AgDevCo $1.5m investment in Rungwe Avocado Company, Tanzania

AgDevCo is delighted to announce a USD1.5 million investment into Rungwe Avocado Company (RAC), an avocado growing and export business based in Tukuyu, in the Rungwe region of southwest Tanzania.

RAC is a pioneer in the development of Tanzania’s horticulture industry. In 2009, it was the first ever farming business to trial avocado exports by air freight to European markets. Today RAC is establishing refrigerated sea shipment routes to Europe and beyond – another important breakthrough for the industry.

The business is helping to improve the living standards of local farmers. RAC engages over 3,000 smallholders as part of its outgrower network. Farmers receive inputs and training as well as a fair price for their production. By 2018, over 75% of the avocados sold by RAC are expected to be grown by local farmers, resulting in some USD0.8m being paid annually into the local community.

RAC is set to receive a USD1.2m loan from AgDevCo with another USD0.3m invested in the form of equity. The investment will support the installation of a micro jet irrigation system on the commercial farm to boost yield performance. It will also fund ongoing operations, including management of the outgrower scheme.

AgDevCo is supporting a range of horticulture projects in Sub-Saharan Africa. We believe that by helping socially-responsible businesses like RAC to access international markets we can contribute to the modernisation of the agriculture sector and help deliver better incomes for thousands of smallholder farmers.

Financing smallholder farmers - the working capital challenge

AgDevCo invests patient capital in small and medium sized agriculture businesses in Africa. We work with companies that are too small to attract private equity but have outgrown microfinance. They typically need long-term investment of between $250k and $5 million to expand their farming or agri-processing operations. Our investment is used to install irrigation equipment, build storage facilities and factories and buy machinery. We expect to have to wait 5 – 10 years before we see a return on our investments.

What we are finding is that all of our investees – and many other companies we come across – are starved of short-term working capital finance. They need finance to invest in their own seasonal production, to provide inputs to networks of outgrowers, and to buy crops from smallholder farmers for processing. Even for relatively small businesses those working capital needs can run into the millions of dollars annually.

Some banks are lending in this part of the market but it is high risk activity, which is reflected by high interest rates. For many small and medium sized agribusinesses which do not have a long track-record or the ability to provide collateral, there is simply no availability of credit. The lack of finance for SMEs makes it very difficult for smallholder farmers to access loans. The African Green Revolution Forum estimates that only 10% of farmers have access to the credit they need to increase their productivity and incomes.

The result is a low-productivity trap for millions of smallholder farmers. Without credit there is limited availability of improved seeds and fertilisers. That constrains yields and quality, making it more challenging for smallholders to access formal markets. Low and unpredictable incomes make it difficult for farmers to invest in their land. And without being able to demonstrate a track record of steady income farmers find it almost impossible to access loans…and the cycle continues.

One way of breaking out of the low productivity trap is to link smallholder farmers to formal markets through a trusted aggregator business. The aggregator can be a Cooperative or a for-profit SME.

Its role is to manage a network of smallholder farmer producers, providing them with finance, inputs and technical support through an equitable contractual arrangement which guarantees a fair price for their production at the end of the season. It then stores and/ or processes the crop and arranges logistics. The aggregator may be able to negotiate long-term sales agreements with commercial buyers – who might be Grow Africa partner companies – for example breweries, food companies or trading groups. Management must understand the market’s requirements on quality and volumes and be able to deliver consistently.

These aggregator businesses are vital to link farmers to markets. They need long-term patient capital investment; but they also need short-term working capital finance to extend loans to small farmers and to have the ability to buy the crop at the end of the season.

A success story in Mozambique is ECA, a smallholder farmer commercialisation business that started three years ago with AgDevCo’s support. AgDevCo invested equity to allow ECA to build its collection and storage infrastructure and buy vehicles. Later AgDevCo finance a Buhler maize mill for on-site processing. ECA management negotiated a three-year offtake agreement with a local brewery, part of the SAB Miller group, to sell maize grits for use in Chibuku beer. It also sells maize flour and bran for consumption in local markets.

ECA provides a full package of finance, agricultural inputs and extension support to its farmers, many of whom have seen their yields and incomes increase by 3-4 times as a result. Last season ECA purchased maize and soya from more than 4,000 farmers and this year it plans to scale up to 10,000 farmers.

In the first two years AgDevCo had to provide the short-term working capital to allow ECA to buy the smallholder production. Last year however, after two successful seasons when there had been 100% recovery of smallholder credit and ECA had repaid its seasonal loans, a local commercial bank was willing to lend to buy the crop. This year ECA is able to borrow at affordable rates both for the smallholder input finance and for the crop purchases.

The lesson of ECA is that it is possible to build commercially viable and scalable agri-businesses that benefit large numbers of smallholder farmers. But those businesses will not be able to attract commercial finance in the early years before the business model is proven.

We believe there is a role for a publicly-back working capital facility to give businesses like ECA the kick start they need.

Working with Grow Africa partners, AgDevCo is raising a pilot working capital facility of $25 million to allow SMEs to work with tens of thousands of smallholder farmers, boosting their productivity and incomes and linking them to profitable markets.

The facility needs a mix of commercial loans and grants to enable it to take the risks of lending to early-stage businesses. Grants and equity will act as a first-loss cushion which could absorb foreign exchange losses, and other risks. A separate technical assistance fund will make available grants to help establish and monitor smallholder farmer outreach schemes, like the ECA model in Mozambique. The facility will focus, but not exclusively, on food crops for local and regional markets.

In time the facility can be increased to $100m or more, with the target of linking 1 million farmers to profitable markets. By proving that smallholder farming can be profitable and commercially viable, the working capital facility aims to leverage in a lot more commercial debt and equity into the sector, helping agriculture thrive as a business, with benefits for all.

The future of development finance - how to fix the "missing middle"

The UK's International Development Committee has published a report on the future of aid, titled The Future of UK Development Corporation: Development Finance. The report makes the case for an increasing proportion of British aid to be delivered as "returnable capital" (i.e. loans or equity), especially where it is used to promote private sector development.

In oral evidence to the IDC enquiry, Dr Chris West of the Shell Foundation made a compelling case for a new approach to supporting social enterprises in the "missing middle". His evidence is worth quoting at length, because few people have such a good understanding of the needs of SMEs in this segment and the challenges of serving them:

"For this market segment, if I look at social enterprises growing… they need skilled support, and they need finance in the right form, which therefore means the transaction cost of servicing that market is high and the risk is high. That is why the end result is a lower yielding return out of investing in that. It is a combination of both cost and risk.

Now, there might be smarter ways of doing it, but I think fundamentally that is why you need a bridging instrument … If we do not have a higher-transactional-cost, risk-tolerant vehicle in the middle, I do not think you will get the graduation of these initiatives to the scale we all hope for.

On your second point about the range of instruments, again, there is a lot of liquidity in a lot of emerging economies…. A lot of that is locked up in banks that have hugely conservative lending rates, and of course it is often provided in short-term debt.

If you are a start-up growing business in any country in the world, you really need some form of patient, flexible finance that adjusts to your cash flow income. It is not necessarily a short-term debt instrument.

Equity is usually not very attractive to the entrepreneur, and it is also not necessarily attractive to the investor, because there is not a very clear exit route from investing in equity in small ventures like this.

You really need different finance forms. You need mezzanine finance forms related to the cash flow performance of the business that are much more patient and much more flexible in tenor."

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.

  

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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.