The Evolution of Blended Finance to Enhance Agricultural Production in West Africa
Agricultural development in West Africa has been constrained by a number of trends that have caused a dramatic decline in production relative to population growth over the past 20+ years.
There has been a confluence of negative factors that have contributed to this decline, and traditional development assistance and private sector investment approaches have not been able to overcome theses broader macro forces.
The consequences of this decline include a lack of food security, high youth unemployment/social instability, as well as personal and national economic vulnerabilities. What is clear now is that traditional approaches to reversing these trends are not providing solutions fast enough for the burgeoning populations in the region.
- Urbanization trends driven by perception of more attractive jobs in cities which remove skilled labor and capital from the agriculture heartland
- Illegal migration to Europe through precarious land and sea borders
- Constrained access to capital for local producers (both in quantum and cost)
- Revenue from extractive industries and increasing public sector employment providing easier alternatives to working the land
- Local currency depreciation and volatility discouraging international investment
- Perceived political risk by international investors
The decline in agriculture is particularly acute in the area of “primary production.” The actual cultivation of crops, and the creation of aquaculture and animal husbandry units have not been perceived as the “sexy” segment of the sector. I believe this is precisely because it is the most challenging segment of the business from an operational standpoint. It is far easier to operate milling equipment for example, than it is to engage in the hard graft of cultivating and harvesting rice or other staple crops. Yet the vast majority of rice mills in Nigeria operate at less than a 30% capacity utilization.
Time for a New Approach
In order to overcome the challenges to self-sufficiency in agriculture, West Africa needs a new approach to financing. I believe an evolved version of “Blended Finance” is the solution.
Blended Finance is the “strategic use of development finance and philanthropic funds to mobilize private capital flows to emerging and frontier markets.” It typically focuses on the scaling up of existing operations by a single private sector operator.
Transformational change in the sector will require both private sector and concessional funding at multiple stages of the evolution of the business, and across the entire value chain.
Phases of Evolution
- Proof of concept/pilot
During the proof of concept/pilot project phase, private sector equity financing and Development Finance Institution (DFI) grant funding are most appropriate due to the high-risk nature of this stage of business development. Clearly the operator needs to demonstrate the technical expertise and business acumen in the core business to encourage follow up investment. Thus the operator’s interests are aligned with the funding partner’s interests as the operator will not move to the next level of funding and revenue growth if they do not perform.
In some cases the operator’s expertise in related operations, and the social and economic impact of the project can justify grant funding to accelerate the development of projects that would otherwise be stalled due to limited availability of private sector capital. Thus, Blended Finance can help accelerate projects in the pilot/proof of concept stage, as well as in subsequent phases.
- Scaling up/vertical integration
Once the viability of the core business has been demonstrated, the business can explore expansion via both scale and vertical integration. These stages are considerably less risky than the previous phase, and therefore should attract concessional debt financing and equity co-investment on favourable terms.
The ability to leverage existing operational platforms and cash flows should engender support from DFI’s to provide financing for capital equipment and business expansion. This is a critical phase where the business surpasses the minimum efficient scale to achieve long-term sustainability. Debt financing on reasonable terms (with regard to cost, collateral and covenants) is critical in this phase of development.
The additional margin capture from economies of scale and vertical integration should provide sufficient cash flow for sustained organic growth. Typical types of investment in this phase would include increased mechanisation in land preparations and primary production, purchasing processing equipment to add value to the product, and adding storage and distribution logistics to achieve the highest possible price for the output.
- Community Integration/Geographical Expansion
Economies of scale can be achieved not only by expanding a company’s primary production, but also by employing outgrower schemes and integrating commercial operations with community involvement. In this way the business can increase the capacity utilization of its capital investments, and achieve greater profitability. This approach also serves to bolster community relations, and thereby land tenure rights for the business.
Ultimately the business will likely want to expand operations geographically in order to diversify risk, and achieve greater scale in both production and distribution. Geographical expansion and capital investment in greenhouses, for example, can also facilitate a continuous crop cycle so there is smoothing of revenues, and a constant supply to ultimate off-takers.
This is a phase where capital should be applied at both the commercial business level, and at the individual outgrower level. The business will now likely be in a position to sell equity at a reasonable valuation, and then take on some additional debt in order to finance this next phase of growth. At this stage both the equity and the debt financing could come from either private sector sources, or DFI’s, or a mix thereof.
Out growers will likely need funding support for technical training, agricultural inputs, and the provision of crop insurance to avoid catastrophic loss. These are areas where DFI support can be highly impactful. Grant funding for technical training, and micro lending on concessional terms to purchase seeds, fertilisers, fish fingerlings, day old chicks, etc. are the key interventions that will have the greatest developmental impact.
The support of the commercial business for the outgrowers dramatically increases their probability of success. A well-implemented outgrower scheme will have the commercial business engaged with the individual farmers at every stage of production. This ensures maximum yield to the individual farmers, and improves profitability for the commercial business by increasing volumes through its infrastructure. Through efficient and savvy operations, the commercial business should be able to pay the individual farmer the highest price for production. This avoids the problem of side selling, and supports a partnership approach to business growth.
The micro-lender can take comfort that the commercial business is providing support and oversight to ensure the funds are repaid, and can then be recycled for further production.
Improving agricultural productivity in West Africa will require new thinking, new business practices, and new methods of financing. An evolved version of Blended Finance that participates at each stage of business development, across the capital structure, and across the agriculture value chain, will be critical to unlocking the potential of private capital.
When properly incentivised, private capital can provide the operational oversight that DFI’s cannot. Under this approach, it’s as if the DFI’s have employed a battalion of field agents to ensure that individual farmers have the technical and operational support so critical to their success. Furthermore, the private sector is equally incentivised to ensure the success of the individual farmers in order to achieve greater economies of scale, increased profitability, and improved community relations/land tenure.
This alignment of interests and creation of partnerships is the most effective way to increase agricultural productivity on a sustainable basis. The evolution of Blended Finance should create these relationships so critical to reversing the negative macro trends in the industry.
Author: Wesley Davis, APQ Global
Wesley, whose specialist areas include Russia, CIS and Nigeria, brings over two decades of credit rating and private equity investing experience to the APQ Global International Advisory Council. He has held a wide range of positions at Chase/JPM, Deutsche Bank, Merrill Lynch, HSBC and Renaissance Capital, and has covered some of the largest hedge funds and institutional investors in emerging markets.