ImpactAlpha, Aug. 24 – AA Fisheries is the kind of enterprise impact investors talk about all the time. But too few turn talk into the capital such businesses need to survive and thrive.
The fish farm supplier in Eastern Uganda was a solid performer until the COVID crisis shut it down. But solid is not what most equity investors, including impact investors, are looking for. Meanwhile banks, especially in emerging markets, largely dismiss small and growing businesses as risky and costly, or charge interest rates that put loans out of reach.
That “missing middle” represents an annual financing gap of at least $930 billion – hence the long-running discussions about how to bridge the capital gap for small and growing businesses among many impact investing and international development organizations.
Netherlands and Uganda-based iungo capital (which uses lower-case for its name) is one of the few capital providers in East Africa to turn the talk into action. In 2017, iungo provided a loan to enable AA Fisheries to buy more hatchlings to sell to farmers in Uganda and the Democratic Republic of the Congo. The loan was the kind of inventory finance and working capital that makes up so much of emerging markets’ small business finance gap.
“The majority of businesses in Africa—probably 95%—will never achieve 3x or 5x growth,” which is the minimum that most equity investors need to justify an investment, says iungo capital’s Roeland Donckers.
Such business owners also are unlikely to give equity investors the exits they expect, typically through acquisitions by larger companies. “Most of them are family businesses. The business is their bread and butter,” says Donckers. “They don’t want to do equity because they don’t want to give up ownership; they want to pass their business on to their kids.”
Defense and offense
If financing was tough before COVID, the crisis has made capital even more scarce for small and growing businesses. Again, iungo has tried to turn talk into action.
One quarter of iungo’s portfolio of two dozen companies in Uganda, Kenya and Rwanda have halted operations altogether, including AA Fisheries; companies have laid off anywhere between 17% and 79% of their staff.
In April, iungo paused loan repayments for three-quarters of its portfolio companies. It is now offering relief capital, at deeply concessionary rates, from an emergency fund of nearly $500,000 from the Doen and Schooner foundations, two of iungo’s investors.
For most of the portfolio, markets are expected to rebound after lockdowns end. “The problem is their liquidity has dried up. They need capital to get back on their feet,” says Donckers. Emergency loans will be used to help companies restock inventory, rehire furloughed staff and implement COVID safety measures.
A new commitment of $4 million from the U.S. International Development Finance Corp., or DFC, means that iungo will also be able to play offense, as well as defense. The firm has completed seven deals since the onset of the global pandemic, bringing its portfolio size to 24 since it launched in Uganda in 2016. The types of businesses in iungo’s portfolio include the fish farm supplier, as well as a farm equipment provider, a transportation management company, and an engineering firm.
Businesses can secure up to $500,000 from iungo (the average ticket size is about $200,000), with a commitment to repay over three-to-four years, on top of a cut of revenues.
iungo is one of East Africa’s few providers of ‘mezzanine’ financing, a flexible category including financial terms that are neither traditional debt nor equity. The terms offer small businesses the growth capital they need; the structured exits, in the form of repayments, give investors greater certainty of a profitable (if below-market) return.
“iungo stands out as unique in our portfolio,” says Richard Greenberg, who heads up the Social Enterprise Finance group at the DFC. Financing small businesses the way iungo does is difficult for most investors, he acknowledges, particularly in amounts of less than $1 million, which the majority of emerging market small businesses need.
Greenberg acknowledges the uncertainty that comes with putting money in the hands of small, first time capital providers like iungo for a market segment that most other investors and commercial lenders avoid due to risk perception. But investing in small businesses via an intermediary like iungo affords DFC an opportunity to indirectly experiment with creative financing structures.
“There’s an important role for the DFC and development finance institutions to play in this market. The capital that small and growing businesses need is not going to be available in the market, generally speaking,” he explains. “We were interested in identifying an intermediary that could take some of our capital and use it productively.”
A number of emerging-markets focused venture and impact funds invest in small businesses indirectly, through tech-enabled startups that are rolling up, streamlining or disrupting whole sectors of local economies. For example, software developer Field Intelligence, for example, raised $3.6 million from venture capital-style impact funds earlier this year to help Africa’s small, locally-owned pharmacies predict, manage and finance their drug inventory needs. Food logistics companies Twiga Foods and East Africa Fruits both secured investments this year for streamlining East Africa’s fragmented farm-to-market food chain, supporting both farmers and informal food retailers along the way.
There is certainly a place for this style of impact investing, given the increasing number of homegrown tech startups and tech hubs in Africa, Asia and Latin America. But the spectrum of opportunity is narrow, and the high expectations of growth mean equity capital isn’t what most businesses want or need.
iungo, in contrast, invests directly in operating businesses, such as light manufacturing and agri-processing enterprises, that reach large numbers of everyday consumers, suppliers and workers. Its thesis includes improving business resilience and performance through impact-targets to which its financing terms are tied, like paying a reasonable living wage or offering company-wide health insurance.
The firm launched four years ago to respond to the market’s enormous capital gap for such businesses. Being nearly alone in the sector with the highest number of businesses gives iungo a robust pipeline and often first pick among the most promising opportunities. “The challenge is coming up with a way to reduce costs and risks,” Donckers says.
iungo operates as a holding company rather than a traditional fund structure, which gives the firm flexibility with the financing terms it offers. The firm diligences its pipeline and offers technical assistance through its investment readiness arm, iungo xl, and co-invests with a network of local angel investors whose business credibility and market knowledge help iungo hedge risk and support its portfolio.
iungo secured early backing to test its thesis and model from the Dutch Good Growth Fund’s pilot fund for first-time emerging market fund managers, which committed $800,000 in 2016. DGGF re-upped with additional commitments, alongside family office Ceniarth, the Doen Foundation and Schooner Foundation. Collectively, the group of investors chipped in another $6 million in debt and equity capital.
Its latest commitment comes from the DFC’s recently expanded Portfolio for Impact, which invests in emerging market enterprises and intermediaries providing access to basic services and support for local small businesses. The initiative, now called Portfolio for Impact and Innovation, or Pi2, has capacity to invest up to $900 million in debt, equity and other mechanisms.
The DFC diligenced the investment before the pandemic shut down in-person visits. And though iungo is a first-time fund manager, its track record making investments for the past few years enabled DFC’s team to visit a number of iungo’s portfolio companies. “That was a really helpful way to get inside the head of the organization and see how they’re executing,” says the DFC’s Alec Paxton.
Of course, much has changed in the world since the DFC performed its on-the-ground due diligence. But the DFC says it remains confident about cutting new checks in the current emerging-market business environment.
“We tend to take the long view and think past the next six months or year,” explains Paxton.
Adds Greenberg: “Sure, it is going to be more difficult now, and come with certain risks than before the COVID crisis.” Still, he says, “We think it’s an appropriate role for DFIs to play.”