private and commercially-minded capital to Africa’s underfinanced agribusinesses.
When AgDevCo started 15 years ago, it was one of the few dedicated private credit providers for Africa’s agribusinesses. It was financed with first-loss junior equity from the UK Foreign Commonwealth and Development Office, then called DFID. Seven years ago it pivoted to mostly mezzanine financing and increased its average ticket size in a bid to become more commercially sustainable.
That pivot enabled AgDevCo to raise $90 million from British International Investment, Norfund, and the US Development Finance Corp. – all senior equity investors that invested because of their protected positions in the fund and AgDevCo’s “lower-risk” strategy. The trade-off: “its ability to provide early-stage capital that nascent small businesses critically need, as it did under its previous strategy,” ISF finds.
The report’s authors suggest that agri-finance fund models that are focused on very small businesses, like SME Impact Fund in Tanzania; underserved markets, like Sinergi’s Burkina Faso-focused fund; that are explicitly designed to be market makers, like Aceli Africa; and almost any agri-finance fund raising less than $50 million “are likely to depend on subsidies indefinitely.”
With this in mind, the question is how much impact investors want to have, says Zook. Short-term debt strategies are less risky, he explains, but “they’re not necessarily going to have the same depth of impact as an equity fund that are meeting a massively underserved need for companies that really need that capital.”
Anchor influence
Examples of where concessional capital is punching above its weight include Acumen’s Resilient Agriculture Fund, which secured $25 million in first-loss junior equity from the Green Climate Fund that helped catalyze $33 million from the French and Dutch development banks, Proparco and FMO, Open Society Foundations, Children’s Investment Fund Foundation, Global Social Impact and other investors.
As ARAF’s anchor investor, Green Climate Fund influenced Acumen’s thesis, including a stronger focus on climate adaptation. It helped Acumen recruit a dedicated climate expert to its team. And it kicked in an additional $2.5 million in technical assistance funding to help the fund’s portfolio businesses manage climate risks and build and strengthen gender inclusivity.
“This collaboration not only contributed to ARAF’s success but also developed sector-wide tools and frameworks, paving the way for the success of future climate adaptation funds,” state ISF’s authors.
“Anchor investors that provide junior capital are crucial for the successful establishment of funds in high-risk market segments,” ISF stresses. In African agri-finance, 16 of the 18 funds featured in the survey had anchor investors, some putting up 40% of the fund’s total capital raise. Most of these investors are bilateral development agencies, like Germany’s KfW or the UK’s FCDO, or foundations.
Development finance institutions, on the other hand, largely have to be incentivized to invest in agri-finance funds. In both ARAF and AgDevCo’s fund, DFIs took senior positions with loss protections.
DFIs can write bigger checks than most other non-commercial investors, bringing critical capital into the sector. But “in many cases, their risk tolerance may not be much different than commercial investors,” finds the report. Moreover, their risk mitigation expectations “may compromise the depth of the additionality generated.”
Execution and innovation
Layering concessional investment capital with technical assistance, fund design grants and other tools, as Green Climate Fund did with ARAF, can be an effective way to mitigate a fund’s portfolio risk and deepen impact. Many of the fund managers surveyed by ISF said technical assistance is a crucial but underfunded tool. All but one offer post-investment support to their portfolio companies. “However, most fund managers mentioned their technical assistance budgets were insufficient,” the survey finds.
Furthermore, “there is no methodology to determine the ideal size of a technical assistance fund.” Ten percent of a fund’s total size has become a standard, but managers say it is not aligned to the real need.
To compensate for lack of technical assistance funding, agri-finance fund managers are joining up with specialized providers, like the Global Alliance for Improved Nutrition, a partner on Incofin’s Nutritious Food Financing Facility, and the Consultative Group on International Agricultural Research, which is working with ResponsAbility’s Climate Smart Food Systems Fund.
Sinergi is providing technical assistance on the front end of its Burkina fund: it runs a donor-funded accelerator program, which serves as an investment pipeline funnel and helps mitigate investment risk by strengthening potential investees’ businesses. It also offers Sinergi an added revenue stream to backstop its challenging fund economics.
Zook tells ImpactAlpha that there is a growing number of local fund managers whose local market knowledge offers an advantage to mobilizing and deploying capital and resources economically. Amid a retreat in international development financing, “that first-loss capital, that anchor funding is so critical to get these local funds going, because it sends a signal to the market,” he says.
But even managers raising their second, third or fourth funds will continue to depend on concessional financing if they seek to be responsive to agribusinesses’ evolving needs. Investors are more likely to back experienced managers, yes. But “positive track records may pigeonhole fund managers into certain fund structures and investment strategies, limiting opportunities for innovation,” ISF observes. “When trying to add a layer of innovation, fund managers typically require higher levels of concessionality to protect senior investors who prefer that managers stick to proven strengths.”
“Stakeholders across the industry – donors, other investors, and fund managers,” ISF concludes, “would benefit from more transparency to ensure better collaboration.”
