Impact Investing for the Missing Middle in Agri-Finance

(Photo by iStock/Olga Seifutdinova)

Imagine being in charge of a profitable vegetable cooperative in Benin. You know the cooperative can increase its income and improve its resilience if most of this year’s profit is set aside for investing in new hardware. You also know that your members are very poor. What would you do? Would you propose foregoing income now for the promise of a higher income later on? Would you be able to resist pressure to deliver immediate income to your cooperative’s members?

The answer is almost certainly no. Cooperatives, including profitable ones, find it extremely difficult to build up accrued reserves, leaving their balance sheets perpetually weak and their businesses dangerously undercapitalized. The vicious cycle of redistributing profits among the members of the cooperative has consequences. It directly limits future growth and also makes it harder for the cooperative to borrow sufficiently to finance its day-to-day activities or operating expenses.

So, if using your own profits is not viable, you need to attract external capital. But how and where? Is external financing available? Affordable? Available in the appropriate form?

The Missing Middle

Agriculture is a central economic pillar in rural communities, especially in developing countries. Smallholder farmers and small and medium enterprises (SMEs) make up the bulk of agri-food businesses worldwide, accounting for a significant part of all formal agribusinesses and more than half of their full-time workforces. In some developing countries, up to two-thirds of the population are employed in agriculture, a sector that can account for more than 25 percent of GDP.

But while SMEs are the backbone of agricultural value chains in such countries, they often lack access to the financing needed to grow their businesses and sustain their activities in the longer term. The International Fund for Agricultural Development estimates that basic financial services reach only 10 percent of rural communities. In Southeast Asia, Sub-Saharan Africa, and Latin America, smallholder farmers require the equivalent of $240 billion in agriculture and non-agriculture finance to meet their needs. Financial institutions are currently supplying $70 billion, leaving a gap of $170 billion. In other words, 70 percent of the global needs for rural finance are currently unmet.

Providing financing in the agricultural sector is often considered risky and costly, with long-term financing of amounts between $50,000 and $1 million being particularly difficult for smallholders to obtain. Such financial support is too big for microcredit lenders but often too small for regular impact investors. Additionally, the banking sector is often underdeveloped in rural areas and clients typically need to put up a lot of collateral. These types of investments are critical if a sector is to be successful and sustainable. The sheer scale of the unfulfilled demand for rural finance means new ways of accessing finance have been gaining momentum. However, few have been successful to date, and important gaps remain.

Why? Because, from a purely commercial perspective, investing in such businesses involves high transaction costs, and is risky because of factors such as governance, lack of long-term contracts, disruption in distribution channels, management deficiencies, lack of data or track records, and exogenous shocks like natural disasters or political disruptions that are more difficult to absorb in a low-income country context. In addition, these types of investments—small and moderately sized financing—also require a long-term engagement. To sufficiently de-risk an investment, the investor needs to be closely involved, increasing the transaction cost and requiring specific expertise. Finally, most clients cannot put up the collateral investors require.

All of the above is compounded when accounting for the size of the investment. Generally, the bigger the investment the greater the ease with which transaction costs can be earned back. By contrast, the transaction cost of small deals is high relative to the amount invested. The result is a gap in agricultural finance between small individual (micro-)loans on the one hand and industrial loans on the other. This shortage in the availability of this specific type of capital—roughly speaking, between 50,000 and 1 million EUR, is referred to as the missing middle, first coined by Brian Milder in his article in Practical Action.

 

This “missing middle” exists because the cost of making an investment is roughly independent of the deal size. Combined with the risk profile, the missing middle, particularly in the agri-food sector in the developing world, has been widely underserved. 

But there is more. The issue is not only a question of ticket size. Other important variables at stake include the type of loan provided and its duration. A short-term senior and collateralized loan, meaning a loan secured by assets, that must be paid off first if the company goes into default, of 200,000 EUR does not allow the recipient to make the same investments as a long-term junior and uncollateralized loan of 200,000 EUR. Whether the money is lent for one year or seven, whether collateral is needed or not, these conditions determine how the money can be deployed and what assets can be acquired with that money. Long-term investment capital without collateral is even scarcer because of its risky nature, impeding the growth of many cooperatives and small businesses.

Reverse-Engineering a New Model

This is precisely where Kampani, a Belgian social impact investment fund with a purpose-built investment strategy, comes in. When addressing access to finance in the agri-food sector in low-income countries, the challenge is not only accessibility and affordability but also the appropriateness of the financial instrument offered, or the conditions attached. 

Kampani was designed with this financing and social need in mind: access to patient growth capital for small, capex heavy investments. Companies have to pay many costs and expenses to run their businesses: The most commonly used categories to differentiate the types of expenses incurred are Opex and Capex. Opex refers to operating expense and means an expense a business incurs through its normal business operations. Capex on the other hand is the abbreviation of capital expenditure and refers to expenses made to acquire or upgrade physical assets such as land, buildings, machinery, or equipment. The Kampani model was reverse-engineered to focus exclusively on the capex segment, arguably the hardest part of the missing middle.

In a nutshell, Kampani’s investment strategy is as follows:

• The social impact the investment unlocks (reducing poverty and vulnerability of smallholder farmers) is central to the decision-making.
• Direct investments in farmer cooperatives or SMEs (not via other funds or microfinance institutions).
• Equity or quasi-equity (subordinated debt), without requiring collateral, thus strengthening the balance sheet of the investee.
• A long investment horizon of up to 10 years
• Only in the agri-food value chain.
• Active involvement in the governance of the investee.
• Small investment amounts (100,000 to 500,000 Euros and via add-on investments up to 1 million Euros).
• The investments are in fixed assets, such as land, buildings, or equipment (capex).

Looking at the investment scope, it can be said that Kampani offers a service that is rare. Other investors such as development finance institutions (DFIs) generally provide senior debt, requiring collateral. Additionally, social lenders often provide bigger investment amounts, with target ticket sizes well above 1 million Euros, or use small investment amounts with a focus on short-term loans.

Kampani is now seven years old, with a portfolio of 17 investees across 12 countries, covering a wide range of commodities in the agricultural sector. In 2022, Kampani’s investments had an impact through its clients on the lives of more than 80,000 farmers. Now more than ever, we see a growing demand for the type of financing Kampani offers. But considering the challenges inherent to the financing segment Kampani wishes to address, it is important to spell out the underlying factors that make this apparently risky model financially viable.

Critical Success Factors

Traditional investment theory holds that having an impact while making money is difficult because social impact comes at the expense of financial return. In the traditional spectrum of risk and return, impact investments have always been considered riskier than traditional investments, and more difficult because investors have been unfamiliar with the field of impact. But recently, investors have begun to appreciate that the growing field of impact investment not only allows capital to be preserved but can also be a driver of business success.

Kampani has sought to address this tension by creating a significant and sustained impact on the one hand, while offering a financially viable investment model with a moderate return on the other. Balancing the risk-return-impact equilibrium in the missing middle is an ambitious and challenging task involving innovative approaches. Through a combination of strategic choices and new ways of collaboration with mission-aligned partners, we think Kampani has managed to find the correct balance.

Stakeholder-Shareholder Model

One essential strength of Kampani’s model is its multi-stakeholder approach. Over the years, Kampani has created a strong, reliable network of mission-aligned partners who actively intervene either at risk or cost level, and who have been the basis for Kampani’s successful expansion. At each stage of the investment process, Kampani relies on these partners, who constitute an inherent and integral part of the fund’s added value.

This network was built over the years and is continuously growing, bringing together established actors in the Belgian and international development sector but also visionaries and pioneers willing to take risks. Convincing these actors was at times a long process. For others, Kampani was what was missing. For instance, the majority of Belgian NGOs that provide technical support to farmers in the agri-food sector in low-income countries are all shareholders of Kampani. In fact, Kampani was founded by several of these NGOs frustrated with the fact that many of their most successful, well-run clients stopped growing for lack of affordable, accessible, and appropriate financing.

A processing facility for ginger in Peru. (Image courtesy of Kampani)

In concrete terms, Kampani’s deal flow is primarily generated by its NGO shareholders who provide technical expertise complemented by deep local knowledge. These NGOs also have a wide geographical scope, meaning they are well-placed to identify deal potential and play a key role in helping build the relationship between Kampani and the producer organization. For example, reluctance on the side of farmers’ organizations can arise when they have to share information. In such instances, NGOs have proven to be vital partners in accelerating the trust-building process. As Kampani shareholders, these NGOs also have a strong incentive to filter and select the most promising deals, substantially reducing Kampani’s deal sourcing costs and risks in the process.

Although cooperatives and businesses can reach out to Kampani directly, the files with intermediation from an NGO partner tend to be much easier. In the case of our investment in Nicaragua, COOSEMPODA, for instance, the cooperative’s leadership often explicitly refers to the feedback loop with the work of the NGO, and has repeatedly said that the involvement of the Belgian NGO Rikolto, which had been working with the cooperative since 2014, was decisive when building the relationship with Kampani.

Secondly, the due diligence process is conducted by a consultant drawn from a small group of qualified partners with dedicated expertise and a willingness to collaborate long-term. Kampani has high requirements in terms of due diligence: In addition to an in-depth analysis of the financial viability of the company or cooperative, its social impact, governance and ownership, and an in-depth market analysis, a set of recommendations is also requested. These recommendations enable Kampani, alongside the SME or cooperative’s internal management, to identify the needs and some of the business’s internal weaknesses, and to start working towards remedying them. This type of analysis and recommendations requires experts with specific skills who understand the very high social standards requested by Kampani to ensure the cooperative or SME aligns with Kampani’s impact goals. Again, the presence of partner NGOs allows the consultant (and Kampani) to conduct the due diligence more efficiently and cost-effectively than other social impact investors.

Once the investment has been made, Kampani works in close collaboration with its NGO partners to provide clients with technical assistance, advice, and support whenever needed, and monitors their growth. This support by Kampani’s partners is crucial in mitigating risks and building resilience.

Next to NGOs and dedicated consultants, Kampani also partners with off-takers for securing access to markets; with social lenders to help secure sufficient working capital; with governmental actors to cut through red tape; with foundations to share some of the risk when appropriate; and with knowledge institutions to accelerate the learning curve. In order to embed this long term, mission-aligned collaboration, some of these actors also became shareholders of Kampani. For each investment, careful analysis establishes who Kampani needs to partner with and what each partner can contribute in terms of reducing risks or absorbing some of the costs.

Building a Long-Term Business Relationship

Another extremely important component of Kampani’s model is its active role in governance. In order to ensure the smooth running of its investments, Kampani has a place on the board of the cooperative or SME, with its representative having veto rights, to add value beyond the cash injection and further mitigate risks. Local experts appointed as board members to represent Kampani are selected first and foremost for the added value and expertise they bring with them. We work with local experts because they are part of the social fabric, bring their own network, speak the local language, and know the local customs.

In the case of our investment in a chicken hatchery in Rwanda, for example, our representative helped manage fast and accelerating growth. In the case of our investment in an SME in the agro-input industry in Ghana, our representative was instrumental in upgrading the overall governance.

We hope Kampani’s model will inspire other practitioners to experiment and eventually succeed in sustainably scaling their solutions.

By the very nature of its investments—long-term, equity or quasi-equity, without collateral requirements—Kampani’s intentions are straightforward: to ensure the client realizes its objectives and meets its growth targets, not only financially, but first and foremost in terms of social impact.

Kampani’s tailor-made approach contrasts with more templated investment procedures, reflecting Kampani’s desire to be—and to be seen as—a long-term business partner rather than as an external actor imposing its views.

A Patient Approach to Scale

As with any innovative approach, the first step—creating a successful proof of concept—needed a pool of financial supporters willing to take on board considerable risk while supporting Kampani’s primary ambition to create social impact and offer a solution to the missing middle. This has required Kampani’s initial shareholders to accept a concessionary mindset, striving for capital preservation rather than risk-adjusted market returns.

Once the model had proved its viability, the next challenge was to attract additional capital providers. But with the high risks and moderate return perception of investments in the missing middle in low-income markets, the flow of private capital remained restrained.

To address this challenge, Kampani was awarded a grant of almost 1 million Euros from the Belgian government to further de-risk its investments, applying more technical assistance, and to install a first loss tranche—a mechanism that acts as a buffer and will suffer the first economic losses if a portfolio of assets loses its value—to cover potential losses to its shareholders. This has allowed the fund to attract additional, more risk-averse capital, growing from an initial fund size of 4 million Euros to nearly 14 million Euros.

Such an example demonstrates how blended finance, aggregating investors with different risk profiles (in this case combining public and private capital), can pave the way for additional investments in projects that would otherwise be considered too risky for commercial capital. Again, Kampani’s impact record was decisive in the government’s decision to award this first loss tranche.

Lessons Learned

A processing facility for ginger in Peru, a cinnamon grinder in Indonesia, banana ripening cells in Tanzania … These are some of the facilities Kampani helped acquire through its investments.

The next target for us is to reach a fund size of 20 million Euros, which would correspond to approximately 40 deals when fully invested. Kampani’s growth was initially slow (one to three new deals a year) and required more effort than anticipated, mainly in educating and aligning the different parties.

Building a well-functioning stakeholder-shareholder model has been a long process, taking nearly five years. As well as involving efficient collaboration, it also requires the NGO partners to have the appropriate level of understanding of the challenges and constraints Kampani is facing as a (social impact) investment fund. Similarly, this reverse-engineering process requires a mindset shift on the part of most other investors to start from the social challenge, understanding the impact focus as well as the realities of impact investing in the missing middle in the agri-food sector. All capital providers must be mission-aligned and subscribe to the fund’s mandate, willing to take risk without expecting a high financial return. And all partners, coming from different backgrounds (investors, NGOs, government agencies, consultants) have to get out of their silo, build trust, and learn to rely on and value each partners’ specific knowledge, expertise, and contribution to the solution. The fact that Kampani could start from an existing network of parties who knew each other already before testing this innovative collaboration model was an important asset.

The slow start allowed us on the other hand to make informed decisions, to carefully analyze the gaps in the model, better understand the market, and be agile when it came to devising our solution.

Addressing New Challenges

Kampani is now experiencing a considerable acceleration, meaning a notable increase in the demand for the specific type of capital it provides. The fund has closed an additional seven new deals in each of the last two years. 

The next step is to further scale this proven model and gain international visibility while preserving its intrinsic added value. The challenge that needs to be addressed when scaling internationally is ensuring the very ingredients that have made Kampani an enduring model are preserved: 

• A network of NGO stakeholder-shareholders, willing and able to play their crucial role of sourcing deals, leveraging their trusted relationships, and providing technical assistance.
• A strong community of mission-aligned investors, including concessionary capital providers.
• A growing community of trusted and knowledgeable partners to provide in-depth due diligence expertise on both social and financial dimensions.
• Developing ways of preserving the high-quality and tailored relationship between the fund and its growing number of investees.
• Addressing the better-known challenges of any fund growing internationally by balancing our risk appetite in terms of crops covered, countries invested in, and currency exposed.
• Making sure that scaling this model does not come at the expense of our focus on maximizing social impact for smallholder farmers.

We view Kampani as a development tool that bridges the chasm of agri-finance’s missing middle. We aim to provide an essential and financially sustainable growth path for cooperatives and SMEs, whilst preserving a high social return on investment. Starting from the social challenge and reverse engineering, the financial solution has already proved to be beneficial, sustainable, and impactful: When agricultural enterprises have access to the right type of capital to grow, they generate great and lasting benefits for the communities they serve.

Today, the missing middle remains widely underserved in the investment landscape, not only in the agricultural sector but also in other sectors such as health and water. We hope Kampani’s model will inspire other practitioners to experiment and eventually succeed in sustainably scaling their solutions. As the field of impact investing continues to expand, the time is right to build upon innovative insights. Pioneering fund models have the potential to tilt this burgeoning field towards more social impact in riskier contexts.

Read more stories by Wouter Vandersypen, Chris Claes & Steven Serneels.