Making the Case for Early-Stage Impact Investing
As investors, we all know that putting money, time and attention into any venture inherently carries some risk. But impact investing in early-stage social enterprises, especially in remote regions of the world, can present a different type of uncertainty. Attracting top talent, establishing operations and demonstrating success in unproven markets are just some of the issues these nascent enterprises face. To investors, no matter how much they believe in the cause and how willing they are to back the venture, these challenges may look like dealbreakers.
However, as many of these startups are dedicated to finding affordable and accessible ways to provide critical goods and services, seed-stage investing is necessary to spur economic development in these growing economies. In a recent study conducted in India by the British Council, 86 percent of the surveyed social enterprises operating in the country stated that access to financial backing was one of their major constraints.
At Beyond Capital, an impact investment fund that invests in early-stage, for-profit social enterprises serving communities at the bottom of the economic pyramid, we focus our efforts in India and East Africa. We support start-up companies that are finding innovative solutions to issues faced in these impoverished regions, in sectors like health care, energy, food security and sanitation. While challenges do exist in funding these ventures, seed-stage investing and addressing the overall capital gap are paramount to creating new financial opportunities, and to fostering gender equity and cultural and societal growth in these emerging economies.
The Challenges of Early-Stage Investing in India and East Africa
Impact investment opportunities in both India and East Africa — two of the world’s most impoverished regions — are robust and continue to grow. According to the Global Impact Investing Network and our internal research, development finance institutions have to date deployed $5 billion and $9 billion in direct investments in India and East Africa respectively.
However, funding early-stage companies in these regions remains uniquely challenging due to several long-standing factors. These include a general lack of awareness and understanding of the broad spectrum of impact investing among policymakers and other key ecosystem actors, contributing to the fundamental constraint of an underdeveloped impact investment support sector.
Recent research by Intellecap supports this assertion, finding that 84 percent of early-stage enterprises in East Africa are unserved or underserved, while 33 percent of social enterprises in India report that access to investors was low due to limited networks and 21 percent report that their limited performance record was a major constraint to securing finance. Many of these entrepreneurs are financing their ventures with personal funds and high-interest loans, because of the difficulty in growing from the first stage to the second stage without the ability to show financial returns.
Conventional bank financing continues to be difficult to access for early-stage businesses in these regions, as financial institutions there tend to be risk-averse. Oftentimes, an enterprise needs to be operational for several years and show returns in order to receive access to any of the existing financial support mechanisms available. Other challenges include tax and contract laws that are often unfavorable to social enterprises, and a lack of due-diligence services available for aspiring impact investors looking to work with social enterprises operating in these deserving areas.
Untapped Opportunities for Impact Investors
Despite these difficulties, impact investment opportunities are plentiful in these regions for investors who are willing to do their homework.
Recent research by Intellecap and the British Council shows that 60 percent of social enterprises in East Africa and India were launched in the last five years. Their company leadership also skews young: The average age is below 44. Many of these innovative companies are also led by women (24 percent in India, versus 9 percent in the country’s mainstream business/private sector firms).
These enterprises also show impressive growth prospects, with 78 percent of the India-based companies analyzed by the British Council reportedly aiming to expand into new geographical areas, 73 percent looking to increase their customer base, 71 percent developing new products/services, 64 percent increasing sales and 56 percent looking to attract investments to expand.
For impact investors, these businesses present promising opportunities to address the social causes that matter to them. The British Council study shows that 80 percent of the social enterprises evaluated in India reinvest a portion of their profits to further their social or environmental goals through growth and development activities. Moreover, 82 percent work with women, 70 percent work with individuals from socially and economically disadvantaged communities, 46 percent work with children and 31 percent work with people with disabilities.
These are the kinds of enterprises Beyond Capital seeks out for investment. One such company, Frontier Markets, serves its community of Rajasthan, India by distributing, servicing and training customers in the use of solar lanterns, torches, home lighting systems and street lights – vastly improving safety throughout this rugged rural region. Sanergy, another of our investees, manufactures and maintains low-cost, high-quality sanitation systems in the informal settlements of Kenya. Operated by a network of local residents, these systems are increasing the income and bettering the health of the entire community. Our portfolio is comprised of eight such enterprises that are blending technological advances with an innate cultural understanding of the communities in which they operate.
The case for investing in these burgeoning seed-stage enterprises has never been stronger.
How Investors Can Boost the Sustainability of Seed-Stage Investments
As in traditional investments, careful due diligence is the first step in vetting an impact investment opportunity. However, with seed-stage enterprises, there is often not enough data for investors to rely solely on the company’s internal reporting.
Beyond Capital addresses this by providing pro bono advisory services to our entrepreneurial partners. We’re structured as a nonprofit, and our leadership team and network of board members and advisors draw from their varied experience and areas of expertise to help these enterprises establish and implement operating procedures and regular reporting systems. These formalized company infrastructures lend credibility and stability to sustain the businesses and attract potential investors.
Working closely with a company, we are also able to construct and institute unique impact frameworks, utilizing both quantitative data and qualitative on-the-ground evidence to evaluate the impact the enterprise has on its consumer base and the community at large. These impact frameworks focus on a carefully articulated theory of change, which guides how impact will be measured, evaluated and shared between our team and the company’s leadership – and often helps the company better know its own customers. The data set includes standardized metrics balanced with outputs that are customized based on the company’s goals and business model. The framework process begins during the due-diligence phase and continues throughout pre-investment and post-investment stages.
One investee that Beyond Capital supported in this way is Farmers Pride, an enterprise aiming to improve the productivity and income of smallholder farmers in rural Eastern Kenya by providing access to quality agricultural inputs, services and training. We worked with company founder and CEO Samuel Munguti to develop one of the first company-level impact scorecards in our portfolio, incorporating a set of metrics that closely align with the Farmers Pride business model as well as its intended social impact. The quantitative metrics help us understand the social impact of the business alongside the financial reporting we receive.
While discovering, evaluating and ultimately investing in an early-stage social enterprise may seem more precarious than putting your money behind a more traditionally established venture, it’s an essential priority for impact investing. Imagine what would happen if the sector neglected to use risk capital to fund early-stage social enterprises: Vital new innovations and enterprises would fail to emerge or scale, as capital concentrated in a limited pool of established businesses. In order to achieve the far-reaching social outcomes required to solve some of mankind’s most pressing problems, we need young, values-driven entrepreneurs to have more capital, access to resources, and overall support and encouragement for their work. My hope is that early-stage social enterprises working in developing countries will one day become as much of a viable investment opportunity as tech companies in Silicon Valley.
Eva Yazhari is the co-founder and CEO of Beyond Capital Fund.
Main photo: Farmers Pride CEO Samuel Munguti (far left) collaborates with one of his company’s smallholder farmers and Beyond Capital’s Osman Khan and Mehak Malik.
Homepage photo: Farmers Pride, a Kenya-based social enterprise providing smallholder farmers with products, services and training to improve their output and increase their income.
Images courtesy of Beyond Capital Fund.