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Impact investments for Sustainable Agri-Business Solutions: Time to change the “Access to Finance” Game

By LightCastle Analytics Wing

Agriculture contributes 20% to Bangladesh's GDP but employs 45% of the workforce. Approximately 80% of the working population involved in agriculture are employed in MSMEs (Medium, Small and Micro Enterprises). However, the overall MSME support ecosystem is underdeveloped with a handful of services and misaligned incentives. As a result of this immature system, Ag-MSMEs receive little market-relevant business development support, practical opportunities to accelerate growth, and opportunities to link with growth-orientated funding opportunities. Additionally, MSMEs are often unaware of the latest Ag-techs, have minimal understanding of forward market dynamics and operate via extractive business strategies.

So who are the current Ag-MSME Finance Providers and what do the market trend looks like?

When it comes to access to finance for MSMEs funding in general, the market is largely concentrated with informal sources followed by traditional MFIs (Microfinance Institutions) as well as commercial/specialized banks (often via agent banking) and NBFIs like IDLC and IPDC. 11 out of 50+ commercial banks have already made a foray into the agent banking business. However, given the risk in the Ag-sector, the market is still very shallow for the Ag-MSMEs.

Ag-MSMEs especially those related to crop production work on plots for absentee landlords. Commercial banks won’t lend directly because of constraints like the high cost of due diligence and lack of collateral. Instead, the banks channel low-cost wholesale loans to MFIs to meet their Bangladesh Bank-set quota for agricultural/rural lending, with very little oversight of where and to whom that money actually goes.

Additionally, a limited number of venture fund managers, having obtained license from BSEC as Alternative Investment Fund Managers, are operating in the market of which VIPB AMC is the pioneer. Other major Bangladeshi VCs/Fund managers include BD Ventures Ltd, Strategic Equity Management Ltd, Maslin Capital Ltd, AIM Steps, Bangladesh Race Management Pvt. Company, Athena Venture and Equities, UFS Equity Partners, Impress Capital, and Lanka Bangla AMC. There are also others who are foreign owned and not incorporated in Bangladesh but invest as Foreign Direct Investments (FDI) like: Tinder Capital, SEAF Bangladesh, Brummer and Partners, Osiris Capital, Aavishkaar, IIX, LR Global Ltd and AT Capital. None of these foreign fund managers have any specific focus on the ag-sector MSMEs.

If we concentrate on impact fund (where the core target is MSME), this would include VIPB, SEAF, Agro-Booster, IIX and AIM Steps. However, none of the impact funds operate with proposed model of combining Expertise, Market Linkage, Ag-Tech and Growth Fund.

Lastly, there are a few accelerator programs in the market – the most popular being GP Accelerator operated by the global telecom giant Telenor for tech companies. Unnoty is another program operated by LCP for Ag-SMBs in southern Bangladesh.

Even if we consider the sector-wise impact investment trends in the last 5 years, we find that out of USD 834 mln DFI (Development Finance Institutions) funds disbursed, 80% was disbursed using debt instrument with rest of them being financed by either equity or quasi-equity instrument. However, when it’s coming out of non-DFI funds, equity and quasi-equity holds 90% share of the pie but keep it in mind that the fund worth only USD 120 mln (only 14% of DFI funds). Therefore, we can safely say that, even though it gained popularity, Bangladesh market hasn’t yet started to explore equity or quasi-equity options, especially for the small and medium agro enterprises.

Entering the Money Plus model for Impact Investments: Intro to Smart Capital

Globally, agriculture has always been a very risky occupation – adversely affected by the vagaries of nature like flood, drought, and storms resulting in unpredictable swings in the business cycle – all lead MSEs to challenges in improving their welfare beyond subsistence farming. This cyclical risk factor is a great detriment for the small farmers to access regular finance from the banks.

The solution lies in developing an integrated approach to solve this to provide “Smart Capital” or “Money Plus” Model. Where not only do we provide growth financing via innovative quasi-equity/equity instruments – make access to finance linkages with Banks – but also provide Capacity Building Services, Market Linkage and Ag-Tech

Syngenta Foundation for Sustainable Agriculture (SFSA) is piloting a similar model in northern region of Bangladesh in the developing 30+ Farmers’ Hubs via a franchising model. The Farmers’ Hub entrepreneur receive four broad services- Capacity Development, Ag-Tech, Market Linkage and Growth Capital. The first three components would be available via the entrepreneur getting selected for the program and subsequently receiving a license. 4 out of the 30 hubs are now exporting potatoes to the global giant Kellogg under the forward market program.

The Smart Capital model is particularly interesting as it bridges the MSMEs gaps in all four major fronts – first access to growth as opposed to working capital, business capacity, access to latest Agri-tech and finally advanced skill sets for tapping to forward market.

Instead of short term seasonal debt capital, Smart Capital Model finances via a quasi-equity instrument for a period of 1 to 2 years. The quasi-equity instrument are essentially profit-share agreements operated via future signed checks acting like a self-liquidating asset. However, dates of encashment of the cheques are contingent on the performance of the entrepreneur. High performing entrepreneurs would receive incremental supports on capacity development, market linkage, Ag-techs (starting with seedlings and moving into mechanization) and further capital rounds which are more patient (3 to 5 years) in proper equity investment structure (purchase of common stock).

Green Signal from Regulators and Way Forward

Bangladesh Bank has introduced circular for banks to invest in alternative financing products outside of the capital markets. Therefore impact funds developed can help the banks to bridge the gap by being a limited partner as opposed to directly investing. Additionally, the banks would also be able to meet the regulators 2.5 to 5% criteria of total loans to be vested in Agro-sector.

The next step would be on-boarding institutional investors like Banks as limited partners in smart capital funds which are managed by impact investment specialists. Given the right lubrication we would be able to see smart capital becoming more popular in creating impact and significantly change the growth trajectory of Agro-MSMEs in Bangladesh.

Author: Bijon Islam, CEO, LCP