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Scaling Up Risk Capital to
Small and Medium-Sized Enterprises
in Emerging Markets
Global Conference 2009
Scaling Up Risk Capital to
Small and Medium-Sized Enterprises
in Emerging MarketsWednesday, April 29, 2009; 8:00 AM - 9:15 AM
Moderator:
Betsy Zeidman, Research Fellow and Director of the Center for Emerging Domestic Markets, Milken Institute
Speakers:
Matthew Gamser, Principal, Advisory Services, East Asia and Pacific Department, IFC
John Lyman, Program Manager, Google.org
Sucharita Mukherjee, Senior Vice President, IFMR Trust; CEO, IFMR Capital
Wayne Silby, Co-Chairman, Calvert Foundation; Founding Chair, Calvert Social Funds
John Simon, Visiting Fellow, Center for Global Development
Peter Tropper, Principal Fund Specialist, Private Equity Department, International Finance Corp.
Hubertus van der Vaart, Co-Founder and Executive Chairman, Small Enterprise Assistance Funds (SEAF)
Troy Wiseman, Chairman, CEO and Co-Founder, TriLinc Global
Problem definition
Small and medium-sized enterprises (SMEs) in
developing countries lack access to patient, non-asset-
based risk capital, particularly for amounts between
$100,000 and $1.5 million.
Challenges to investing inemerging-market SMEs
• Underdeveloped capital markets and a shortage of buyers
• Usually more time-intensive for the investor
• Need for technical assistance
• High risk and transaction costs
• Tendency for investors to move up-market
• Investments do not achieve fully risk-adjusted returns
Milken Institute Financial Innovations Lab February 3, 2009
• Investors in these markets discussed their expectations,motivations and objectives
• Participants explored two case studies:
– 1st party exit: Business Partners’ investment in Swift Micro Laboratories
– 3rd party exit: SEAF-Macedonia’s investment in On.net
• Fund managers discussed strategies for attracting capital to funds
• Participants brainstormed ways to increase scalable risk capital toemerging market SMEs
Best practices
• Plan exits from the outset
• Expand fund scale to reduce expenses
• Use structured finance to broaden the investor base
– Align interest transactions to increase IRRs
• Use local investor networks
• Create mechanisms to match investors and entrepreneurs
• Approach standardization
• Reduce information asymmetries
Potential capital solutions
Raising capital
• Regional funds or fund of funds
• Side-by-side technical assistance and investment funds
• Higher return tranches leveraged by PRIs/government funds
• Guarantee fund for local banks
• Public/private fund with high net-worth social investors
Exiting investments
• Royalty model
• OPIC exit finance facility
• Permanent capital vehicle (e.g., business development company)
• Map and match vectors /sectors– Clean-tech– Sustainable agriculture / food
processing– Health– Value chains
• Map and match– Market coverage– Investors / flows
• FDI• Multilateral / bilateral• Portfolio• Diaspora
Bridging information technology andfinancial technology asymmetries
• Map and match exit options
• Map and match deal flow (e.g.,BP)
• Map and match back office /overhead / marketing
Permanent capital
What would it look like?
Panelists’ slides
Matthew GamserPrincipal, Advisory Services
East Asia and Pacific Department
International Finance Corp.
12
Fiscal year 2008 highlights
• Investments: 372 new projects in 85 countries
• Advisory services: 299 new projects in 75 countries
• $16.2 billion in financing: $11.4 billion for IFC’s own account,$4.8 billion mobilized
• IDA countries accounted for 45 percent of IFC investments.Overall:
– $1.4 billion invested in Sub-Saharan Africa
– $1.4 billion invested in the Middle East and NorthAfrica
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08
$0
$2
$4
$6
$8
$10
$12
$14
$16
$18
$20
Net income and net worth
Net income (US$ millions) Net worth (US$ billions)
Net worth
Net income
$0
$2
$4
$6
$8
$10
$12
$14
$16
$18
FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 FY 2008
IFC financing
* “Mobilization” for 2006 and 2007 includes structured finance, loan participations, and parallel loans.
US$ billions
IFC’s ownaccount
Mobilization*
Loanparticipations
15
By offering to share risks on loan portfolios, IFC’s objectives are:
• To improve access to financing;
• To improve financing conditions;
• For banks: to support the growth of its lending activities to IFCpriority sectors and to improve the bank’s origination and monitoringcapabilities;
• For other clients: to support the growth of their business and totransfer the responsibility of managing the loans.
Structured finance andprivate finance mobilization
16
Borrower A
Risk
protection
Borrower B
Borrower C
Disburs
ements
Inte
rest &
princip
al
repaym
ent
The risk-sharing facility
17
• Loans to schools (Ghana, Kenya)
• Student loans (Indonesia, Chile)
• Loans to SMEs (IDA facilities in CAF)
• Loans for energy efficiency (CEU + CHUEE)
• Loans to health facilities (Nigeria – pending approval)
• Loans to agricultural supply chains (Cambodia, Indonesia, PNG)
• Loans for cellphone distributors (East Africa, Pacific)
IFC experience and plans with RSF
Debt
18
Structured fund (sector/region)for RSF and investments
RSF
FL
IFC, other DFIs
Donor funds
Investors (?)
Equity
Fund liabilities
Potential assets of fund
RSF
Mezz
Sucharita MukherjeeSenior Vice President, IFMR Trust
CEO, IFMR Capital
• Small industries in India contribute 40% of the country’s total industrialoutput
55% of the 12 million small enterprises in India are in rural areas
These enterprises are financially constrained by a lack of access to formalfinancial channels, working capital and the high cost of funds available
Growth is also hampered by lack of adequate infrastructure, limitededucation and access to networks
Interface to markets is weakened by remoteness of rural enterprises, smalland disaggregated nature of the sector, lack of standardized tools forevaluation, which results in high transaction costs
Small-scale industries (SSI) sector in India
• Provide rural enterprises with strong underlying businesses access todebt funding through securitizations
Pool together portfolios of assets generated by rural enterprises andissue securities providing investors access to a diversified range ofrural businesses
Rating methodologies for rural asset classes and structures with ratingagencies
Provide rural enterprises access to working capital financing
Use guarantees and credit enhancements to create high quality assetsand facilitate debt funding at a cheaper cost
Create a specialist institution that has expertise in this sector and canevaluate its risks and rewards
IFMR Capital’s strategy
Securitization Portfolio sale
MFI1 MFI2 MFI3 MFIn
•Ramp up risk portfolio
•Portfolio risk management via:
Risk pooling
Tailoring assets
Criteria and standards
Repackaging and subsequentsale of securities
IFMR Capital
Capitalmarkets
Banks
ORIGINATION
DISTRIBUTION
Pooled portfolio of loans to rural enterprises,infrastructure and micro-finance loans
EnE2E1
InfrastructureMicro-financeRural
enterprises
InI2I1
IFMR Capital’s strategy
Case study 1: Working capital financing
• Masuta is a producer company involved in the business of procurement, marketing and selling ofthe tasar (silk).
• The tasar is produced by a Mutual Benefiting Trust (MBT) that is comprised of women producers.
• The MBT requires financing for purchase of raw materials, and Masuta requires funding for itsworking capital requirements.
• IFMR Trust proposes to structure the loan as a commodity backed financing product under which:
• The cocoons will be stored in warehouses managed by Masuta
• Warehouse receipts will be issued by Masuta which certify the quantity and quality of thecommodity being held
• The loan will be extended to each woman MBT producer and is secured by the respective
collateral
• The warehousing of raw material and work in progress will be managed by Masuta, who will providea guarantee on the quality, quantity and storage of the collateral to the lender.
• The Loans will be pooled into portfolios (the “Warehouse Receipt Loan Portfolio”) and purchased bythe IFMR Trust at a mutually agreed price.
Repayment of loanfor raw materialpurchase
Loan
Repayment ofworking capital
loan
Working capitalloan
Case study 1: Working capital financing
• Servicer Company sets up water purification plants in rural India using its patentedtechnologies, gets into long term agreements with the village panchayat for access tosurface water and land.
• Panchayat makes a down payment of ~30% of the capital cost of the plant and the rest isfinanced through long term debt
• Panchayat owns the plant from day one but the company has rights to the user feesgenerated from water sales to cover debt service and operating expenses
• If user fees collected are insufficient for debt service, the company is liable for any shortfall
• If there is a surplus, it goes into a surplus account, where it stays for 8 years. At the end of8 years, the surplus is split between the panchayat, the company and the debt provider ona preagreed basis
• At the end of 8 years, the Panchayat gets complete rights to the user fees collected andcan choose to go with any operator for O&M from that point forward.
Case study 2: Credit enhancement unlocks value
An infrastructure case study
SPV
IFMR Trust
FundsFunds
Portfolio ofclean drinkingwater plants
Securities
Assignment and monitoringof portfolio rating
Guarantee/creditenhancement
InvestorsServicer CompanyServicer Company
IFMR Trust
Servicer Company Investors
IFMR Capital
Rating Agency
Servicer company
Financing structure
Case study 2: Credit enhancementunlocks value
Originate to distribute model for MFIs
• Releases capital and improves liquidity
• Access to the capital market for unrated entities
• New avenues to raise funds
– Lenders will have tools to evaluate risk of loan pools and risk manage exposures
– Second loss enables larger exposures
• Brings down the cost of capital
• Reduces dependence on a few lending agencies
• Incentives to improve transparency, quality and efficiency of operations
EquitasMicro Finance
Rating Agency
Case study: Equitas Microloansecuritization structure
Rs. 16 crores
Portfolio ofmicrofinance
loans
Securities withperiodic
principal andinterest payments
Assigns andmaintains rating forthe portfolio
Rs. 16 crores
Credit enhancementSenior note• Cash collateral by the MFI• Junior note fully subscribed by IFMR Capital• Excess interest spreadJunior note• Cash collateral by Equitas
SpecialPurposeVehicle
Cash Collateral(First-loss by
Equitas: 11.7% )
AA Senior Notes(80%)
Banks, mutualfunds
BBB Junior Notes (20%)
Fully subscribed by IFMR Capital
How the risks are mitigated
John SimonVisiting Fellow
Center for Global Development
Consortium of SME funders
SME#1
SME#2
SME#3
SME#4
SME#5
DFI/OPIC financing= 90%
First loss = 10%
DFI/OPIC
Senior debtto facility
Foundation SME venture fund Social investment fund
Payback of initialinvestment
Capitalization of consortium –fraction of investment in SMEs
Consortium contribution to exit facility
SME exit facility
Loans to SMEs based on potential of businesses to service debt
Hubertus van der VaartCo-Founder and Executive Chairman
Small Enterprise Assistance Funds (SEAF)
Established 1989 as a subsidiary of CARE
• Separated in 1995 to pursue a more commercial development strategy
• Today manages $480 million in 19 funds
• 285 investments, with an average size of a litte over $1 million
SEAF
• Small Industries Development Bank of India• State Secretariat for Economic Affairs,Switzerland• Swedfund International AB• United States Agency for InternationalDevelopment
Commercial investors• Kotak Mahindra Bank• Life Insurance Corporation of India• New York Life International• Pound Capital
• Seguros Suramericana
Socially responsibleinvestors
• Calvert Social Investment Fund• Calvert World Values International Equity Fund
•
Development financeinstitutions
• Belgian Investment Office• Black Sea Trade and DevelopmentBank• Deutsche Investions- undEntwicklungsgesellschaft
• European Bank for Reconstruction andDevelopment• FMO• Finnish Fund Industrial Cooperation• International Finance Corporation• Kazakh National Innovation Fund• Millennium Challenge Georgia Fund(MCG)• Norwegian International Fund for
Developing Countries• Overseas Private InvestmentCorporation (OPIC)• Polish Cooperation Fund
Pension funds• AFP Prima
• AFP Integra• Proteccion
• Provenir• Colfondos• Evangelische Kirche in Hesse andNassau
Foundations• Ford Foundation
• Foundation for the Development ofPolish Agriculture
Total committed capitalapproximately $480 million
Representative investors
Full cycle experience Nuevos Fondos SEAF vs. PIB Mercados Emergentes (1989-2008)
Exit experience of SEAF with SMEs
Exit experience of SEAF with SMEs
Fund name Realizations Mult. of cap. inv. Gross IRRAfghanistan 2 1.9x 37%
BSEF 22 2.2x 21%
SEAF-Croatia Fund 20 1.6x 12%SEAF-Macedonia Fund 14 2.2x 25%
Caresbac Poland - Developmental 24 0.3x -27%
Caresbac Poland - Commercial 23 3.1x 21%
Caresbac Bulgaria 23 0.9x -3%Central Asia 1 1.2x 7%Colombia 2 1.3x 26%TBF Bulgaria Fund 6 2.1x 16%TBF Romania Fund 10 2.4x 39%Sichuan 1 1.8x 10%Russia 7 1.0x -5%TOTAL 158 1.8x 13.0%
Exits from all SEAF investment funds
Highlights include:
• Every $1 invested generates $12 inlocal community benefits
• 66% economic rate of return oninvestments
• 26% rate of employment growth;25% wage growth
• 72% of new jobs go to semi- andunskilled workers
• SMEs train employees andincrease benefits
SME Financ ie rs
Emplo ye e s
Lo c al Co mmunity
Financ ial Institutio ns
Similar Pro duc e rs
Custo me rs
Supplie rs
Lo c al Go ve rnme nt
Co mpe tito rs
SEAF’S development impact record Original research for our development impact report
26% average annual employmentgrowth
84% of the jobs at the surveyedcompanies go to unskilled and semi-skilled employees
Skill breakdown of employees at surveyed companies, Dec 2005
Semi-skilled29%
Skilled 16%
Unskilled55%
Impact on lives of employees
• Wages – 25% compoundedannual wage growth (in US dollarterms)
• Training – 85% of the SMEsprovide formal or informal trainingto their employees
• Promotions – almost 10% ofemployees promoted in 2005
• Benefits – 83% of employeesreceived health and pensionbenefits in 2005
Representative wage growth at
surveyed firms
Intitial Year (Average of
2002)
Year 2005
25% compound annual growth rate
in wages in US dollar terms, presented
over the average number of years
invested of 2.67
Impact on lives of employees
19.2%
10.9%
2.1%2.4%
1.6%3.0%Carried interest Cash management
Fund expensesPCDEs
Fund managementexpenses
39.1%
Gross IRRto fund
Net IRR to members
TBF Romania Breakdown of IRR performance
32.3%
2.9%0.7%
4.1%Carried interest
Fund expensesFund management expenses
40.0%
Gross IRRto fund
Net IRR to members
SEAF Global Fund = USD 90 million Breakdown of IRR performance
Investors want:
• Professional reporting and transparency, double bottom line
• Liquidity
• (Some) current returns
SMEs need:
* Patient capital (as long as they are are growing)
* Follow-on investment when needed
* On-the-ground monitoring but global benchmarks and advice/marketaccess
Scaling up is necessary, but how?
• SEAF and OPIC--$30 million global debt facility
• Need matching equity line
• Gradually building to an invested PCV of at least $500million
• Blended instruments
• Likely annual returns of 10-15%
Toward a permanent capital vehicle
Troy WisemanChairman, CEO and Co-Founder
TriLinc Global
• SME growth, especially in emerging markets, can provide the best risk-adjustedinvestment returns and create the most significant sustainable social andenvironmental impacts.
• The key to economic growth and environmental sustainability is a thriving middleclass and that the critical driver of a successful middle class is growth in SMEs.
• Providing attractive financial returns with high social and environmental impact is thekey to attracting enough scalable risk capital to bring about meaningful sustainablechange.
• Transparency is critical, not only in financial reporting but, also in social andenvironmental impact reporting.
• Investing in companies that have strong ESG (Environmental, Social and
Governance) policies will outperform their counterparts
and create the best long term value.
TriLinc Global Our beliefs
Individual Investors are seeking:• Predictable, income-generating investments• Social impact investments that meet or beat traditional risk-adjusted returns (do well by doing good)• Evidence that their social impact capital generates quantifiable social and environmental impact
SME Intermediaries are seeking:• Access to a dependable and predictable private capital partner• Increased capital to leverage existing cost base required to serve the SME space• Assistance with the T.A. needs of the high-impact entrepreneur• MBO exit financing• Ability to re-circulate committed capital
SMEs are seeking:• Access to appropriate and affordable capital• Access to more technical assistance to help improve the performance of their company• Ability to “buy back” their company equity with mezzanine debt
Scalable SME risk capital challenges
Support and
impact costs
First-loss
guarantees andhedges
$
Financial
Returns; social and environmental
impact reporting
Social and environmental impact
Buy
s pr
edic
tabl
e ca
sh fl
ow
Portfolio investments
TriLinc Global SME Social Impact Fund
Low-interestleverage
Analysis, Structuring & PortfolioMonitoring
AggregatedLoans
$
Latin Americaspecial purpose
vehicle
Eastern Europespecial purpose
vehicle
Africa specialpurpose vehicle
TriLinc CapitalManagement
New private capital through intermediaries to SMEhigh-impact entrepreneurs
Scalable SME risk capital solution
So
cia
lly
co
ns
cio
us
inv
es
tors
Pu
bli
cp
art
ne
rsh
ips
Lo
ca
l g
ov
ta
nd
DF
Is
Pri
va
tein
ve
stm
en
tF
ou
nd
atio
ns
Sr. &
MezzanineDebt
Tranches:
High-Yield
Tranche:
LocalInstitutional
Investors
ForeignInstitutionalInvestors
TLG orThird-PartyInvestors
Bonds
$
Bonds
$
SOCIAL IMPACT BONDS
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