Beware the Valley of Death

Where should early-stage businesses in developing countries look to secure the growth capital and support services they need to get to scale? This was a theme at an event hosted by the Business Innovation Facility (BIF) in London today.

BIF provides practical, hands-on advice and technical expertise, to support companies to develop or scale up inclusive business models. After three years BIF is showing some impressive results, but also hitting some of the constraints that are familiar to entrepreneurs in frontier markets.

A key constraint is access to finance, especially for firms who are too large for microfinance and grant programmes, but are not yet mature enough to attract interest from development finance institutions (DFIs) or private equity. It's the problem of the "missing middle" or, as panellist Chris West from the Shell Foundation memorably put it, the "Valley of Death".  

Participants at the event highlighted the gap in the market for firms who need $100k to $2.5m of long-term, equity-like finance. Private foundations like Shell Foundation and the Omidyar Network, and social impact investment funds like Acumen and AgDevCo, are operating in this gap. But the unmet demand is massive.

Targeting fully commercial returns at the early stages of a business' development, given the pioneering nature of what they do in difficult markets, is often unrealistic. More needs to be done to find ways of blending traditional aid, DFI finance and commercial capital in ways that can buy down start-up costs and risks, to help SMEs navigate the Valley of Death.

AgDevCo announces "Green Ag" investments in Tanzania

AgDevCo is pleased to confirm that we are entering into three co-investment partnerships with Tanzanian businesses. The proposed AgDevCo investments will be funded by the UK Department for International Development as announced today by Secretary of State, Justine Greening – see DFID press notice.

• With Tanzania Tea Packers (Tatepa), to support the pioneering Suma Hydro Project, which is part of tea industry efforts to ‘green’ tea production in Tanzania. The project has the potential to provide Wakalima Tea Company with a reliable and renewable power source, whilst also selling power onto the local grid, boosting employment and incomes in the Rungwe District. With DFID funding, AgDevCo intends to support the project in its early stages through the provision of development capital, following which and subject to further due diligence, AgDevCo is pleased to provide in principle support for up to £2.5 million equivalent of risk capital to implement the project.

• With Equity for Tanzania (EFTA), to support the expansion of EFTA’s innovative financial leasing business, which provides equipment finance to small enterprises and farmer groups who are beyond the scale of micro-credit. The expansion of this business will allow access to finance for agribusiness entrepreneurs and farmers who might otherwise be “unbankable”.  Subject to further due diligence and the development of an agreed business plan, AgDevCo is pleased to provide in principle support for up to £3.3 million equivalent of risk capital to the business.  We see our proposed investment in EFTA as part of a strategic alliance reflecting AgDevCo and EFTA’s common objectives.

• With Agrica, an intention to invest £6.3 million ($10m) in Kilombero Plantations Ltd (KPL), the Tanzanian subsidiary of Agrica, a British farm development company. AgDevCo’s investment is funded by DFID as part of their Blended Partnerships initiative. Since 2008, after $40 million of investment, KPL has become East Africa’s leading rice producer with a 5,000-hectare nucleus commercial farm and a transformative satellite smallholder programme lifting 5,000 farmer families from subsistence to surplus. The AgDevCo investment, which assumes improvements in the application of agricultural tariff policy by the Government of Tanzania, will be divided into two parts: an initial investment of $850,000 for a pilot rice-husk gasification plant to provide electricity for KPL’s current operations and prove concept for larger biomass plants needed to expand irrigation across 3,000 hectares, and subject to customary due diligence, a follow-on investment in mid-2014 of $9.15 million for the expansion of biomass power, irrigation and the smallholder programme. This DFID investment in sustainable commercial staple crop production is a model for future African food security.

Some striking stats on food security, jobs and irrigation in Africa

• In the next 40 years, the world’s farmers will need to produce more food than they have had to in the last 8,000 years, to feed a fast-growing population (World Economic Forum).
• Sub-Saharan Africa's current population, at 856m, is little more than Europe's and a fifth of Asia's. By 2050 it could be almost three times Europe's and by 2100 might even be three-quarters of the size of Asia. (Economist).
• Compared to 14% living in urban areas in 1950, by 2015, 45% of people in sub-Saharan Africa will be urbanized (World Bank).
• Africa's domestic food market is expected to rise threefold from USD 313 bn today to USD 1 trillion by 2030. Over half the demand will come from growing urban centres where the rapidly increasing middle-class will be requiring higher quality food (World Bank).
• Agricultural production (i.e. growing crops and livestock) currently represents over 60% of the value of the entire value chain in Africa. Globally the figure is 22%, with the remainder being derived from off-farm value creation (i.e food processing, logistics and marketing) (Rabobank).
• Currently, 70% of Africans are under the age of 30. By 2040, 50% of the world’s youth will be African, most of whom will be women and girls. In sub-Saharan Africa, 10-12 million new workers seek employment every year (Forbes).
• Irrigation is practised on 6 percent of the total cultivated area of the African continent. This percentage is much lower than that for other regions: 38 percent in Asia, 27 percent in the Caribbean, and 12 percent in Latin America (FAO).
• About 70 percent of the total area under irrigation is concentrated in five countries (South Africa, Egypt, Madagascar, Morocco and Sudan), all of which, with the exception of Madagascar, are now using 100% or more of their annual renewable water resources (FAO).
• AgDevCo operates in five countries in SSA (Mozambique, Zambia, Malawi, Tanzania and Ghana) all of which have irrigation on less than 5% of available land and use less than 25% of their renewable annual water resources (FAO).

Why small investments are likely to lose you money – and the case for doing them anyway

As a social impact investor, AgDevCo is set up to invest in early-stage businesses in the African agriculture sector. We provide finance and business development support to help companies grow and eventually graduate to access private sources of capital. We work with businesses that need investment in the range $250,000 to $2.5 million.

 

We don’t expect to make money on the smaller investments in our portfolio, but we do them anyway. The reason we don’t expect to make money is fairly simple: transaction costs are high relative to the size of the deal. The reason we do them anyway is because small businesses are fundamental to building a profitable agricultural sector and, for those that do manage to get to scale, the social impact can be very large.

 

Why are transaction costs so high? Agriculture is not a sector that lends itself to a “cookie-cutter” approach to deal-making. Every opportunity is different – crops, technology, markets, revenue models, weather risks, management quality. In environments where reliable information is often scarce, an investor needs to understand and develop risk mitigation strategies for all of these areas. That involves time and money, not least travel costs in visiting remote areas.

 

Then there are legal costs associated with structuring and documenting the deal, often in a legal and policy context which is rather opaque; and with project sponsors and regulators who are not familiar with standard venture capital type structures (e.g. convertible debt instruments). These due diligence and legal costs can easily exceed $30,000, even for the smallest transactions.

 

Once the investment is made a fund manager often has to spend significant time working with sponsors to help build financial management systems, formalise business processes and develop marketing strategies. From the 20 or so investments AgDevCo has made to date, we have found that the first year costs of this type of activity can easily be $25,000 or more. More significantly, supporting small businesses can take up a disproportionate amount of management time.

 

If total first year cost for a typical small deal exceed $55,000 then – assuming an interest rate payable by borrowers of 7.5% and a seven year loan term – an investment of anything less than $500,000 delivers a negative net present value for the fund, after taking into account on-going monitoring & evaluation costs. That is without making any provision for non-performing loans in the portfolio. Taking some equity can provide upside but doing so pushes transaction costs higher, and exit opportunities for small deals are likely to be limited.

 

The case for doing small deals rests on the fact that small and medium sized enterprises (SMEs) are the backbone of any economy – and typically the largest overall employer. That is especially true in the agriculture sector. Agricultural development requires multiple small, profitable businesses operating along the supply chain from input supply to production, processing, logistics and marketing. By investing in “clusters” of small businesses a social impact investor can attempt to build supply chains which benefit the sector as a whole.

 

Over time we expect the cost of doing smaller deals to fall. The first mezzanine debt investment in a Mozambican soya processing facility will be expensive; the second should be easier. Over time we would expect to see better data availability, streamlined regulatory and approvals processes, and the emergence of local service providers. In other words, there will be fewer market failures acting to increase transaction costs and risks.

Until then social impact investors who are prepared to operate at the smaller end of the deal spectrum will need to find ways of balancing the books. That can be done through a combination of building portfolios which include a mix of small and large investments, and by making the case to donors that the first year or two of costs of small investments should be partly grant funded. There are also innovative models for lease financing of small farming businesses, such as Equity for Africa.

 

The wrong conclusion would be for social impact investors to withdraw from smaller deals, or to cut corners on due diligence. Social impact investors bring a much needed dose of commercial discipline to small businesses which can help them reach the next level. The reality is that small businesses in the African agricultural sector face costs and uncertainties that early-stage businesses in more developed parts of the world do not. It makes sense to mix in grant funding to help get them across the first few humps in the road.

  

---------

  

A recent survey on entrepreneurship in Africa by the Omidyar Network, Accelerating Entrepreneurship in Africa, highlights some of the challenges faced by early-stage businesses:

 

• 84% of SMEs in Africa are either un-served or underserved in terms of access to capital, representing a value gap in credit financing of $140-170 billion
• Over two-thirds of respondents believe there is an insufficient supply of venture or private equity capital for small and growing firms.
• Debt financing from banks is viewed as unsuitable funding source for entrepreneurs given the structure and cost.
• Government funding is viewed as difficult to access due to bureaucracy and nepotism; and there is a shortage of alternative sources of "patient capital"
• Only a quarter of respondents believe that business support services - such as lawyers, accountants and consultants – are sufficient to meet the needs of new firms. Availability of these services is especially limited in more rural areas away from large urban centres.
• Many new businesses operate “below the radar” in the informal sector because of the high costs and uncertainties of operating in a more regulated environment, where penalties for non-compliance can be high.
• From investors’ point of view, the key determinants of success for a business are the entrepreneur’s ability to adapt to market changes and cope with uncertainty, as well as his or her level of tenacity.

 

Is supporting smallholder farmers enough?

A thought-provoking piece from Lion’s Head, a UK-based investment group, calls for more donor support for commercial agriculture in Africa. An exclusive focus on smallholder farmers, say the authors, risks leaving countries dependent on food imports.

Lion's Head also want to see private investors doing more to tackle start-up agribusinesses and invest growth equity. The closed end private equity fund model – which seeks large financial payoffs within 5-7 years – does not match the long-term nature of agriculture. New and more patient approaches are needed, which may require blending public and commercial finance.

Since the food crisis of 2008, donors and governments have shown more willingness to engage with the private sector as a partner to promote agricultural development. The Grow Africa initiative of the Africa Union and the World Economic Forum is an example. But in recent months, campaign groups have turned up the heat highlighting “land grabs” and stoking fears of a corporate take-over of African agriculture.

Lion’s Head is concerned that, in the face of criticism, the main donor agencies are falling back on traditional approaches that prioritise support to smallholder farmers, instead of seeking creative solutions to promote responsible investment in commercial agriculture.

At AgDevCo we invest in both smallholder and commercial agriculture. Our ECA business in Mozambique shows what can be achieved when smallholder farmers are given access to better inputs (quality seed and a little fertiliser) and linked to reliable markets.  ECA is already benefitting over 2,200 farmers and will expand to 5,000 this year. Farmer incomes have doubled or tripled as a result.

Is ECA enough? We don’t think so. For a country like Mozambique to achieve its potential and become self-sufficient in major food crops like maize, soya and rice it needs mechanised farming and large-scale irrigation schemes (plus modern logistics and marketing) alongside smallholder and emergent farmer outgrower systems.

As Lion’s Head says, while the concerns of campaigners should not be dismissed, they should not be allowed to crowd-out the debate. Donors need to have the courage of their convictions to support responsible private investment in commercial agriculture. And investors need to take a longer-term approach, recognising the agriculture opportunity remains attractive but there are no easy wins. 

As argued previously on this blog, an informed and pragmatic approach bringing together the public and private sectors has the best chance of solving the food security challenge.

UK invests £50 million in AgDevCo to support smallholder farmers and tackle malnutrition

The UK Government will provide £50 million to help the Agricultural Development Company (AgDevCo) set up a new fund which will invest in agricultural SMEs, smallholder farms and new agribusiness ventures. This will benefit 650,000 people across Africa with jobs and better incomes, as well as help smallholder farmers grow more food to combat food shortages and malnutrition.

A non-profit social impact investor, AgDevCo specialises in investing in African agricultural companies that are at their earliest stages, turning them into commercially-viable businesses that can then find support through private investors and ploughing its profits back into future investments. The UK’s funding will be redeployable, allowing AgDevCo to reinvest in new opportunities as its investments mature and develop.

Investments made over the next five years are predicted to attract over £7 in private sector investment for every £1 invested by AgDevCo.

Africa has more unexploited potential for food production than anywhere else in the world, holding 50% of the world’s uncultivated fertile land, yet its commercial agriculture sector attracts relatively little investment. The new UK-backed fund will:

 - Develop or expand 45 agribusinesses, 30 of which will be SMEs. AgDevCo predict this could increase the turnover in these countries by £60 million by 2018
- Create 27,000 additional jobs and help 90,000 people to benefit from an average additional income of over $1000 per year over the next decade.
- Improve irrigation and processing for commercial agribusiness for 49,000 farmers. By 2018, up to 30,000 additional hectares will be under irrigation.

Three new AgDevCo SMEs Catalytic Funds in Malawi, Zambia and Ghana will receive £10 million each from the Department for International Development (DFID), while £20 million will be invested into a new Regional Innovation Investment Fund to boost production and cross-border trade across Africa.

International Development Secretary Justine Greening said:
“Part of the solution to hunger in Africa is for Africa's farmers and agricultural sector to be able to produce the food it needs for itself.

“Smart UK investment like this will help thousands of farmers develop their businesses to grow food for millions, whilst generating revenues that can be reinvested back into Africa's agricultural sector.
“This sort of innovative, self-sustaining, job-creating investment which generates a return that can be itself reinvested will become an increasingly important part of DFID’s development approach.”

Dr Keith Palmer OBE, AgDevCo Chairman and founder, said:

“Investment in agriculture is the most effective way of stimulating inclusive economic growth, reducing poverty and tackling malnutrition. With UK government support, AgDevCo will support many more African SME agribusinesses and link thousands of smallholder farmers with markets”. 

Examples of businesses AgDevCo is already investing in include:

So Soja – a Mozambican SME soy milk and yoghurt processing business which supplies hospitals and primary schools with highly nutritious milk drinks and yoghurts throughout the country. AgDevCo’s investment will allow So Soja to build a modern processing facility, scaling up its production and helping it to meet international food safety standards. 
 
Sao Hill – A Tanzanian production and processing firm producing seed maize, soya and horticulture. AgDevCo’s investment will help it to raise incomes, reduce poverty-levels and improve nutrition for 3,200 farmer households.

Eastern Province Farmers – a groundnuts farming and processing operation in Zambia which is already working with 3,500 smallholder farmers to eliminate aflatoxin, a mould and a poison, from the food chain. This will have health benefits for consumers in local and regional markets and allow smallholder farmers to sell premium grade nuts into higher value export markets. 

AgDevCo highlighted in Grow Africa progress report

The Grow Africa partnership aims to accelerate private-sector investment for sustainable growth in African agriculture.  Seven countries joined the initiative when it was launched in 2011 - Burkina Faso, Ethiopia, Ghana, Kenya, Mozambique, Rwanda and Tanzania. Malawi has since joined.

To date these countries have attracted investment commitments from 62 companies including 39 based in Africa. The Grow Africa report highlights AgDevCo's work building profitable and sustainable agriculture businesses in Mozambique and Ghana:

• development of three irrigated farming blocks in Ghana aimed at generating income transformation and food security for large numbers of farmers 
• management of a $20 million catalytic fund in Mozambique which has invested in 14 farming and agriprocessing businesses to date, including ECA which works with smallholder farmers to supply maize to a local brewery and other customers

One of the main conclusions of the Grow Africa forum meetings in Cape Town in May 2013 was that agricultural finance can be unlocked by impact investors providing medium-sized investment in SMEs.

Don’t beat up the banks, they can’t fix African agri-finance on their own

I have attended countless conferences and workshops on African agriculture – in South Africa, Mozambique, Ghana, Tanzania, Ethiopia, Europe and the US. There’s always a panel session on access to finance. The discussion usually follows a similar script.

Farmers and entrepreneurs complain about the high cost of finance. “We cannot afford 25% interest rates”, they say. Governments insist banks should lend more to the agriculture sector. The banks say there are too few investment opportunities; and they are forced to charge high interest rates because of macroeconomic fundamentals and the unavoidable fact that agriculture is risky.

“A quarter of our clients’ fields were under water” a Mozambican banker told a conference in Maputo earlier this month (the result of recent floods in the Limpopo Valley). “We are not making money on our agriculture loan book”.

In the discussion that follows there’s often a lot of scepticism. Surely the banks could try harder to find good investments? They should get out into the field, learn more about agricultural economics and develop affordable loan products that meet farmers’ needs.

In AgDevCo’s view, criticising the banks misses the point. Most agribusiness opportunities in Sub-Saharan Africa are greenfield or early-stage, without a strong balance sheet or management track record. Yields and markets are uncertain. The weather is always a factor. Commercial banks are just not set up to provide finance to that type of client.

Banks are – at least they should be – conservative institutions which seek to protect their depositors’ capital by taking manageable risks and earning a steady return. Would you be happy if your bank was investing your savings in unproven agriculture businesses?

What the African agriculture sector needs is risk capital in the form of equity and long-term loans. There is a strong case for subsidising risk capital for African agriculture because, while agriculture will never deliver spectacular financial returns, it can have a hugely positive impact on employment creation, rural economic growth and food security.

Where will the risk capital come from? There are private equity firms targeting African agriculture but they are looking for large deals (typically $5 million +) which are in short supply. The development finance institutions, such as the IFC and CDC group, are slowly getting back into agriculture but they also seek large deals because of high transaction costs.

Social impact investment funds like AgDevCo, Root Capital and Acumen can play a role. Unlike traditional venture capital, they raise money from a combination of charitable, government and commercial sources which allows them to take (a little) more risk and accept a (slightly) lower financial return in order to achieve high social impact.

Social impact investors can fill the agri-financing gap by investing a few hundred thousand dollars or more – bundled with professional, hands-on management support – to help SMEs grow into the commercial debt and equity markets. As with any venture capital investment there will be failures as well as successes. However, those successes could help kick-start a profitable agriculture sector.

So go easy on the banks, they are supposed to be (!) boring, conservative investors. What African agriculture needs is capital with more risk appetite - and plenty of patience.  

Unlocking the Potential of Agribusiness

A new World Bank report titled Growing Africa explores the  role of agribusiness in creating jobs and reducing poverty in Sub Saharan Africa.

• Africa has a huge challenge to create jobs, especially for the 25 million young people who will enter the labour force each year by 2025.
• Agriculture and agribusiness together are projected to be a US$ 1 trillion industry in Sub-Saharan Africa (SSA) by 2030 compared to US$ 313 billion in 2010.
• Agribusiness can play a critical role in jump-starting economic transformation through the development of agro-based industries that bring much-needed jobs and incomes.
• The attention focused on production agriculture will not achieve its developmental goals in isolation from agribusinesses, ranging from small and medium enterprises to multinational companies.
• The challenge is thus threefold: (1) develop downstream agribusiness activities (such as processing) as well as upstream activities (such as supplying inputs), (2) develop commercial agriculture, and (3) support and link smallholders and small enterprises to productive value chains.
• Private sector interest in African agribusiness is unprecedented. The past decade has witnessed an upsurge in interest from the private sector in African agriculture and agribusiness, including interest from foreign investors and investment funds. The challenge is to harness investors’ interest in ways that generate jobs, provide opportunities for smallholders, respect the rights of local communities, and protect the environment.
• The growth of competitive agribusiness in Africa is severely constrained by the low use of modern inputs and limited access to improved technologies
• Irrigation is critical to increase and stabilize production, reduce risks, and provide the basis for higher-value agriculture. Given the severe constraints on public sector resources and capacity, tapping private capital and management skills will be essential to accelerate investment in irrigation.

The report cites AgDevCo as an example of an innovative financing facility which can help early-stage agribusinessess overcome the challenges of operating in frontier markets.

UK Deputy PM praises AgDevCo's work in Mozambique

UK Deputy Prime Minister Nick Clegg and DFID Minister Lynne Featherstone visited Maputo on Wednesday 13th February, where they spent an afternoon with SME agriculture businesses supported by AgDevCo, as part of the Beira Agricultural Growth Corridor (BAGC) initative.

Nick Clegg  praised the work undertaken by the BAGC in supporting small scale agricultural producers in the central Mozambican provinces of Manica, Sofala and Tete.

Launched in 2010, BAGC is a partnership between the Mozambican government, private companies and donor agencies, including the British Department for international Development (DFID). Clegg, who is on a two day working visit to Mozambique, declared that the initiative will bring substantial and positive changes in the lives of farmers in the areas covered.

DFID Minister Lynne Featherstone welcomed the work AgDevCo was doing saying that small and medium-sized businesses were critical for inclusive growth and job creation in Mozambique. In an article in the Huffington Post she wrote about the potential for mobile money solutions to provide new opportunities for farmers, such as those linked to AgDevCo's ECA smallholder farmer business.

--------------------------------------------

Opening remarks by Chris Isaac, Director Business Development AgDevCo:

"Small and medium sized enterprises (SMEs) are the engine of economic growth in all countries. Agriculture is the backbone of Mozambique’s economy engaging over 80% of the workforce. More investment in Mozambican agricultural SMEs is essential to:

• Create jobs
• Ensure economic growth is broad based
• Provide opportunities for small entrepreneurs and farmers, many of whom are women

The problem is that it is very difficult for SMEs to access financial capital. Most banks will not provide loans to SMEs due to the high-risks of starting a business – or they will only do so at very high interest rates. And private equity funds typically look for deals of 5 million dollars or more, far too big for most SMEs.

Catalytic Finance is the solution. A Catalytic Fund provides a combination of low-cost capital and “hands on” technical support to help SMEs grow, to the point where they can graduate to access commercial debt and equity. Backed by development agencies like the UK’s Department for International Development (DFID), a catalytic fund can do smaller deals, take a little more risk and accept a slightly lower rate of financial return than a private investor, while insisting on the highest social and environmental standards.

Today you will meet a number of Mozambican SMEs funded by the BAGC Catalytic Fund, which is managed by AgDevCo.

Businesses like So Soja, run by a brilliant entrepreneur Lucas Mujuju, who is bringing nutritious and delicious soy-based products to Mozambique’s schools and hospitals.

Or the Mozambique Honey Company which is creating a market for high quality honey buying from rural beekeepers, run by Anifa Osman, to be distributed throughout the country by Tropigalia.

Or Frutis Lda, owned by the charismatic Sr Issufo Valy who was born on his farm and is now singlehandedly setting about the revival of the fresh fruit industry in the Beira corridor.

You will also meet some of our corporate partners who work with us to link smallholder farmers and SMEs to reliable markets, allowing us to scale up our impact. Like Rio Tinto who are working with us to ensure that every vegetable eaten in the mining canteens of Tete has been grown in Mozambican soil; or Cervejas de Moçambique who are buying fair-trade maize from our small farmer marketing business ECA.

Lastly you will meet some financial services companies like Hollard who is working with us to introduce innovative drought insurance products for the first time in Mozambique, protecting farmers like Mussa Macaliha from the changing climate.

None of this would be possible without funding support from UK Aid. None of this would happen without the dedication and commitment day in and day out of people like Lucas, Anifa, Issufo and Mussa. At a time when all eyes are on the big discoveries of coal and gas in Mozambique, we believe it is small entrepreneurs and farmers like those here today who are the real future of the Mozambican economy."