ImpactAlpha, Feb. 11 – Change the incentives, change the results.
Those results are dramatic for the $11.5 million in loans that agricultural lender Root Capital has made over the last two years to agribusinesses across Latin America deemed too small or too risky for other lenders to make.
The nearly three dozen businesses went on to generate almost $50 million in revenue. They paid $41 million directly to smallholder farmers in Colombia, Costa Rica, Guatemala, Honduras, Mexico, Nicaragua and Peru. Already, four of those businesses have been able to access new loans from other sources.
The small and “risky” loans are on top of Root’s regular lending activity. The catalyst: Just $1 million in “outcome” payments from the Swiss Agency for Development and Cooperation and IDB Lab, the innovation laboratory of the Inter-American Development Bank Group. The “social impact incentives” scheme, known as SIINC, is proving effective at incentivizing companies and fund managers to go down market, to serve lower-income customers, and early-stage enterprises otherwise unable to access finance.
The payments effectively compensated Root for the additional cost of lending to smaller and higher-risk agriculture companies. IDB Lab kicked in another $550,000 for Root Capital to provide technical support to the enterprises.
Root Capital will now leverage an additional $750,000 in SIINC outcome payments to deploy roughly $6 million in loans to 25 early-stage businesses in Latin America.
Bolstered by such successes, Roots of Impact, the German advisory firm that popularized the model, is expanding “impact-linked finance” to loan repayments and revenue sharing agreements. The firm is also seeking to scale up the model, with multiple sector-based facilities that pool donor funds and distribute incentives to a portfolio of enterprises.
Last year, Root Capital alumni Brian Milder launched Aceli Africa. As part of the model, the vehicle deploys donor capital to compensate roughly two-dozen financial institutions for the lower revenues and higher costs of originating loans to new, high-impact African agribusinesses (see, “Smart subsidies for Africa’s high risk, low return smallholder finance market”).
“Impact-linked finance is getting massive traction now,” Roots of Impact’s Bjoern Struewer told ImpactAlpha. More public and philanthropic donors are deploying the model to drive more social and economic outcomes in private markets. “It’s clear how to build this model based on achieving outcomes.”
When the effort launched two years ago, Root Capital’s Willy Foote said, “The SIINC model is a game-changer. It will enable Root Capital—and ultimately many other financial institutions—to lend to the enterprises that need it most.”
The results suggest that linking impact to financial rewards can be a strong lever for catalytic donors and funders looking to close hard to fill capital gaps.
In an earlier SIINC pilot, the SDC paid out $275,000 over two years to Clínicas del Azúcar, a string of diabetes clinics in Mexico, for serving an additional 10,000 low-income clients. By opening up the market, Clinicas raised an additional $7.5 million in equity and debt from impact investors and development finance institutions including the IDB and International Finance Corporation.
“It’s important that the incentives are where the value is created, and this is typically on the ground,” says Struewer.
Another four SIINC transactions are underway and 13 others are in the pipeline across Asia, Africa and Latin America. Struewer says the firm has secured funding for up to three-dozen additional transactions. Outcome payers have expanded from the SDC to include the IDB Lab, German development bank DEG and the Netherlands’ Aqua for All.
To help social enterprises in Latin America stay on mission during the pandemic, Roots of Impact and the SDC launched impact-linked finance projects with New Ventures’ Viwala in Mexico and Open Road Alliance in the rest of Latin America.
For investments in alumni of regional social enterprise accelerator PES Latam, SDC payments reduced the multiple companies owed on revenue share agreements (in the case of Viwala) and reduced repayments on loans (in the case of Open Road).
Key to the scaling strategy are sector specific approaches, says Struewer, “where you can learn from repeating and repeating and repeating and also create standardized frameworks, in particular on the impact side.”
Roots of Impact is working with donor partners to develop section-level facilities to deploy incentives to enterprises in off-grid energy, gender-inclusive fintech, water, sanitation and hygiene, and agtech.
“It’s providing SIINC on steroids,” says Struewer.
Years of internal studies, and other external literature, demonstrate that agricultural businesses generate impact in rural communities. What they lack is the credit that they need to be able to pay farmers on time, connect them to markets and build infrastructure.
The model “is catalytic,” Root Capital’s Katie Naeve told ImpactAlpha. “It’s about bringing in these businesses for the first time, providing them the resources and the services that they need to grow, and once they grow, they no longer need subsidy and support.”
Root received at least $22,000 per loan, with bonuses for additional impact. “High additionality” means no other lender would make the loan, while “medium additionality” indicates only government entities or other social lenders would lend. Loans to gender-inclusive businesses get a $1,000 bonus.
“With that capital commercial lenders aren’t willing to provide, these businesses can generate that impact and grow,” says Naeve.
In a year and a half of the program, more than half of the businesses grew an average of 41%. That not only puts them on a trajectory to be eligible for loans in Root’s broader portfolio, but places them in the pipeline of the broader community of smallholder ag lenders.
Within the Council on Smallholder Agricultural Finance, a network of social lending institutions, Root Capital lends at the lower end of the market and is a substantial source of new clients into the CSAF portfolio.
“If SIINC allows Root Capital to bring in that many feeder clients and help them grow,” says Naeve, “imagine what all CSAF members could do if they also have this support.”