Impact Investing
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Impact Investing Headwinds: A Conversation with Antony Bugg-Levine and Willy Foote

Burgess COMMENTARY

Peter Burgess

Impact Investing Headwinds: A Conversation with Antony Bugg-Levine

2013 has been an interesting year for Root Capital, the impact-first agricultural lender that I founded just over a decade ago to help catalyze the smallholder finance sector in sub-Saharan Africa and Latin America. After a 5-year run of double-digit growth and real progress toward financial sustainability and improving farmer livelihoods, we’ve hit some bumps in the road.

Consider specialty coffee, which still represents over 50 percent of our lending, even as we’ve diversified in recent years to over 25 other agricultural products (from cashews in Togo to finger millet in Tanzania to sugar snap peas in Guatemala). There’s a storm a-brewing as coffee market fundamentals aren’t holding. Prices are rock bottom and yet overstocked buyers aren’t buying, and the coffee rust epidemic sweeping Southern Mexico, Central America and now Peru is hitting our clients’ harvests hard. As a result, our lending to small and growing agricultural businesses in Latin America and Africa has slowed. Our financials are strong, but we aren’t meeting our targets.

In the spirit of transparency, I sent an open letter to Root Capital’s investors recently, describing these headwinds and outlining our approach to addressing them, which essentially boils down to industry diversification, product innovation, and technical assistance for clients.

The letter kick started a fascinating dialogue with Antony Bugg-Levine, CEO of the Nonprofit Finance Fund (NFF), and author of Impact Investing: Transforming How We Make Money While Making a Difference. Antony is an old friend, who I’ve known since his days at the Rockefeller Foundation in the mid 2000’s. Interestingly, though our organizations have very different missions, we’re facing some of the same headwinds and same difficulties moving capital to the people and businesses who need it most.

Published below is the gist of my conversation with Antony—for others in the impact investing sector that might be facing similar challenges.

Willy Foote: What’s the nature of the headwinds you’re facing at NFF?

Antony Bugg-Levine: NFF borrowers range from health clinics, to charter schools, to social service agencies like homeless shelters, to arts organizations, and even the occasional circus. Our main lending business is facing a bit of a squeeze with increased competition for a shrinking pool of viable deals. On the competition side, mainstream banks in some markets aggressively target the most financially secure borrowers and are often able to offer a lower rate. Some private foundations are also starting to lend directly to these organizations as their interest in impact investing grows.

More daunting for us and for our sector is the reality that more and more nonprofit organizations, especially those providing essential services in poor communities, are less financially secure. They face increased demand for services that they must meet with reduced government support and flat private donations. Our annual survey on the state of nonprofit financial health in the US this year showed for the first time that fewer than half of the nonprofits in the US have the resources to meet rising demand. So the pool of potential borrowers who can take on traditional loans is shrinking. Yet the need for capital remains for these riskier prospects.

In hearing you describe the situation for Root Capital’s borrowers, I was struck by how in some cases, funding cuts have played the same role for US nonprofits that the coffee rust has for Root Capital’s borrowers—reducing revenues and the capability of these organizations to pay back debt.

Foote: What do you think are the root causes for the headwinds that both of our organizations, and other impact investing organizations, face in addressing social challenges?

Bugg-Levine: As impact investors, we look to operate in the gap between where mainstream markets serve clients effectively and where economic realities require reliance exclusively on charity. This space can narrow or expand depending on external conditions that are often unpredictable. When NFF began lending to nonprofits in the early 1980s banks did not recognize these organizations as a potential business opportunity. And foundations were not making direct impact investments. Now that they do it’s great for our mission and for our clients who qualify for their loans, but costs us revenue opportunities in the short-term.

The effect of the global coffee market that is challenging your borrowers also shows how often macro forces beyond our control can be even more threatening to the best-laid strategies. At the end of the day, impact investors finance our clients’ ability to produce the goods and services that create social value, but we rely on someone else to pay our clients for these goods and services so that they in turn can repay us. If a local government cuts the budget for homeless services to the point where the homeless shelter cannot cover its costs, or a coffee co-op in Southern Mexico cannot sell its members’ crops because global markets have frozen, then a loan from NFF or Root Capital or any other impact investor is not going to be enough to stabilize the organization.

Foote: How can we best confront these headwinds?

Bugg-Levine: We are responding to these new realities in two ways: we increasingly provide tailored investments that bring together subsidies and credit enhancement along with our loan capital. This allows us to lend to organizations that would otherwise not be able to take on debt. We have not lowered our credit standards but instead invest more time and energy bringing together more complex and creative partnerships to get deals done to help our clients.

We also see great opportunity in helping the new group of impact investors do deals themselves. Instead of worrying about competing for deals with these foundations, private bank clients and family offices, we are partnering and advising; we are drawing on our experience and track record of making investments to help them be smarter and more efficient in their investing.

We are also increasingly finding in our work that impact investing needs to be understood as one part of a broader “complete capital” solution. The complete capital approach recognizes that enabling organizations to navigate this challenging environment often requires them to fundamentally adapt how they run their operation. This requires not only financial capital (impact investments and grants), but also intellectual capital (the right ideas about what needs to get done), human capital (the management skills and tools to do it) and social capital (the ability to bring different partners to the table). We have built a national consulting practice that provides some of this to our clients alongside our lending capabilities and partner widely to bring the skills we do not have in-house.

Foote: Please give a specific example how NFF is employing the complete capital approach.

Bugg-Levine: In New York City, the combination of increased demand for social services and cuts in government budgets is leaving the nonprofits that provide basic social services in a perilous position. They need loans to help cover their short-term working capital needs. But they also need to fundamentally change how they operate in the medium term. Loans alone will not allow them to innovate as needed. So we are bringing together a group that includes private foundations, government and impact investors to set up an integrated initiative that will enable us to work with these organizations to help them understand how they can best adapt, provide grant support to implement some changes, and ultimately make credit-enhanced loans available to give these organizations the breathing room they need to put these changes into place.

Foote: What is your biggest challenge in harnessing these four areas of capital into an integrated approach?

Bugg-Levine: Complete capital initiatives are inherently complex and also often require people unused to working together to collaborate effectively. In more typical investing or grant-funded initiatives, we can plant seeds in well-hoed furrows where established procedures, long-honed relationships, and habit are all in place and support decisions and actions. In complete capital initiatives we often have to spend a lot of time and energy preparing the ground by getting people comfortable working in new ways and with new partners before we can begin the substantive work. It can be exhausting.

Foote: In light of these challenges, is impact investment still relevant?

Bugg-Levine: Absolutely. Organizations and entire social systems require more capital than charity alone can provide to adapt and become sustainable. Investors have a crucial role to play in financing the specific actions that organizations will need to take, such as investments in new data-tracking systems, expanding physical facilities, and building new service capabilities to serve new clients.

But I increasingly believe that the most exciting impact investing will be done when the investment is recognized as a means to an end and not a starting point. Rather than starting with the question, “Where can we invest?” we should instead ask, “What are the social issues we want to address and how can impact investment be one part of an integrated solution?” In reframing this, we open up opportunities to serve more clients more powerfully in more sustainable ways.

Foote: On the surface, Root Capital and NFF have little in common. Yet, it’s striking that even as we serve such different clients – farmer enterprises in Africa and Latin America vs. health clinics in Oakland, CA — our organizations face similar pressures. Due to our own demonstration effects, we are both experiencing increasing competition for the better deals while we each see a vast pool of unaddressed need for early-stage businesses or organizations that aren’t quite ready for financing, whether due to poor financial health or a lack of basic financial management skills. Those deals often have the potential for huge social or environmental impact, but are time consuming and costly in the short to medium term to serve.

We’ve each crafted approaches that prepare these organizations for financing. For NFF it’s complete capital. At Root Capital, we invest heavily in financial management training and, where necessary, supply chain integration (e.g., between natural product buyers, third-party certifiers, local technical assistance providers, and other social lenders) for both pipeline development and to prepare our clients for long-term, sustainable growth in volatile agricultural commodity markets. While time intensive, our approach bears fruit as these earlier-stage businesses tend to grow, expand their impact, and take on successively larger loans.

Root Capital would like to see all social-purpose finance companies develop their own complete capital approaches for investing in these more difficult, yet potentially high-impact deals, rather than cherry picking the most robust clients — that often have other options for financing. It’s hard work to prime early-stage businesses or financially weak non-profits for growth and impact. But it’s necessary if we are to scale the impact investing sector and expand our collective ability to address the world’s critical social needs—whether enabling small-scale farmers in Africa to access better-paying markets or helping homeless people in the United States to rebuild their lives.