September 3

Aleem Walji

NexThought Monday: It’s a Capital (Plus Advisory) Problem, Not a Pipeline Problem

Editor’s note: This post was originally published on the World Bank’s Development Marketplace blog and republished here with permission.

I recently returned from travel to India and East Africa where I attended a round table on social enterprise with the Government of India and met impact investors focused on Kenya, Tanzania, Rwanda, and Uganda. After listening carefully to entrepreneurs, investors, and government officials, I’m compelled to say something entirely inconsistent with conventional wisdom in the world of impact investing: there is not enough capital to support the pipeline of enterprises focused on solving our most vexing social problems. By social problems, I mean the provision of basic goods and services to the bottom of the economic pyramid where governments and markets often fail.

Take access to energy for example or access to sanitation in much of Africa and South Asia. More than 1.3 billion people on the globe still lack access to electricity and over 2.5 billion lack basic sanitation. Every 20 seconds a child dies because of poor sanitation.

These are public goods and unambiguously the responsibility of public actors. But in reality, governments often don’t have the resources, the will, or the capacity to provide these basic services to many of their citizens. And purely commercial enterprises lack incentives to provide services where financial upside is limited and the ability of poor people to pay is constrained. But this is precisely where inclusive (or socially driven) businesses and social entrepreneurs, for profit and not-for-profit, are innovating and developing new business models to solve our most pressing social challenges.

But flexible and longer-term capital is in short supply in the marketplace. This capital should align with an enterprise’s stage of maturity, business model, and possibility of exit whether to commercial investors, hybrid investors, or public actors. There remains a need for grant capital but grants need to be strategic, much like Angel finance. It must also be the most risk-tolerant capital, and unlock other forms of capital such as debt, equity, or permutations of the two.

Inadvertently, the field of ‘impact investing’ has done society a great disservice by implying that all problems can be solved by market-based solutions. There continues to be a role for public actors, civil society and the ‘longer-term capital they can bring. Ironically, advanced economies continue to provide many kinds of subsidies to industries like health care, education, agriculture, while pushing for basic services like water, sanitation, and education to be commercially viable in the developing world.

This is not to deny opportunities ‘to do good and do well’ in many emerging markets. Significant risk-adjusted financial returns are achievable in areas like fast moving consumer goods, energy, telecom, and even broadband. But emerging market investors have been active in these sectors for years and balance risk with reward. The opportunity today is to go beyond ‘emerging markets’ and consider how different forms of private capital and financial instruments ( impact bonds) can help solve frontier challenges like food security, off-grid energy, climate change and youth unemployment. While many of these wicked problems require convening multiple stakeholders, the opportunity to layer different forms of capital through financial innovation could really help move the needle on poverty.

Monitor’s recent report “From Blueprint to Scale” proposes that ‘enterprise philanthropy’ could unlock significant amounts of commercial capital if ‘risk tolerant grant capital’ were willing to invest in areas where others could not or would not. Why can’t philanthropists act as ‘angels’ for social enterprises and use grants to unlock other forms of capital? Combining grants with subordinated debt and quasi-equity instruments could bring new investors to the table to realize different rates of return (social and financial).

Where markets and governments fail, multilateral institutions like the World Bank and International Finance Corporation (IFC) have a special responsibility to act. We need to go where markets are unlikely to act on their own and create the tracks and pathways for others to tread. We have a responsibility to crowd-in others as we can’t solve these challenges on our own.

For many years, the Development Marketplace provided early stage grant capital to social enterprises delivering goods and services to those at the Bottom of the Economic Pyramid. Perhaps the time has come to shift from supporting social enterprises directly to supporting value-added intermediaries, unlocking policy and regulatory constraints, and investing in the financial infrastructure that will help much more capital flow to the sector.

Without access to multiple forms of finance, technical assistance, enabling legislation, and a variety of intermediaries active in the ecosystem, this sector will stall and investors will migrate to other pastures complaining that pipeline is scarce. Microfinance took nearly 20 years and billions of dollars in grant capital to kick-start a market and demonstrate commercial opportunities. It need not take two decades this time around. What can the Development Marketplace and World Bank Group do to unlock multiple forms of finance, convene stakeholders nationally and globally, and leverage strong relationships with government and policy makers to bridge the gap between pipeline and capital?

impact investing, investment fund, patient capital