Home motorcycle price Using debt to make an impact

Using debt to make an impact

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Debt financing is crucial for impact businesses, but it remains inaccessible to many.

Impact Investment Firms, a growing number of companies formed to pursue a social or environmental goal, have the potential to be a transformative force to address key societal challenges India faces.

Since 2010, impact investing support has spread from microfinance to other sectors, such as agriculture, health and education, and annual investments have increased from $ 323 million to $ 2.7 billion. However, not all trends are going in the right direction, especially from the perspective of the beneficiaries of the investment. To date, impact investors have strongly favored equity participation in emerging impact companies, rather than lending money for working or growth capital (also known as debt financing. ). Debt remains particularly difficult to secure for young companies with increasing impact, in large part due to perceived risk and lack of creditworthiness. Yet without a sufficient supply of borrowed money, expansion and working capital needs are not met, leaving impact businesses unable to reach their full potential.

To better understand these challenges, the India Impact Investors Council (IIC) and the Bridgespan Group released a report that analyzes the balance sheets of 422 leading impact companies and assesses their creditworthiness, identifies barriers to debt financing and offers solutions for make debt more accessible.

Related article: IDR Explains | Impact investing

Barriers to debt financing

Cautious investors are only part of this complex story. Our research and interviews with over two dozen impact investors and impact business leaders led us to conclude that all of the major players in India’s debt ecosystem play a role, often inadvertently. , in limiting access to credit. We summarize these obstacles below.

  • Impact businesses struggle to find and obtain loans. As the CEO of an impact startup told us, they’d rather go into debt than give up a share of ownership for money. Yet the latter option is often the only option for impact businesses, as they typically lack the collateral required for standard asset-backed loans. Additionally, many impact businesses have not matured enough to be able to implement robust management reporting systems that capture critical data on finances, employees, customers, accounts, products. and performance. Poor reporting systems lead to poor quality financial statements that make it difficult, if not impossible, for impact businesses to achieve a good credit rating.
  • Non-bank financial corporations (NBFCs) lend when banks are reluctant to do so. Collateral-based bank lending practices are more suited to conventional, asset-intensive manufacturing firms than to low-asset impact firms. Many, if not most, impact companies have little (if any) on-balance sheet assets, such as equipment and inventory, to offer as collateral. As a result, loan officers often view small businesses as too risky to operate. On the other hand, NBFCs specialize in serving businesses that banks consider too risky. However, the interest rates they offer tend to be higher because their operating costs are higher than those of banks. This, in turn, strains the cash flow of many start-ups, preventing them from accepting loans.
  • Lack of data hinders credit scores. Lenders recognize the need for more and better data to assess the creditworthiness of potential clients. To address this issue, the Reserve Bank of India approved in 2016 a new category of NBFC to act as account aggregators to consolidate and digitize personal and business information, and make it usable by financial institutions. Additionally, emerging data and analytics platforms such as Crediwatch can provide independent third-party data on business performance. While neither of these approaches has proven successful yet, their performance before the COVID-19 pandemic hit the economy was encouraging.
  • Government regulations affect domestic and foreign capital. In recent years, the Indian government has taken steps to improve financing options for small and medium-sized businesses, but regulations that slow and even hamper debt investment and impact businesses remain. For example, impact investing is not recognized as a separate asset class that would allow regulators to apply different standards for investors and impact companies. Non-performing loan regulations lack the flexibility to allow banks to make changes to loans to accommodate fluctuations in an impact company’s cash flow. Regulations also prevent CSR funds from having an impact on businesses. Finally, external commercial borrowing is heavily regulated by the Reserve Bank of India and comes with restrictions and guidelines that limit their attractiveness.

Make debt more accessible

The mismatch between the supply (too little) of debt finance and the demand (too much) continues to hamper the ability of social enterprises in India to realize their potential. As impact investors and bankers we interviewed told us, a number of solutions are within reach.

Cash loans

This approach responds to a common complaint from owners of small and medium-sized enterprises (SMEs) in India: Companies are not reaching their growth potential because banks do not provide loans without collateral. Cash loans allow banks, NBFCs, and FinTech companies to make loans based on the company’s current and projected cash flows. Compared to conventional business loans, cash loans require less paperwork and shorter approval times, in part because they eliminate the valuation of collateral.

Market watchers expect cash loans to be a boon for micro, small and medium enterprises (MSMEs), startups, and impact businesses that may not have durable assets as collateral. In June 2019, the Reserve Bank of India recommended that banks opt for cash flow based loans. And the country’s largest lender, the State Bank of India, announced in early 2020 that it plans to switch from asset-based lending to cash lending. While not specifically aimed at impact businesses, cash loans will undoubtedly benefit them.

Loan guarantees by third parties

These address the real and perceived risks that may prevent commercial banks, NBFCs, and impact investors from providing debt financing to impact businesses. For example, the Impact Investing division of IndusInd Bank is actively seeking collateral arrangements, such as the $ 5 million debt financing at Grameen Impact. The loan is backed by a guarantee from the American International Development Finance Corporation (DFC) and supports Grameen Impact loans to local SMEs.

Rabo Foundation, the corporate foundation of Rabobank, a Netherlands-based cooperative bank that focuses on the food and agriculture sectors globally, demonstrated how credit guarantees can work on the Indian agricultural market. Due to the regulations on offshore financing in the agricultural sector, the Rabo Foundation could not offer loans directly to Indian agricultural cooperatives. To get around this problem, six years ago he introduced credit guarantees, starting with a cooperative of organic cotton producers. Many financial institutions now participate in guarantees by extending credit to otherwise underserved markets and organizations. Subsequently, the Rabo Foundation set up a warehouse receipt financing program, an agricultural technology support program and a climate-smart agriculture financing program for farmer organizations.

Related article: Five Myths About Impact Bonds

Alternative investment funds (AIF)

AIFs have grown in popularity in recent years. It designates any fund established in India which brings together investment funds of institutional or high net worth investors, Indian or foreign, according to a defined investment policy. The minimum investment for a sponsor is INR 1 crore. Today, more than 695 funds are registered with the Securities and Exchange Board of India.

New approaches to due diligence and underwriting

These methods go beyond traditional collateral-based loans to assess the creditworthiness of potential issuers. All of the impact investors we interviewed have developed proprietary methodologies that vary widely. At Caspian Debt, for example, every credit decision is approved by a centralized credit committee. Specialized teams perform due diligence through in-depth field and field research that includes visits to facilities and customers. The selection of transactions also includes a strict exclusion list for companies that do not meet environmental, social and governance (ESG) standards. In contrast, Vivriti Capital has developed a highly automated, rapid-response credit underwriting platform called CredAvenue that connects businesses in need of debt financing with potential lenders.

While proprietary platforms like these can validate new ways of doing due diligence and credit underwriting, they remain the exclusive domain of their developers. The industry would benefit from standardized tools and platforms widely available to banks and other financial institutions. Swasti Saraogi also contributed to this article.

Swasti Saraogi also contributed to this article.



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The opinions expressed above are those of the author.



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