For decades, the same models of funding were used to effect positive social and environmental impact. Corporates across the continent channel grant funding into projects and programmes that attempt to achieve the same social outcomes that many peer organisations, governments and international donors are working towards, yet each party often works independently. A myriad of silo interventions and an over-reliance on grant funding run the risk of being unsustainable and inefficient. Natasha Suchecki, impact investing project manager at the Bertha Centre for Social Innovation & Entrepreneurship, explores how the ecosystem is shifting; with innovative approaches to funding social and environmental impact being developed, tested and scaled – creating new opportunities for corporates to get involved and assume bold positions of leadership in development.
Channels for corporates to become trailblazers
Corporates can use innovative financing tools in enterprise and supplier development (ESD) funding, corporate social investment (CSI) and Broad-Based Black Economic Empowerment (BBBEE) community trusts.
The 2015 revised BBBEE Codes place greater emphasis on ESD activities, which include interest-free and preferential loans, equity, grants, pro bono services, business development services, training and mentoring. These activities generally focus on job creation and inclusive development through support for enterprises and supply-chain businesses. Since the mission of ESD funding goes beyond financial returns, towards social impact, ESD structures are well placed to test and scale innovative financial structures.
CSI is encouraged through the socioeconomic development (SED) criteria of the BBBEE Codes, which prescribes that companies spend 1% of net profit after tax on social development. Trialogue research has tracked the growth of CSI in South Africa, from R1.5 billion collective spend in 1998, to R9.7 billion in 2018. Although SED is not synonymous with CSI, the strong overlap incentivises corporates to tailor their CSI spend to align with SED and increases the focus on a more strategic approach to community development.
Significant value has also been created through BBBEE community trusts. According to The Empowerment Endowment report by Intellidex, released in 2017, BBBEE trusts have been endowed with R32 billion of assets as a result of maturing BBBEE deals, with a further R19 billion directed to public benefit causes on the maturity of these deals.
Although CSI and community trust funding is generally required to be channelled to public benefit organisations (PBO), it can still be used to support innovative funding models. For example, CSI or trust funding can be used as the grant or loan element to a PBO, or to support the development of blended finance vehicles or impact bonds. If any return is received it can be reinvested in social initiatives.
Blended finance: A collaborative tool to leverage finance for impact
Blended finance – the strategic use of development and philanthropic funds to mobilise private capital flows – is one of the most relevant and effective financial structures for bringing together different market players to effect social change. Blended finance is a case of the 1 + 1 = 3 principle, combining grant funding, concessionary capital (below market rates) and private sector finance to achieve more together than any single source could achieve alone.
Bringing together different types of capital provides an opportunity for collaboration between funders that have similar mandates, but different levels of risk tolerance and return expectations. This means that donors, foundations and government can combine resources with investors seeking the same positive outcomes. Grants and philanthropic funding can be used to de-risk investments into high-impact initiatives that would otherwise be perceived as too costly or risky for investors.
There is a strong argument for the use of blended finance for ESD investments. Investment risk is high in early-stage businesses that have limited or no track record, and often need business development and management support, which can be costly for investors. As a result, fund managers tend to support more established and larger businesses that are less likely to default on their loans, leaving early-stage, high-impact potential businesses underserved.
Blended finance is one solution to this challenge. Grant funding can de- risk early-stage investments, making them more attractive and feasible for investors. Three main vehicles for grants within a blended finance structure are technical assistance, risk underwriting and market incentives. Supporting the costs of technical assistance in a blended investment will supplement the capacity of investees and lower origination and transaction costs. Risk underwriting on investments that would otherwise not be undertaken will protect the investor against capital losses and ensure that high-impact investments do not go unfunded.
Finally, grant funding can be used to provide market incentives in the form of results-based financing and offtake guarantees contingent on performance, in exchange for upfront financing in new or distressed markets.
The partnership between the Association for Savings and Investment South Africa (ASISA) Fund and USAID’s Partnering to Accelerate Entrepreneurship (PACE) Initiative is an example of using blended finance for ESD. Corporate ASISA members provide grant and investment capital into the ASISA Fund, which is managed by Edge Growth. Edge Growth directs this capital into investments into small, medium and micro-sized enterprises (SMMEs), coupled with business development support to ensure their sustainability.
Grant funding from USAID provides Edge Growth with upfront funding needed to source support and deploy capital to SMMEs. The ASISA Fund is thus able to offer tailored business development support to its investees, building their internal capacity and making them scalable and sustainable, while decreasing the risk that they will default on their loans.
Philanthropic funders, such as CSI and community trusts, also have a role to play in providing grant funding to support blended finance structures. For funders who have traditionally focused on
direct grants, blended finance offers an opportunity to lead the market, increase the impact per rand and develop an ecosystem approach.
Supporting high-impact enterprises through revenue-participation agreements
Supporting early-stage businesses is widely acknowledged to be an effective way to stimulate economic growth and create jobs. There are a number of investors, incubators, accelerators and government departments working to build this segment of the market in South Africa. However, according to FinFind’s 2018 Inaugural South African SMME Access to Finance Report, the credit gap for SMMEs is still estimated to be over R86 billion.
Revenue participation or demand dividends are hybrid financial instruments that allow the investor and investee to share the risk and reward of the enterprise more flexibly than with traditional debt or equity. Rather than taking a share of ownership in the business, an investor obtains a right to a percentage share in the revenue or cash flow of the enterprise.
After a ‘honeymoon’ period to allow early- stage enterprises to begin generating revenues, periodic repayments are made to the investor based on a percentage of revenue or cash flow, up to an agreed- upon multiple of the investment.
For early-stage enterprises, particularly social ventures, this arrangement offers more flexibility at pre-revenue stage and does not bind them to loan repayment schedules when cash flows are difficult to predict. Because revenue-participation or demand dividend agreements are not equity investments, they are applicable to social enterprises registered as both for- and non-profits, and circumvent the challenges of finding viable exit potential.
Revenue-participation or demand dividend agreements are another way that ESD funding could be used to support early-stage social ventures. In Belize, Spain, investors provided a $200 000 investment to an enterprise called Maya Mountain Cacao, which prioritises sustainable growth techniques and assists smallholder farmers with microloans to finance equipment and training. The terms of the loan included a two-year payment holiday, allowing Maya Mountain Cacao to start generating revenue.
Following this, repayments are made based on a percentage of free cash flow, until a multiple of the investment is paid off. If the enterprise misses its projections by a huge margin, the agreement is restructured. If it takes off, the loan may be converted and investors have a right to participate in future rounds of funding. ESD funders, who generally have a stronger impact focus and more flexibility in investment returns, are ideally placed to pilot similar financing structures in South Africa.
Guaranteeing social and environmental impact through outcomes-based contracts
Another innovative funding mechanism that offers increased cost-efficiency for corporates is an outcomes-based contract: an agreement between a funder and service provider whereby payments are contingent on the achievement of pre-agreed, measurable outcomes.
The promise inherent in these contracts is that the donor only pays for what works, as opposed to inputs and activities that might produce results. While the concept is attractive in an environment in which significant sums of money seem to be spent on poor social results, it is not without complexities. More work needs to be done to create efficiencies that extract the most value from this methodology.
A well-known application of outcomes- based contracts is impact bonds. An impact bond is an alternate way of paying for an outcomes-based contract, where investors provide capital to underwrite social projects usually funded by tax money and philanthropists. If a project is successful as measured against pre-agreed benchmarks, the investor gets a return on the economic value created for government, and government saves money by only paying for interventions that work.
Impact bonds have shown significant uptake in recent years, with over 100 instruments launched globally, including at least three in Africa. The Bertha Centre has launched one of these impact bonds in South Africa, which is managed by the Department of Social Development. This impact bond will focus on early childhood development, and will work towards meeting developmental outcomes in children aged three to five years, alongside reputable partners and implementers.
The concept of results-based finance, or outcomes-based contracts, offers interesting opportunities for CSI and community trust donations. To date, philanthropic support has played a crucial market-building role. Eight of the 12 development impact bonds with investor information available involved a foundation or philanthropist in an investor role.
The Standard Bank Tutuwa Community Foundation, for example, has invested in Bonds4Jobs – a social impact bond that is addressing the need for social upliftment programmes that create employment. The Standard Bank Tutuwa Community Foundation, Hollard and The Legacy Fund make upfront funding available for Harambee, a non-profit company that sources, matches, trains and places unemployed youth in jobs. When outcomes (such as job placements) are created, the ‘outcomes funders’ (made up of the Gauteng Provincial Government, National Treasury’s Jobs Fund, Yellowwoods and the Allan Gray Orbis Foundation) reimburse the investors for their upfront payment. If the target outcomes are achieved, the investors earn a return on their funding, which Tutuwa plans to reinvest in other social initiatives.
The structure ensures that taxpayer money is only disbursed when actual outcomes are achieved, increasing efficiency of donor and government funding by shifting the risk of non- achievement to investors such as the Tutuwa Community Foundation.
Since outcomes-based contracts tie flows of funding to tangible outcomes, a rigorous monitoring and evaluation framework is imperative from the outset. This framework needs to include coherent measures and verification methods of outcomes, as well as a clear set of baseline data to demonstrate achieved outcomes. With verified data that demonstrates outcomes achieved, outcomes-based contracts are able to monetise impact, focusing on driving funding directly to what works.
Systems thinking to catalyse significant change
Innovative finance for social development requires a shift away from the traditional mindset of discrete, stand-alone interventions, towards an intentional process of creating lasting change through collaboration of players.
Partnerships can be quick wins for corporates, with ESD fund managers with sector-specific expertise offering tested models of allocating ESD funding to impactful enterprises. Since SMME funds operate more efficiently at scale, by investing ESD funding into local fund managers, corporates are increasing the impact of both their own funds and that of the wider market. Phakamani Impact Capital is one such manager that specialises in helping corporates to cost-effectively invest in black-owned enterprises within their supply chains and the communities in which they operate. Through a tested model, Phakamani offers a combination of hands-on business development support and finance to SMMEs particularly focused on the agriculture and mining sectors.
ESD funds aren’t the only way to ensure an ecosystem approach. According to Aspen Network of Development Entrepreneurs South Africa’s entrepreneurial ecosystem map (www.andeglobal.org), there were almost 150 business development service providers supporting entrepreneurs in South Africa in 2017. However, the majority of these (just under 75%) do not provide funding to entrepreneurs in their programmes.
There is significant potential for collaboration between ESD funders and these business development service providers, either in offering a lifecycle approach whereby early-stage businesses are incubated until they are investment- ready, or through co-creation of applicable incubation programmes to build corporate supply chains. E-Squared offers end-to-end business support to impact entrepreneurs, from idea to scale up, through both financial and non-financial mechanisms. This lifecycle approach, in collaboration with partners such as the Allan Gray Orbis Foundation and SiMODiSA, ensures that funding is used to provide holistic support across the growth spectrum.
A shift to innovative funding approaches would also not be complete for CSI and community trusts without a systems approach. To create tangible, widespread impact, it is imperative that philanthropic funders develop a coherent impact strategy that aligns with their mission. To achieve this in a sustainable way, grant- makers must engage with the rest of the market and ecosystem to share knowledge and experience, maximise synergies and ensure that there is no duplication of efforts. Based on this ongoing dialogue, a strategy can be developed that speaks to the specific gaps and blockages in current systems, and different financial tools and structures can be used to innovatively address different challenges that all speak to a broader social goal.
The DG Murray Trust (DGMT ) is one organisation taking a systems approach. Their strategy tackles challenges to education from multiple angles; starting at early childhood and going all the way through to job creation. The DGMT has created stand-alone institutions under the DGMT umbrella that leverage partnerships and work collaboratively to achieve their mission.
For example, Ilifa Labantwana is a South African early childhood development programme developed in collaboration with government. Innovation Edge, another DGMT initiative, invests in unconventional ideas that find solutions to early childhood care and education challenges in under-resourced communities, and brings together multiple players such as the Omidyar Network, the ELMA Foundation and FirstRand Foundation, among others.
JET Education Services is another example of this type of approach. JET works with government, the private sector, international development agencies, other funders and education institutions to address the blockages in education, skills development and the world of work. JET works through a range of interventions to address challenges from different angles, to ensure a holistic contribution to improved education. They provide resources for early childhood development practitioners, a systemic school improvement model, an e-learning platform for teacher training and development, and a suite of assessments for learners and teachers. These interventions are based on experience in the education sector, combined with rigorous research and engagement with the sector.
Investing for impact
To maximise the ecosystem approach, foundations can also look beyond traditional grants towards impact investing. Internationally, the MacArthur Foundation, one of the US’s largest independent foundations, offers best practice on incorporating a systems approach with innovative finance and impact investing. Instead of going the traditional philanthropic route, the foundation makes high impact investments out of their endowment. The MacArthur Foundation focuses on providing catalytic capital – investments that are patient, flexible, risk-tolerant and can take a lower return to deliver valuable services to low income communities.
To complement investments, the MacArthur Foundation focuses on collaborations with partners intended to bridge the capital gaps that have been identified globally. In a recent article entitled Four Lessons from Four Decades of Impact Investing, they highlight the importance of working with intermediaries to multiply impact, collaborating with partners to reach scale, and combining grants and investments to unlock systems change.
For South African foundations, a similar model of using endowments to invest in impactful initiatives, either in place of or as a complement to grantfunding, would not only have direct impact, but would also leverage other investors and ecosystem players.
The time for innovation is now
With the emergence of novel and successful approaches to creating social good, there has never been a better time for corporates to increase their appetite for innovation in their funding approaches. There are ample opportunities to combine and blend funding pots across common goals, or structure investments in a way that combines finance with support. With multiple channels acting as potential conduits for innovative finance, the time is ripe for corporates to seize the opportunity to position themselves as trailblazers in the innovative finance space.