By Amélie Baudot, General Counsel and Company Secretary
Blended finance has been successful in large and, often very costly, transactions (an OECD report that used Convergence data stated the median blended finance deal is $56 million, and only 3% of deals are below $5 million) but it’s also a great tool for smaller investments. With advocacy for blended finance to help close the $2.5 trillion investment gap to achieve the Sustainable Development Goals gaining traction, here’s how we at GIF have found blended finance to be a powerful tool to catalyse commercial finance for development outcomes.
How have we used blended finance at GIF?
GIF has successfully used blended finance to support innovators who are struggling to obtain finance in the ‘pioneer gap’ in order to scale – this is the gap between grant/seed funding and commercial finance; and to support innovators in social sectors like education.
Features of blended finance are:
- It’s concessional – making it more tolerant to failures either because of lower risk-adjusted returns, or it is being deployed as grant.
- It’s patient – it is willing to stay invested for longer time frames.
- It’s credible – the use of public money tends to lower uncertainty from political risks and signals credibility to private investors.
These three distinct features of blended finance all played a role in two investments in GIF’s pipeline – Educational Initiatives and Babban Gona.
When can blended finance be used in an innovation?
Blending can be done on the preparation, investment, and market-making sides of the innovation:
Preparation – Concessional finance can be used to provide technical assistance grants that are critical to the feasibility and design of an innovation and for it to attract even seed investment.
Investment side – Most of the focus is on the use of blended finance in investments. Blended finance can be deployed in debt or equity investments; and concessional finance can also be used for business development or viability gap funding.
Here’s an overview of the range of investments GIF offers:
- Debt – public finance/philanthropic debt; sub-ordinated debt layers; concessional debt; credit enhancement (loan guarantee, loss absorption, credit insurance etc)
- Equity – public finance/philanthropic equity; SAFE (Simple Agreement for Future Equity)
- Currency – local currency loan; currency hedge
- Grant – business development or viability gap funding
Market-making – Blended finance can be used to create new markets, and specifically to support the entry of commercial players into markets that serve the poor by using outcomes-based payments (payment by results) or mechanisms that create an advance market commitment.
GIF investments that illustrate the creative use of blended finance
The first is a grant to a company called Educational Initiatives (EI), a for-profit in India that has developed adaptive learning platform software, called Mindspark, for classrooms and parents.
The innovation addresses the ‘learning crisis’ in India – school enrolment rates exceed 95%, but more than half of grade-five children are unable to read at the second-grade level; and nearly three-quarters of students in grade three cannot solve a two-digit subtraction such as “46 – 17.”
Classrooms in many developing countries, including India, have large variation in student knowledge within a grade or classroom. Teachers tend to teach to the level of the smartest students and others fall behind.
Mindspark uses a series of questions to benchmark students and personalise the material so it matches the level of the student. The software was being purchased by middle-class parents who could afford it, and it was present in some private schools. The efficacy of the innovation was proven in that market but EI had little incentive to break into the much larger public school market because the risks associated with government bureaucracy and procurement rules were too high to make it attractive for them.
On the government side, state governments hadn’t procured for adaptive learning software before, and absent evidence that the software was effective in public schools (and in the government proscribed curriculum) meant there was little incentive to embark on this procurement exercise.
This is where GIF came in – we used blended finance as a market-making tool to support the entry of EI into the public school market that serves our beneficiaries: those living on less than $5 a day; and to generate the evidence the government needed to justify procuring the software. Our team also worked closely with the government to develop the national procurement guidelines for the software.
We did this using an outcomes-based grant for approximately $3 million that was conditional on EI selling Mindspark to government schools at the marginal cost of the product or at a price schedule that decreased progressively with the increase in students. This kept the cost from rising substantially and incentivised EI to target the public school market.
At the time of approval for the outcomes-based grant we expected pilot implementation in 50 schools. The result has been pilot implementation in 750 schools. Also, standards for procuring personalised adapted learning software at the national level have been adopted – and states have initiated procurement for at least 6,600 schools.
This isn’t a classic use of blended finance in the impact investing space, but it was relatively simple to structure and highly impactful. Supporting this innovation has led to thousands of poor children having access to valuable adaptive learning software.
The second example is an agriculture innovation in northern Nigeria by a business called Babban Gona, which provides a comprehensive set of agricultural extensions services and last mile logistics support to smallholder farms. This consists of end-to-end assistance from seed to harvest, including credit to help the farmers access the markets, and providing consumer goods. Babban Gona’s innovation is not in a single part of its business but in the profitable implementation of that whole suite of services. When GIF invested, the business was serving 9,000 smallholder farmers and it’s now on track to serve 80,000 farmers by 2020. The business has managed to deliver significant improvements to the net income of rural farmers in a very poor region.
Babban Gona has large capital requirements to operate and struggled to raise local currency debt. It was raising a $20 million debt round but needed an investor like GIF to take the subordinated tranche to de-risk the investment for senior debt providers. GIF made a $2.5 million investment in the subordinated tranche and took local currency risk on that investment – significantly de-risking the investment for other investors and making it attractive for development finance institutions and local funds. The use of a subordinated local currency-linked loan was one use of concessional capital to catalyse commercial capital. The second in this same investment was incorporating an impact-linked interest-ratchet in GIF’s loan and providing a separate grant to fund an independent impact evaluation of the businesses – the more social impact that Babban Gona has, the lower the interest rate on GIF’s loan. This incentivised the company to meet these impact milestones and made the investment as a whole more attractive for other impact-focused investors.
These two examples to illustrate a way that we can use blended finance in smaller investments and in a way that is highly impactful. GIF has done this using a mix of outcomes-based grants, technical assistance, debt and equity without incurring exorbitant transaction costs. To date, we have invested $69 million (grant and risk capital). On the investment (pure risk capital) side, using blended finance GIF has crowded in $3.40 of less risk-tolerant capital for every dollar invested. This is one small but highly effective and impactful way to convert the billions to the trillions needed to achieve the Sustainable Development Goals.
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