Innovative African entrepreneurs will benefit from blended finance model
Entrepreneurs across Africa are coming up with innovative solutions to everyday problems, which often also create jobs and solve social challenges. Yet many of these solutions never reach the market.
Consider EcoZoom East Africa, a social enterprise producing solar-powered lamps and portable, clean-burning cooking stoves. More than 80% of households in sub-Saharan Africa use wood, charcoal or animal waste as fuel for cooking, which produce gases that are harmful to the household and damaging to the environment.
Families, often women, spend up to 20 hours per week collecting the firewood and charcoal needed for cooking, limiting the amount of time they can spend on income-generating activities. Fetching firewood in remote areas also means they are more exposed to gender-based violence.
EcoZoom’s stoves offer solutions to these challenges: 60% less smoke than traditional cooking systems and 70% lower fuel requirements, providing health benefits, environmental gains and increased opportunities for women empowerment. Small and growing businesses such as EcoZoom make up about 90% of sub-Saharan Africa’s business operations and contribute to more than half of the region’s employment and GDP. However, 45% of these businesses lack access to investment to help them grow, scale and maximise their impact.
Part of the reason for this is that traditional financial institutions are understandably reluctant to invest in early-stage businesses, since they are inevitably high risk. To become sustainable, these businesses also often require business development support, which places further demands on investors. To improve their chances of earning a return, financial institutions often have to be willing to be “hands-on” in assisting enterprises with business models, skills development and strategy. For most financial institutions, these risks and costs are simply too high.
This is especially the case when it comes to investing in early-stage businesses that explicitly target social or environmental impact. These kinds of enterprises often use new, untested business models that are even less understood and therefore even less likely to receive investment.
It’s a situation that demands a novel approach and non-profit impact investing firm MCE Social Capital is providing just that. MCE has designed a solution to generate economic opportunities for early-stage, emerging-market businesses such as EcoZoom. Its unique model works with high net worth individuals, foundations and charitable trusts who act as guarantors on loans to small businesses. These guarantors pledge tax-deductible contributions to cover a loss if a business fails to repay a loan. Using these guarantees as collateral, MCE borrows funding from financial institutions and accredited investors, which is on-lent to small businesses at affordable interest rates.
In doing so, the fund creates jobs, supports smallholder farmers, improves access to clean water and electricity, and helps lift people out of poverty. What makes this model particularly compelling is that it is backed by a blended finance structure that brings together philanthropic or concessional finance (from governments, donors or development agencies that are willing to accept below-market rates) and private capital to achieve the same goal. Without this innovative blend of funds, it’s doubtful whether the kind of early-stage finance companies like EcoZoom need would be available.
Blended finance, a structure that uses grant or concessionary finance to reduce risk to private-sector investors, is rapidly gaining international acceptance. The power of this model is that public-sector or grant funding, which previously might have been the only financing available, becomes a tool for leveraging investments of potentially many times more. This exponentially increases its impact. MCE Social Capital’s philanthropic guarantors are doing exactly this.
Another organisation that has done this successfully is USAid. Through its partnering to accelerate entrepreneurship (Pace) initiative, USAid provides funding to catalyse private-sector investment into early-stage enterprises. Pace has partnered with more than 40 incubators, accelerators and seed-stage impact investors, including MCE Social Capital. These partnerships are expected to leverage $100m of private and public capital over their lifetime, illustrating how effective blended finance models can be.
For private investors, the potential impact is an added bonus, since they still benefit from market-rate financial returns.
By decreasing the risk to private investors, the commercial opportunity for investing in early-stage businesses becomes more attractive, thanks to their high growth potential. This also means that public and philanthropic funders can focus on channelling their money to businesses targeting social and environmental returns, and — simply by doing that — make them more attractive as commercial investment opportunities.
For private investors, the potential impact is an added bonus, since they still benefit from market-rate financial returns. In addition, blended finance gives donors the opportunity to use their funds in a way that builds an ecosystem and has more of a systemic impact than once-off grants or donations. Instead of donating R5m to a single climate-change project, for example, a donor could commit R5m to a blended finance fund supporting small-scale installations that could potentially leverage R20m or R30m in private-sector investment.
Globally, many philanthropic organisations are realising the potential in doing this. They are moving away from providing funding on a project-by-project basis to rather using their money to build broader ecosystems. In SA specifically, discussions are starting to take place on how we could do something similar with enterprise development spending. Under the revised broad-based BEE codes, large companies are encouraged to allocate 2% of their net profit after tax to supplier development initiatives and a further 1% of net profit after tax on enterprise development. In total, this amounts to about R30bn a year.
With the inclusion of blended finance models that support the ecosystem, this would have incredible potential for developing more sustainable, impactful businesses such as EcoZoom that can have a material impact on the continent’s future.
•Suchecki is the innovative finance and impact investing project manager at the Bertha Centre for Social Innovation and Entrepreneurship at the UCT Graduate School of Business.