Catalyzing Retail Investment to Fund the ‘Missing Part’ of the Missing Middle
Editor’s Note: Led by contributors from NextBillion’s Managing Partner, New Ventures, this is the latest in a series of articles showcasing the achievements of environmental entrepreneurs with insights from impact investing leaders on how to further scale sustainable enterprises. Other articles can be found here.
Recent developments in crowdfunding legislation under the JOBS Act and general growing interest in retail investment in Europe and the U.S. are signaling a growth in new capital available for impact investing. But how does the impact sector ensure that there are enough investment products to cater to the hundreds of thousands, if not millions, of unaccredited investors increasingly interested in international investment opportunities that will deliver diverse environmental, social, and financial returns?
And then there’s the challenge that Jenny Everett, with the Aspen Network of Development Entrepreneurs, cited in a recent article for NextBillion, that one of the biggest impediments still facing the impact investing sector is connecting emerging market entrepreneurs with the right type of capital at the right time. As Jenny explains, ANDE has come to find that the missing middle itself has a missing part, and that very few members of their network are able to provide financing at the critical $25,000-$200,000 range due to high transaction costs and high risk factors. As we all know, it’s not like there aren’t plenty of great ideas out there – early-stage financing with a low cost of capital is just tough to access. Harvey Koh et al. refer to this stage the “pioneer gap” in their recent publication, From Blueprint to Scale, on the importance of philanthropic capital for early-stage investment. (Read a NextBillion post on this report here.)
So we need more investment products and we also need more early-stage financing for emerging market SMEs. How do we more effectively put two and two together? If funds and other larger investors aren’t willing to provide early-stage financing due to high transaction costs, risk factors, and the time horizon required for the investments to scale (Monitor’s Africa research found that only six of the 84 funds investing in Africa or across regions offered early-stage capital, and this was reinforced in the Blueprint study), how can we harness retail capital to help early-stage businesses with flexible capital (both debt and equity) that can help them prepare for larger investment? From the demand side, it seems clear that we need to provide retail investors with more investment products and options.
Until the recent crowdfunding legislation, only debt-based instruments have been available to retail investors in the US for early-stage SME financing, but no doubt this will change significantly as the SEC irons out the regulations between now and 2013. Nevertheless, there are existing investment products already available to U.S.-based retail investors (this article doesn’t focus on investment options available to retail investors outside the US, although a few listed below are), some of which I’ve listed below. (Note: quick disclaimer that neither I nor NextBillion are endorsing any of these particular financial products):
Calvert Foundation: has served as a leader in the retail sector, especially with its Community Investment Note. This program, to-date, has leveraged over $200 million for community development initiatives, like low-income housing, and has less than a 1 percent loan default rate. Writ large, The Calvert Foundation currently has $2 million invested in SGBs in over 50 countries, primarily through intermediaries. Although not just designed for retail investors, individuals who invested directly and online through Microplace.com make up a large percentage of the investment in the Note annually.
TriLinc Global: is a company that has emerged as an example of a private investment manager with a retail product focused on channeling investment into SMEs in emerging economies. They launched their $1.25 billion retail product in early 2012.
Microplace.com: is a PayPal company whose mission is to help alleviate global poverty by inspiring individuals to make investments to support the world’s poor. Their online platform enables retail investors to invest in various microfinance projects all around the world. There are a number of other issuers on Microplace.com that allow for retail investment (i.e. The Calvert Foundation’s Community Investment Note). In addition, Microplace is currently the only online broker-dealer intermediary that is well positioned to accept crowdsourcing capital under the current legislation, although they still have some details to iron out related to how to handle the investment capital.
RSF Social Finance: The RSF Social Investment Fund is a diversified, direct loan fund run by RSF Social Finance, which is comprised of over 75 leading non-profit organizations and for-profit social enterprises. Investments provide mortgage loans, working capital lines of credit, and inventory financing for non-profit and for-profit organizations. It provides retail investors the opportunity to invest (with a minimum investment of $1,000) and achieve a financial return similar to that of a bank CD, while also generating substantial social and environmental returns.
Shared-Interest: Founded in 1990, Shared-Interest works in 36 countries around the globe and continues to be the world’s only 100 percent fair trade lender. They created a financial cooperative to pool money from investors that is lent to farmers and handicraft makers in the developing world.
Oikocredit: A large Oikocredit USA offers Definitive Notes under its Global Community Notes program. Notes are available to individuals with a minimum deposit of $250 (after the initial deposit, increments are possible in any amount) that invests in the microfinance sector and also SMEs abroad.
Kiva: This popular online micro-lending platform partners with existing microfinance institutions around the world, and these institutions facilitate the loans to entrepreneurs on the ground. Lenders can fund as little as $25 and as much as the entire amount of the loan. Kiva aggregates these funds from lenders and provides them to the Field Partner, which then receives the payments and interest into an account. Lenders can then re-lend their funds, donate their funds to Kiva (to cover operational expenses), or withdraw their funds. Although Kiva has been traditionally focused on microfinance lending, they are also considering getting into the SME space.
Hundreds of Community Development Financial Institutions (CDFIs), including Calvert Foundation, across the US offer opportunities to do place-based lending.
And the space of retail investment is continuously evolving. For instance, the UK has pioneered social impact bonds, and “pay for success” social impact bonds have also started to emerge in the U.S (currently being piloted in Minnesota and Massachusetts). And just last month, ANDE announced its Finance Challenge in partnership with the Argidius Foundation. The goal is to host a competition to support innovative ways to provide financing to small businesses that require $20,000-$250,000 in early-stage stage capital in some of the most difficult geographies, including Burkina Faso, Guatemala, Honduras, Mali, Moldova, and Nicaragua. Crowdsourcing is considered a potential financing option, in addition to other models, including innovative bank lending and incubator/accelerator financing. We’ll see what develops, but ANDE Executive Director Randall Kempner believes that “whatever model shakes out, it is clear that retail investment needs to be part of rectifying this missing financing piece one way or another.”
The challenge now for the impact investing sector is to figure out innovative ways to continue to draw retail capital by providing interesting and diversified investment products, “more could be done to focus investment products in a way that appeals to a suite of different retail investors, perhaps by tailoring the investment product to allow investors to select which companies or which projects they want to invest in by sector,” says Patrick Davis, Strategic Initiatives Officer at Calvert Foundation. For instance, Kiva’s new online microlending platform that has launched KivaZip to make it easier for people to invest directly in another project or idea, rather than through a microfinance institution.
In addition, many people discover new investments through their financial advisor or broker, and this suggests that a crucial step in expanding impact investing through retail investors will be educating advisors and brokers on the industry. With education, notes Calvert Foundation in a recent article, there is also the opportunity for large financial institutions such as Fidelity to structure and sell impact investments.
And it’s important to remember that while opening up the doorway to retail clients is valuable in terms of bringing in more volume of investment capital, taking impact investing retail is important for more than sheer capital reasons. As Antony Bugg-Levine and Jed Emerson write in their recent book, Impact Investing: Transforming How We Make Money While Making a Difference, “it is about creating a more integrated relationship between our assets and our values,” and it’s about transforming what society values and how we organize our resources to achieve these values. If impact investing remains confined to the upper echelons of society, then opportunities for transformation at other levels are limited. What we need are less boutique, innovative deals, and more products that can be accessed by a wider range of people.
The recent JOBS Act legislation took us in the right direction in terms of unlocking retail investment capital in the US, but the impact sector needs to ensure that there are enough innovative products to capture the new surge of funding for early-stage SMEs, especially in emerging economies.