Tools of the Trade: Building a Robust Deal Pipeline of Impact Companies in Emerging Economies – Part 3
Editor’s Note: Led by contributors from NextBillion’s Managing Partner, New Ventures, this is the third in a series of articles (the first can be found here and the second here) showcasing the achievements of environmental SMEs with insights from impact investing leaders on how to further scale these enterprises. This article (broken into 3 parts) outlines how various actors in the impact investing space are involved in identifying and investing in environmentally-focused SMEs in emerging economies. In part one of this three-part article, interviewees talked about how to identify and select companies, mostly through building strong, on-the-ground partnerships. In part two, the group shared insights into fighting the barriers and inefficiencies of identifying and selecting impact companies in emerging economies.
What are the biggest lessons learned when it comes to finding high-quality companies in emerging markets?
I posed this final question to our virtual panel of interviewees. Among other things, the group of impact investing leaders recommended teaming up with other investors to providing appropriate financing, making sure to select companies with a core social/environmental mission, embracing creativity, and embedding capacity building into the due diligence process as critical tactics that they have learned over the years.
As with the previous two articles, the interviewees included:
- Ian Fisk, executive director of the William James Foundation, a non-profit organization that manages socially responsible business plan competitions for venture-phase and idea-phase entrepreneurs.
- Amos Gilkey, CEO of Clean Wave Group, a for-profit business catalyst and the creative and strategic advisory services business that provides unique and customized client and venture opportunities, strategic partnerships, and new market potential.
- Kevin Jones, co-founder and convener of Social Capital Markets, an annual event series that connects leading global innovators (investors, foundations, institutions and social entrepreneurs) to build the social impact market.
- Jesse Last, senior lending and strategy associate at Root Capital, a nonprofit social investment fund that grows rural prosperity in poor, environmentally vulnerable places in Africa and Latin America by lending capital, delivering financial training, and strengthening market connecting for small and growing agricultural businesses.
- Walter Vargas, investment officer at E+Co in Costa Rica. E+Co makes clean energy investments in developing countries to provide lasting solutions to climate change and poverty.
- Michael Stulman, communications officer for Grassroots Business Fund, a global impact investing organization whose mission is to help build and support high impact businesses that provide sustainable economic opportunities to millions of people living at the base of the economic pyramid.
Biggest lessons learned:
Team up with other investors and providing appropriate financing: Root Capital has found a lot of value in working with other providers of debt capital. Root Capital generally makes loans up to $2 million in private companies or cooperatives. If a company needs more capital, is in seed stage, or there’s something about the risk profile that makes them uncertain, then Root will work with other capital providers who can provide debt. They are also, however, increasingly looking for opportunities to work with equity providers, and where they can provide an exit by offering debt afterwards and work with them to increase their loan size as appropriate over time.
More recently, Root Capital has been lending to cooperatives and companies not just focused on export cash crops, but also in domestic value chains (i.e. agricultural inputs to increase productivity and yield of smallholder farmers and food processers).
Since their mission is to improve smallholder livelihoods, one of the major challenges is determining where to provide financing along the supply chain. Many cooperatives manage their own contracts when it comes to export crops. But with local or domestic supply chains, many suppliers are scattered, so Last says Root generally looks to move the lending efforts up the value chain. Also, one of the biggest barriers to finance small and growing businesses (SGBs), including cooperatives, is that they don’t have any collateral. So Root uses existing cooperative contracts as collateral for the initial loans.
Select companies with a core social/environmental mission: Jones and his team at Good Capital were approached by a traditional investor a few years ago who wanted to co-invest in a deal to invest in a juice company. Their role was to serve as the “mission anchor.” This proved very really challenging because the enterprise didn’t already have a core social/environmental mission, which made it difficult to keep the mission intact as the company grew.
Recognize the ratios: Vargas focuses on companies that already have a solid management structure and solid business plan that make them ready for investment. “There are a lot of great ideas, but there are a list of things a company needs before it can attract investment capital – in general, from 20 projects that I see in one year, I present four to the investment committee and maybe one to two are actually ready for investment,” Vargas said. Basic as it may sound, Vargas suggests that for companies without management resources, it’s worth hiring the right people to get the business ready for capital. Or, make sure to go through an accelerator or competition of some kind to get the essentials in place before seeking investment.
Embed capacity building into the due-diligence process: For companies with an NGO heritage, the transition to a for-profit can be very challenging; many businesses are simply not ready for commercial capital. Thus, GBF targets businesses that are ready and willing to participate in capacity building programs, and embeds these programs into the due-diligence process upfront. “It’s important to clearly communicate and agree on potential investment structures early on in the due diligence process; this can help ensure that potential deal-breakers are out of the way early on,” says Michael. GBF tailors these services to the needs of businesses; flexible milestones are developed and tracked by both company management and GBF.
Different types of companies are emerging: Fisk spoke to the evolution in the types of companies he’s seeing emerge today, relative to a decade ago. He discussed three stages of development in terms of the types of companies he’s seeing coming down the pipeline over the years:
Consultants: the first wave of companies usually were European or American graduates who eager to know what the most pressing social and environmental problems were and how to best plug into them;
Gadgets: the second phase of companies were focused on building enterprises around products and services that didn’t already exist; and,
Distribution: the third wave of companies are focused on getting past just developing gadgets and actually developing partnerships for distribution models for these products and services.
Gilkey, CEO of Clean Wave Group, also commented that up to this point, there have been a lot of end-products that are very visible to consumers in the advanced energy/clean tech sector. However, also is observing many back-end innovations in software with tremendous opportunity, which he believes is a great sign of market maturation. Software is much easier to bring to new markets, spur more innovation, help the sector move beyond just consumer products, and ultimately help the sector become more robust.
Related to this point, Gilkey also said that “until recently, the impression of relative progress and success of the sector has largely been focused on the end user/visible products. This makes the sector fragile and too reliant on these particular types of products as a gauge of broader sector progress and successes. The development of more software and other back-end types of products is stabilizing and encouraging development.”
Embrace creativity: So many factors go into getting the right investment deal that many entrepreneurs with great ideas get intimidated. Since the impact investing sector is still splintered and there are a lot of groups trying to solve the same challenges, this requires an enormous amount of creativity, and enterprises have to do a lot of their own research.
However, Amos believes this creativity will make companies more seasoned and market-ready. It also makes companies realize that they can’t stay siloed, and savvy companies are realizing they need all hands on deck; engineers and marketing staff alike need to be involved with various facets of the company. “Ultimately, the silver lining is that the political, financial, and technological challenges in the impact sector are forcing people to think outside of the box; the hope is that if you get a group of smart people together in the face of adversity, in enough cases it will help them come up with something that they wouldn’t have otherwise and that will benefit all of us,” says Amos.
Resources for those involved in developing deal pipelines:
A number of groups allow practitioners who support sustainable businesses to get together. For instance, there’s a meeting coming up that includes the Buckminster Fuller Institute, Root Capital, the Hub, Aspen, AVINA, Nest, Omidyar Network, Halloran Philanthropies, and a number of others. For more information, email: firstname.lastname@example.org
The William James Foundation is working on an initiative to create a common form with other institutions in order to standardize the process of applying to various business plan competitions. For more information, email: email@example.com
New Ventures, WRI’s center for environmental enterprise, is a business accelerator that helps identify, select, mentor, showcase, and connect environmental SMEs with investors. New Ventures has Local Centers in Brazil, China, Colombia, India, Indonesia and Mexico.
More broadly, there are several investor groups that have formed in order to share due diligence, deal structures, lessons learned, and more. These groups include Toniic, Investors Circle, Hub Ventures, Village Capital, and the Unreasonable Institute.