How to attract more private sector capital to development.

By Avinash Mishra, Chief Investment Officer

Jun 01, 2023

The Global Innovation Fund was established as an impact-focused, venture-style investment vehicle, designed to take informed risks and invest in the best social innovation ideas early on. The ability to tolerate risk is crucial in the development investment space, since addressing market failures and frictions is bound to be a slow and uncertain process. The absence of risk-taking capital presents itself as the well-documented ‘pioneer gap’, which often leaves early-stage ideas and innovations struggling to access funding, despite their potential for outsized social impact.

Just like GIF, Development Finance Institutions (DFIs) are already implementing some strategies which address the pioneer gap. The US Development Finance Corporation’s PI2 programme and the British International Investment’s Catalyst and Climate Innovation facilities are two such examples. This is a task that must be undertaken collectively and collaboratively throughout the development investment space, and it’s great to see ongoing conversations on how they and others can take even more risk for impact. We’re all learning together.

If we don’t invest in high-risk environments, who will?

Throughout the developing world, there are countless social innovation ideas and projects with the potential for substantial impact on poor people’s lives. But they may never get done, because most DFIs and Multilateral Development Banks (MDBs) regard them as too risky to invest in. If the development finance community won’t underwrite such projects, then commercial banks and private sector investors certainly won’t.

This understanding is increasingly becoming consensus in the development investment space. The solution requires organisations to review their investment and financing models, particularly regarding risk. If action can be taken to mitigate or reduce risk, informed risks on the worthiest projects become feasible.

No one is saying that finding and completing deals in lesser economically developed countries or fragile states is easy. But with a firm commitment on our part, through patient and flexible investment structures and with some sensible risk-taking, we can work towards plugging the pioneer gap, and maximising social impact through funding the worthiest innovations.

We can drive the mobilisation of “trillions” in private capital

With the 2015 adoption of the SDGs, there came a prediction that “trillions” in private capital would need to be mobilised to help achieve these crucial global development goals. Now, there is growing recognition that unless DFIs and MDBs are willing to take greater country and project risk, there is little hope of this ever-elusive private capital following.

For development organisations, this means that specific attention should be paid to what steps can be taken to mobilise substantially more private capital. The key to achieving this is de-risking projects and programmes, and tools such as concessional finance, first loss funds and targeted guarantees are all available to do so.

Ultimately, the demand-side need for risk-taking, patient, and flexible capital needs to meet the supply-side constraints of private investor capital, which in most cases requires risk adjusted returns.

Collaboration is key

Risk sharing with other DFIs, MDBs or third parties such as foundations sends a clear signal to the private sector that a concerted effort is being made to bring them onboard as investors, keeping their needs in mind. Besides greatly increasing the pool of capital available for investing and lending, greater cooperation and collaboration within the space also brings a multitude of other advantages: sharing pipelines, lessons, knowledge and resources to build capacity and for venture support and lower transaction costs.

By working collaboratively to share risk, we give ourselves the strongest fighting chance of leveraging the vast resources of the private sector, as well as the ability to plug the pioneer gap and support worthy projects in the crucial infancy stage. Not only this, but by sharing knowledge of what works in development, we maximise our collective ability to get the best out of the projects we choose to support.