Whether for profit or social motives - and often both - an increasing number of investors are targeting opportunities in African agriculture. At the same time innovative approaches for deploying aid to support farming businesses linked to smallholders are emerging. This blog provides a snapshot of who is doing what, where and how.

1 October 2014

Investing in African Agriculture – More Bang for the Philanthropic Buck

This article written by Chris Isaac of AgDevCo first appeared here on the European Venture Capital Association (EVPA) website on 1st October 2014.

It is a huge opportunity. According to the United Nations’ Food & Agriculture Organisation (FAO), $35 billion worth of agricultural goods is imported into Africa annually. With a growing middle class and a population set to reach two billion by 2050, demand for more and better quality food will continue to rise. There are large areas of arable land and plentiful water resources in many parts of Africa. Surely investors can play a role in reversing the flow of food imports? With the right types of capital and expertise, Africa should be able to feed itself and sell a surplus to the rest of the world.

There’s a strong developmental case for investing in African agriculture, not least to create the job opportunities for a young and rapidly growing workforce. 700 million people are set to enter the workforce in the next 30 years. Per the World Bank, growth in agriculture is 2.5 times more effective in reducing extreme poverty than growth in the rest of the economy.

But in the short-term the investment case for African agriculture remains unclear. Competing with highly efficient producers in Latin America, Europe and the Far East is not easy, even when you benefit from transport cost advantages. The landed price at African ports of frozen chicken from Brazil, rice from Thailand or palm oil from Indonesia is often lower than the local cost of production. Unpredictable import tariff regimes don’t help.

Production costs are high because African agriculture is still largely an infant industry, which receives little of the support that is taken for granted in developed countries. In Europe, farm subsidies average more than €200 per hectare, which is more than the income most African smallholder farmers earn from crop sales. Public spending on research and development in Africa is a fraction of other regions in the world. Investors face additional challenges of poor roads and power networks, a lack of service providers, complex local bureaucracy and a scarcity of experienced management. If a tractor breaks down it can take days to get spare parts sent via international courier; producing accounts can be a challenge when the nearest qualified accountant is over 1,000km away in the capital city.

The main access road to the Kilombero Valley, in southern Tanzania, during the wet season.

Investing in agriculture requires a long-term approach. In AgDevCo’s experience, there are no easy returns to be made, especially in primary production (i.e. growing crops). Proper consultation and engagement with local communities – about land rights, jobs and outgrower schemes – is necessary, not only because it is the right thing to do, but because it makes for a more sustainable investment. A full understanding of environmental risks and how to manage them is also essential. It all takes time and money.

Understandably the commercial banks, as guardians of their depositors’ funds, are wary of agriculture given the high risks. There has been a surge of interest in Africa recently by private equity funds, but the majority focus on sectors that offer higher returns such as financial services, healthcare or property. Where PE funds do look at agriculture they shy away from farming, preferring well-established trading or processing businesses, and they tend to invest no less than $10 million at a time.

Within this context, AgDevCo believes that unlocking Africa’s agriculture potential requires a new approach: social venture capital. Social venture capital can step into the gap between aid and fully commercial capital. It brings the discipline of an investment approach with a willingness to take risks in exchange for high social impact. It is prepared to absorb the relatively high transactions costs (due diligence, legal etc.) associated with smaller deal sizes ($500,000 to $5 million) for early-stage businesses. At the portfolio level, taking into account successes and failures, it is satisfied with capital recovery or modest single digit returns net of costs.

A member of the Phata Coop, an AgDevCo investee in Malawi, tends an irrigated beans crop.

If private foundations, high net worth individuals and family offices could be persuaded to allocate part of their portfolios to African agriculture, through a social venture capital model, it might just be enough over a number of years to kick-start a critical mass of investment, which would catalyse the entry of more investors and service providers, and help the agriculture sector escape the infant industry trap.

For investors with a long-term outlook, who care about the state of the world, there are few better ways of investing with a social purpose than supporting African agriculture. Those who get in early may even find that, when the tipping point comes, they are well-placed to reap the financial rewards. Some social investors might choose to recover their capital, others may decide to recycle it, putting their philanthropic funds to work many times over. That’s real bang for the buck.