Ask Ag About... Access to Finance for Small and Growing Businesses

Getinet, these are both critical questions. In terms of availability of finance, a few thoughts: 1) From an investor perspective, the issue is often that finances are availability, but comfort level with SGB investment opportunities is not. In other words, the question becomes, how can more SGBs become more investable, and thus more appealing to people and institutions with financing available? 2) Networking is critical. SGB financing is still largely focused on key urban hubs (e.g. Nairobi), with less knowledge about and linkages to SGBs in rural and peri-urban areas. To help facilitate access to finance for these non-metro SGBs, facilitating networking and encouraging visits to business sites is useful.

Your second question, about efficient utilization of funds: as with all financial resources, planning is key! A common understanding between the financier and the business about intended use of funds (and mutual agreement about extent of flexibility), milestones for tracking progress, monitoring and a plan for action of milestones fall behind help set the stage not only for fund utilization, for for long-term relationship building.

The two trillion dollar question!

• Loan guarantees are certainly helpful - particularly if you're operating in difficult geographies/environments, very early stage businesses, and first-tme borrowers.
• Collateral is helpful to an extent - as pricing it, writing it into an enforcable contract, and calling on it can be complex, time-consuming, and expensive.
• Lending against purchase orders (trade credit) can be effective - particularly if you know the buyers well.  

But none of the above ensure repayment without transaction costs! If you're looking to make your money back without taking a lot of risk, it probably means investing via a financial intermediary - impact oriented or otherwise - in a sr. debt tranche. 

Due to the nature of agriculture lending, managing transactional costs is an uphill task.  However to keep it manageable, one must invest in market led product development and match the credit cycle with the crop cycles.  In some instances this might require you to accept ballon payments at the end of the cycle and after farmer payments have been effected.  One might also consider having the farmers pay the interest bit of the loan only for the time before harvest, and settle the principal and remaining interest post harvest and sales (moratorium on the principal).  This works best if the farmers are organized under a cooperative or buyer/aggregators.

Hi Jeannette, a bit more context might help here.  In which country are you referring to reform of secured transactions laws?  There are examples of debenture and other alternatives to traditional collateral in many countries in Africa where I was based.  In the case of the livestock, the business model of Juhudi Kilimo for example is asset-financing for livestock, e.g. a $1000 loan for a cow where the cow itself is the collateral.  

http://juhudikilimo.com/

Thanks for your reply, Jason. I had a quick look at the website - it is not clear, but appears to be an NGO? I am eager to examine the website more closely later on to see how the loans operate. Would this work for commercial banks?  We have a "Model Law on Secured Transactions" for use by OAS member states (ie., Latin America and Caribbean)  interested in reform of their legislation to enable the use of non-traditional forms of collateral (including livestock, crops, etc.) I would appreciate references to any resources about how this is actually done in practice. i.e., if the cow is the collateral for the $1000, both lenders and farmers want to know, what happens if the cow dies, is stolen, or ends up in a stew? etc.  Livestock is not like other inventory that can be seized and sold in the event of default. Answers to such pragmatic issues, much appreciated. (sorry, I've been looking at these issues from the perspective of "legal doctrine" - a bit far removed from the field and I want to understand the pragmatics.)    

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Juhudi Kilimo is a social enterprise akin to an MFI, but definitely looking to be profitable in what they do.  (I will warn them however that their website appears NGO-like :)  They combine livestock asset lending with a group-based model.  It's true that it is very hard to repossess a cow, for example because of the cultural implications of losing your cow.  Sometimes the group will come together to prevent that from happening, but I do believe it is possible to re-possess in the extreme cases.  As with any asset-financing model, the lender has to have a least some understanding of that asset.  In this case, Juhudi started with cows from the beginning of their business model, and they insure them to cover the risk of health problems/death.  The cows usually produce enough milk to basically cover the loan payments, which happen over one year, so default rates are very low.  They are usually happy to talk about their model, btw.

In Kenya, institutions that use livestock as security, apply it when the loan is actually for asset finance to buy that particular livestock. The livestock is tagged and insured during the loan term and can be recovered incase of default. Livestock is rarely used as collateral esp by small holder farmers (emotive, hard to enforce)

Thanks, Titianne, that makes sense and is what can be referred to as a "purchase money security interest" - where the loan is used to buy the very collateral for the loan itself. I guess I was hoping there were also additional options...  

I don't think there is a legal barrier to doing so (e.g. Kenyan lenders can use household furniture as collateral) but yes "emotive and hard to enforce" is correct outside of the asset-financing model

While not in Guatemala, it's worth noting that there are lot of big initiatives right now targetin post harvest loss, which will include investing in private sector solutions.  One really interesting new one is YieldWise, a Rockefeller Foundation initiative in Africa: https://www.rockefellerfoundation.org/our-work/initiatives/yieldwise/

Hi Bruce, private sector funders expect monetary returns. 

As your project is more social and research inclined (for now), your best bet for financing will be a development partner who would invest for the benefit of the community and their ROI would be the impact on the farmers from your project.  You would then use the data to develop a for-profit model and scale to other regions

Hi Bruce, private sector funders expect monetary returns. 

As your project is more social and research inclined (for now), your best bet for financing will be a development partner who would invest for the benefit of the community and their ROI would be the impact on the farmers from your project.  You would then use the data to develop a for-profit model and scale to other regions

A function that has increasingly being used (e.g., the Tropical Landscape Bond in Indonesia) is setting up two separate facilities - a fund facility dedicated to actual investments, and a separate TA facility that raises and they deploys technical assistance monies to on-ground partners (enables the money to be earmarked). The TA facility acts as a de-risking mechanism and strengthens the actual investment deployment. Another resource to look at for blended finance instruments is the Canadian funded platform, Convergence. 

Building off Martin's comment, Root offers financial management training to the majority of our clients - a necessary step to both protect our own investment but moreso to improve business operations among borrowers and maximize their earning potential. To date, these services have been almost entirely grant funded - particularly for first-time borrowers. We're pleased to see that new funds in this space often include dedicated funding for TA.

Mark, thanks for the great question. Like Martin, I also encourage you to check out Convergence - a platform for facilitating blended finance and also the development of new product/vehicle design. In my experience, funds often have parallel TA facilities (e.g. Africa Agriculture and Trade Investment Fund, Fund for Agricultural Finance in Nigeria) - which are often grant funded. The PRI model has also been used to cover initial TA costs. Many investors have noted the importance of TA in improving and expanding the investment pipeline, but I have seen few instances so far where the financing side has talked about investing in TA directly. 

Stepping back from the question of blending capital for TA specifically, and just thinking about the need for what we call "smart subsidy" in spaces that are high impact with risky returns, there definitely can be a role for credit guarantees in making finance available to SGBs that they otherwise couldn't access.  USAID's DCA is a good example of a 50-50 partial credit guarantee that I've researched and found successful in a number of cases of getting financial institutions to venture into the SGB lending space.  The 50-50 ensures that financial institutions have some skin in the game and thus see SGBs as a strategic priority, but provides some cushion for the risk of investing in high-impact, high-risk businesses.

Great point, Jason, completely agree. On the smart subsidy, if anyone is interested, we (the Initiative for Smallholder Finance) actually worked with Jason at RAFLL and Dalberg, where smart subsidy was one of the recommendations to move the sector forward (along with progressive partnerships and customer centricity). Link if interested: https://www.raflearning.org/sites/default/files/inflection_point_april_2016.pdf?token=OS8hc14U

Thank you all for the very helpful insight - I've now signed up to Convergence and will definitely use the USAID DCA cast-studies to demonstrate the value in guarantees to key stakeholders here in Australia. 

Hi Myriam -

Root launched a dedicated "financial advisory" department after encountering this problem for 6 years with new prospective borrowers. We oftentimes use large workshop formats to help multiple groups better understand the loan application process and put together relevant documentation for our loan officers to review.

I was wondering if we can do better improving on locally available non-interest based sources of finance such as ROSAS for SGBs.

Are you talking about rotating savings and credit assocations?

One thing you see in the SGB world is that it's not always the best ideas or most dynamic entrpreneurs that get invested, but those that are able to organize and professionalize themselves internally in order to speak the language of investors and assuage their concerns about risk.  Whether this is the ideal priority or not, if you want investment, getting internal systems right is critical.

Banks and local financial institutions are usually quite interested in participating in the sector, but a critical barrier is the financial maturity of the companies. Banks look for track record and a history (at least a few years) of successful operations (along with a business plan and forward looking projections - in this case, there are some local consulting firms, one in Kenya, that helps promissing businesses become investment ready through business planning support), and ideally other existing financing partners to derisk participation.

Additionaly, they need a pipeline of, in this case, SGBs, to justify participation for their internal credit committees (for department expansion, and even increased internal lending limit caps). If a bank has only 5 SGBs to finance over the coming 2 years, it's hard for them to justify economies of scale to particpate. The upfront due diligence cost is quite high irregardless of amount (in this sector), especially with only 5 companies; however, if you show a bank or syndicate of banks a strong and robust pipeline of investible opportunties over the next 5 years (call it 50 SGBs capable of absorbing financing responsibly in a specific sub-market), they will gladly particpate. 

An interesting model is using exsiting pipeline of other actors (such as NGOs or local aggregators) to aggregate pipeline and continue due diligence they're already doing for other projects, and then directing them to local FIs. 

Also, important to note that the role of technology has been increasing the ability of financial institutions to evaluate credit risk and offer traditional products and non-banking institutions to offer technology enabled solutions. Alterative credit scoring and technological data aggregation is allowing banks to use traditionally unusable sources of information evaluate the ability of an individual or company to repay a loan. In some cases, it also allows them to control the actual underlying use of product - for example, MKopa allows solar users the ability to aggregate credit through payments, but then can also have it shut down for non-compliance. Therefore, helping SGBs get comfortable using technology based products (and the ability to feed data into them - e.g., automated accounting software, rather than Excel inputs), would be useful in allowing them to access additional products. Important to note, that many of these alternate credit sourcing methods don't require individiduals or SGBs to have technological proficiency. Examples of psyhchometric and behavarial - Arifu, Visual DNA. Ones using geographic, climate, value chain, and market data to assess borrowers - Telephone Farmers, Acre Africa, Geotraceability, MFarm, FarmDrive.

During our first six years of lending to rural enterprises, we came to recognize that access to credit as a stand-alone financial service was often insufficient to spur the growth and success of our clients. Many rural enterprises lack the skills and experience to manage credit effectively (e.g., creating financial statements, budgeting, financial forecasting). In 2006, we launched our Advisory Services program to broaden the funnel of our lending pipeline, support enterprises in our portfolio through targeted training, and enhance the efficiency of loan officer due diligence

 Root has identified a number of ‘financial fundamentals’ that we use to determine the strength of an enterprise as well as areas for improvement (via workshops or targeted training). They include financial planning, financial statement creation & analysis, financial risk management, loan application preparation, internal credit management, and farmer financial literacy.

Similarly, as businesses grow, so do their needs for diversified loan products that often demand new management skills to maximize success.

Few things to keep in mind, the business must have a clear and replicable business model.   The enterpreneur must have the ability to give a succinct and convincing pitch on their business.  They must also have a good understanding of the financial model, including projections (best and worse case scenarios), cost and revenue drivers and ROI

re: Q1 - the answer is a very unsatisfying "it depends!"  

If ACCEPTING impact investment: I'd consider the trade-offs between all the potential benefits of an NGO status (including access to grant funding) versus the terms of a potential impact investment (e.g., access to networks, expertise, quantity of capital) - and all this in the context of how much capital you need for what.  We've also seen NGOs with fully-owned, for-profit subsidiaries - spun off for exactly this purpose.

If MAKING impact investments: As it sounds like you have very specific technological expertise, you might be well positioned to advise investment funds, and through them potentially place some capital of your own. This could be preferable to building out an entirely new veritical - investment capacity - which could be a distraction from your core busienss. Using investment/lending partners could also help you get a toe in the water to see if it's a place you really want to develop additional expertise. My two cents!

Hi Claire, thanks for your questions.

1. What returns are investors looking for: the reality is, it depends. The range of impact invesments is large, with some investors expecting market-rate returns and others expecting less in return for the social bottom line achieved. Also note that some impact investors will have specific geographic and/or certain sector preferences, and meeting those alongside return expectations will be important. As you consider adding impact investments, I encourage your organization to think about a) what sectors will you be asking investors to focus on? b) what geographies? c) what rate of return can you offer over the next 5 years? I suggest leaning towards the conservative side at this early stage. Your answers will help you identify the individuals/firms willing to take on the risk/return combination you're offering.

2) To the best of my knowledge, continental registration is quite a ways off. Even within economic communities like EAC, individual country registration and permitting is generally necessary and can be cumbersome. Building in longer-than-expected start-up time for expansion into a new country is generally recommended. Many hoops ahead, I'm afraid. However, showing permits and test results from one country can help accelerate the pace in a neighboring country.

Claire, it's great that your work aligns with a lot of social bottom line issues that resonate with people - you can use this to tailor your investment pitch. In terms of "One Africa," yes, there is interest in creating bridges between entities like EAC, SADC, ECOWAS, etc. I anticipate that in early years this will be about attitude, as you mentioned, freedom of movement if you are a resident in region, and facilitation of trade. For non-local businesses, however, I expect that country-by-country registration will remain necessary for the medium-term.

Agree with Scott on the "it depends". More often than not, what I hear from impact investors or development focused funds, is that it's increasingly not about the rate of return but the amount of risk and their ability to hedge downside contingencies. Depending on the type of investor (running from high subsidized grant funding, to "market rate" debt/equity - which is still below traditional financial returns), they've become comfortable with a trade off for impact for return, which in my mind should not be the case (but a conversation for another time), but what it really comes down what are the different types of risks associated with your business (and how can they control it, and how it interacts with their broader portfolio in terms of sizing, geography, etc.). The pricing they'll use on a development ag investment will be attributed to risk. Typcial returns can range from at cost (grant funding), up to 1-5% (subsizied capital with a guarantee), 5-12% more "market rate" investors in the space. Please note these are highly generalized. 

The obvious ones are that with debt, you don't lose any control of the business or any stake in future profits, but the bank doesn't really share your risk.  So the bank gets limited upside and limited downside, and you get capital that you have to pay back even if things go wrong.  With equity, your investor shares both in the upside and the downside risks.  In exchange for that you might give up some control of your business, but in my experieince entrepreneurs are often overly afraid of this.  Typically equity investors add a lot of value in terms of expertise and connections that a bank will not give you, and in the end would you rather own 100% of a $500,000 company or 50% of a $5 million company?

That said, debt typically has to be a part of your overall financing picture if you can get it (often equity is easier to come by if you don't have much collateral or cash flow history).  If you can grow as fast as you want without selling a stake in your business, then great! 

Root Capital is a credit provider, and we offer loans ranging between $50K and $2M. However, we also recognize that credit is a blunt instrument and not well suited for all stages and types of businesses. Early stage enterprises in particular may be looking to make longer term investments or may be uncertain about growth prospects - making short-term credit particularly difficult. Unfortunately we see a real dearth of investors and lenders targeting these early stage entrepreneurs with appropriate financial products (particularly equity).

Important to note and something to consider, while there are plenty of loan products available, and many institutions (and credit providers) provide debt participation, something I've herad increasingly from SGBs and even local agriculture tech enabled startups is the lack of equity available in the market. Obviously debt is a less risky endeavor for institutions and a shorter tenor (in many cases, you don't have long term debt plays like in the traditional private capital markets) than equity, but it's greatly needed. The problem is it's a longer-term play, and more often than not needs a certain amount of sector expertise to help an entrepreneur grow their business (in the case of private equity). Convertible debt is also becoming an increasingly used instrument, as it allows the investor to have the comfort of a debt product with a guaranteed payment and covenants for non-compliance, but the ability to particpate in a longer engagement converting to equity if the partnership and business are doing well. 

Crop insurance is something that a lot of people need (studies show it has high impact in enabling farmers to take more risks), more firms are looking to provide (using approaches like weather-based index insurance, area-yield crop insurance) but very few want to pay for (uptake of crop insurance is typically low).  To address uptake, organizations like ACRE Africa are bundling weather-index insurance with seed, so the consumer does not pay a price for it separately, but that insurance only covers the value of the seed itself.  This is a good start, and meant to hopefully lead to larger amounts of coverage.  APA insurance in Kenya is looking to dramatically scale up a range of smallholder insurance products in Kenya with funding from FRP (frp.org).  You can read a bit more about the question of impact and uptake here: https://www.raflearning.org/post/need-for-weather-index-insurance-what-do-farmers-really-want

Agriculture is a risky endeavor. And the market-returns are often not sufficient to cover those risks (for example, a set amount of land can only produce so much maize, which can only be sold at the going price).  So your question becomes one of risk management - how can we measure and manage all the risks associated with agricultural lending. To name a few: farm yield gap among smallholder farmers (particularly in Africa), soil degradation, lack of inputs, lack of market access, climate change, access to water, transportation and storage infrastructure, farmer knowledge, availability of labor, pest and disease incidence, and on and on and on!  The exact combination of risks will depend on the opportunity in question, but any financial institution considering a loan to an early-stage SGB in the agricultural sector will need to understand these elements. That requires experience and expertise - ultimately a very human process. Now add in the human factor of entrepreneur talent and integrity - something very difficult to evaluate and protect against. See an earlier post for some risk mitigation elements on the lender side.

Thanks very much for your detailed and clear response to my question

We are currently exploring how digitialization can improve the business case for serving smallholder farmers with credit (and other financial solutions).  High transaction costs of dealing with rural clients have made it difficult to do so in a profitable way, but digital technologies, including but not limited to mobile money, may help us overcome this decades-old challenge.  It's too early to say for sure, but we've published some of our early findings on how financial institutions serving smallholders are emarking on their digital journeys here:  https://www.raflearning.org/post/how-does-digital-technology-make-lending-farmers-more-viable-early-findings

Never underestimate the power of people! Particularly for early-stage enterprises, investors want to have faith in the people they are investing in - not just the product or service. The management team's ability to demonstrate relevant experience, expertise, a strong network and reliability will go along way - in addition to more quantitative business metrics.

Actually part of this in my response to question #1 above. There are two considerations 1.) the invididual company and 2.) the industry or sector specific ecosystem (i.e., what is the broader opportunity for the FI to play in the space. 

1. Individual company. Increased stardardization and professionalization from SGBs is being requested by banks, but they are also realizing that they can use tools such as alterative credit scoring methods and leveraging technology data aggregation into their credit risk modeling. Team's are also an important consideration, whether it's a small SGB or a local startup, the financing partners wants to see that the team has experience in their given field and either a shop keeper that has sold say dairy, or a tech startup owner that's had experience executing his product vision.  

2. Ecosystem development. Investibility for one company might actually be a result of an FI thinking, or not thinking, they can make this a business line internally. They need a pipeline of investments to justify cost - more in my post above. 

Quick note, I think it's very important to significantly increase the particpation and appetite of local financial institutions. The problem with foreign institutions is the issue of hard currency lending leading to large exposure to currency fluctuations, and the fact that hedging products for this sector are not only hard to find, but expensive as well (that deincentivize usage - the economics of a hedging product in these scenarios make it almost useless to use). Not only does it create the need for foreign players to create solutions that reduce their bottom line (and affect impact), but also forces them to impose soft hedging such as geographic limitations (further reducing the availability of financing in a given region). A solution that has been on my mind is to use securitization as a way to transfer risk off financial institutions balance sheet into a tradeable product. In this scenario, local financial institutions that should be financing SGBs, would be able to increase their lending limits because they could recycle their balance sheet at higher volumes. Obviously, responsible lending requirements would need to be imposed to mitigate moral hazard. Ping me if you have further interest in discussing. 

To determine investability, Root considers both (1) impact, and (2) risk. 

Regarding (1) impact – we are a non-profit organization whose reason for existence is growing rural prosperity in poor and oftentimes environmentally sensitive areas. All prospective borrowers are thus subjected to social and environmental screening as part of our due diligence process. Is this agro-processor paying a fair wage? Is this farmer cooperative monitoring the use of agrochemicals? Are farmers involved in deforestation or operating in sensitive areas?

Regarding (2) risk, Root has now disbursed more than $1B to more than 600 businesses Latin America, Africa, and Indonesia. We have built up a database from which we are able to run analyses to better understand risk by value chain, geography, industry, business stage, business type, etc. Our risk management team has captured and analyzed more than 100 credit & impact indicators to refine our credit scoring methodology for agricultural SMEs. This analysis informs our risk ratings, regional portfolio allocations, loan pricing, and allocation of our very precious subsidy dollars (particularly for high-impact clients).

While the exact formula and weighting of our credit scoring may be complex, the factors we ultimately consider are not. They include management character and depth (very strongly weighted), business-specific indicators (e.g., size, stage of development), business performance indicators (e.g., gross margins, growth rates), credit-specific indicators (e.g., repayment history),  general indicators (e.g., country, industry), and other quality indicators such as the state of their financial statements.

As for make-or-break, a business may not meet our credit threshold due to risks in any of the above mentioned elements, or it might be specific to the enterprise. Are the growth projections too ambitious? Are the farmers likely to side-sell? What's happening in the broader market? Is there a guaranteed off-taker or - even better - a purchase order? All of these things will affect a go/no-go decision.

Good point to bring up Claire. A point of clarification, are you speaking about an individual company or a proof of concept product/idea? I'm actually working with two seperate companies that are looking at corporate structure options as it pertains to layering both non-profit and investment monies as leverage to eachother.