Giving Compass' Take:
- Here are ways that an innovative impact investing model can help support smaller agricultural farmers.
- How can agricultural farmers build trust in these relationships with investors? What can donors learn from these investment models?
- Read about impact investing and the future of farming.
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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?
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.
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.
Read the full article about impact investing in agriculture by Wouter Vandersypen, Chris Claes and Steven Serneels at Stanford Social Innovation Review.