Impact investors are no stranger to private debt. But are they too shy about these instruments, right when impact-focused fintech companies need them the most?
It’s a reasonable question for any institution, family office or high net worth individual intrigued by financial technology companies serving underbanked populations in developing markets. Having gained traction over the last half-decade, these pioneers in responsible digital finance are ready to scale. Another equity-led capital raise isn’t the most efficient way to get them there. Private debt is.
Impact-focused fintech companies have played a pivotal role, alongside microfinance firms, development finance institutions and others, in promoting financial inclusion. These companies have devised innovative methods to connect debtors and creditors with traditional underwriting techniques. Some have transformed the rules of underwriting altogether. Their emphasis on technology has solved many of the inefficiencies that can prevent financial services from reaching worthy individuals and businesses.
The financial impacts of these companies are measurable; the societal benefits they provide are immeasurable. One company that MicroVest has worked with is Zoona, a fintech company operating across Southern Africa. Zoona utilizes an expansive agent network to enable over one million individuals to make payments electronically without making the arduous and potentially dangerous trek to distant bank branches.
For Zoona and other first-generation impact fintechs, the business model has been proven. The technology and infrastructure are in place. To further bridge the divide between the underbanked and low-cost financial products, they need the financial capacity to expand their services and their user base.
Most impact-focused fintechs have relied on Series A and B fundraising rounds to secure capital. Given the relative success of these fundraising efforts, it’s tempting to say that this capital can serve two objectives: growth and scale. It can’t.
Ultimately, equity capital is best deployed to spur growth and achieve efficiency. To attract and support new users, capital must continuously be going into marketing, bolstering credit teams and technological development. Without new innovations and operational efficiencies, the costs of lending becomes too high for these companies to sustain their business model.
In contrast, private debt provides the liquidity needed for loan-making. It also happens to be an untapped reservoir of potential for impact-focused fintech companies. Currently, most fintech balance sheets are free of borrowing or leverage. This is a surprise: according to an April 2018 report from the Global Impact Investing Network, private debt is the most popular asset class in impact investment portfolios.
There are some perfectly logical, if sometimes inaccurate, reasons behind this. Impact investors might be nervous about the ability of fintech companies to ascertain the credit risk profile of individuals or businesses in developing markets, making them hesitant to provide the capital to fund loans. For many fintechs, however, the opposite is true.
Though some fintechs are focused on alternative credit lending models, many are simply using technology to deploy tried and true underwriting methods more efficiently. The underwriting models being utilized by this latter group and the very short duration of loans means that the balance sheet risks are far better managed than most people realize. And the firms’ business models are solid, and often cultivated by former banking professionals who see the potential of serving underbanked populations in more ethical and efficient ways.
Private debt comes in a variety of structures, suited to an array of risk, return and impact appetites. One approach could involve lending through master trust structures, where capital is deposited straight into the trust and consumer or business loans are distributed straight from it. Other structures involve revenue-sharing and bridge financing between equity rounds.
The abundance of flexible investment opportunities such as these should intrigue many impact investors. But what should really motivate these investors into embracing private debt is the opportunity at their feet: turning a nascent marketplace for impact fintechs into a thriving one.
It’s up to investment firms to accelerate the pace of providing financial services, in order to give fintech companies a means to achieve the financial and societal impact we aspire for.
The industry is starting to realize this. More streamlined access to capital was among the International Finance Corp.’s guidelines for responsible digital finance. The initiative was developed and launched earlier this year by more than 50 co-founders, including MicroVest.
The more impact investors embrace private debt as a catalyst for scale, the more fintech companies will succeed in their mission to promote financial inclusion across developing and frontier markets.
John Beckham is Microvest’s chief investment officer.