Harnessing the tools of capitalism as a force for good
Charm Co-Founder, Bethany Larsen, was published in the latest issue of Philanthropy Impact Magazine, which focused on accelerating progress towards achieving the UN’s Sustainable Development Goals. In case you missed it, we’ve shared the article below!
TLDR
Wildfires, flash floods, famine: in the last month alone, we’ve witnessed a dozen natural disasters wreak havoc on communities across the globe. “Wicked” problems like climate change and poverty have historically been the purview of the public sector, but solving these challenges has become too complex and urgent for the public sector to handle alone. We need innovative solutions that unlock finance from the private sector if we want to have a chance at creating a world where we can thrive while remaining within the boundaries of our natural resources.
Blended finance is one tool that philanthropists can employ to catalyse private funding to generate social and environmental change. Charm has been using blended finance to both attract private investors to high risk markets and keep our loans affordable for borrowers that otherwise would not have access to commercial capital. By driving finance into the hands of overlooked founders running high impact companies in underserved markets, blended finance has the potential to build equitable capital markets that actively protect people and the planet.
“We need innovative solutions that can unlock capital from the private sector if we want to ensure a prosperous and sustainable future for us all.”
Introduction
Global social and environmental challenges, such as those outlined in the UN’s Sustainable Development Goals (SDGs), have typically been within the purview of the public sector. However, these problems have become too large and too complex for the public sector to handle alone. There is still an estimated $2.5 trillion funding gap per year to reach the SDGs by 2030, and that kind of money is not coming from the public sector. Annual overseas development assistance has totalled in the range of $150 billion since 2017. In contrast, total global assets under management topped $100 trillion in 2019 and are expected to reach $150 trillion by 2025. We need innovative solutions that can unlock capital from the private sector if we want to ensure a prosperous and sustainable future for us all.
Fortunately, times are changing and the lines between profit and purpose are becoming increasingly blurred. People are more aware of the impact of their financial decisions and are starting to vote with their wallets. In a 2019 Accenture survey, 72% of respondents reported buying more environmentally-friendly products today than five years ago, and 50% said they would pay more for products that were designed to be reused or recycled. People are choosing products that may be more expensive but are more sustainable and supporting companies that have a social or environmental mission at their core. They are also holding institutions accountable, advocating for divestment from harmful investment products such as big oil and gas, and demanding more sustainable investment options for themselves.
While the tides are turning on the individual level, it has taken philanthropic institutions longer to realise their potential and the role they have in reshaping how the world does business. Many impact leaders are reluctant to get involved in the private sector, particularly when it comes to investing, as they are concerned they might perpetuate global wealth inequalities. This risk is absolutely real and not to be taken lightly. However, drawing a sharp distinction between profit and purpose leads many to overlook the potential to harness capitalist structures to accelerate social and environmental impact. Philanthropic participation in for-profit investments will be critical in both unlocking private wealth to address the SDGs and ensuring this wealth is channelled in a way that builds markets that are just and equitable.
Our Challenge
The solutions to these massive global challenges are built from the ground up. As Scottish social activist and conservationist Patrick Geddes said at the turn of the 20th century, “Think Globally, Act Locally”. To illustrate the importance of philanthropy in unlocking private wealth at the grassroots level, we would like to use a case study of Charm Impact, an impact investing platform that crowdsources debt for clean energy startups in developing markets.
Charm sits at the intersection of private investment and philanthropy. The platform uses a blended finance approach, blending each loan with subordinate debt provided by philanthropic organisations that derisks loans for investors and keeps the interest rates affordable for borrowers. Charm is trying to solve what’s known as the ‘pioneer gap’ in early stage financing, which refers to the lack of available funding for companies that are too large for microfinance but too small for traditional investment. These companies are led predominantly by local entrepreneurs, women and people of color, all of whom are overlooked consistently by investors.
“The proliferation of sustainable, profitable businesses is a prerequisite for achieving positive impact at scale.”
Though Charm is focussed on clean energy, this problem is not unique: the pioneer gap persists across all sectors and geographies. The reason that entrepreneurs in developing economies find it so difficult to access the funding they need to grow their businesses is that local financing options either charge severe interest rates (20%+ p.a.) or require enormous amounts of collateral that young companies do not have. Most early stage impact investors have minimum investment sizes of around £350k but still are not interested in investment sizes of less than £1m-£2m; It simply does not make sense to them from a cost or time perspective.
The result is that the vast majority of funding is going to large, foreign-owned companies. In 2020, the Global Off-Grid Lighting Association found that 75% of investment in off-grid energy went to just three companies. This is incredibly problematic, not only in terms of the questionable health of a market with limited competition but also in terms of the socioeconomic inequities that are being perpetuated in a market dominated by foreign companies. Clearly, Adam Smith’s ‘invisible hand’ cannot be left to its own devices if we wish to live in a just world.
The Need for Blended Finance
In the investment world, decisions are all about risk and return. Does the potential return make sense given the risk of losing some or all of the investment? Charm operates in a high-risk investment environment, providing loans to very early stage companies that are testing new business models in new markets. There are a variety of risks to consider, ranging from internal management capabilities to external regulatory and macroeconomic fluctuations. This is why most financing options that are available for these companies are so expensive. As stewards of other people’s money, financial institutions must ensure that they are taking precautions to protect their customers and pricing their products accordingly.
Blended finance can be transformative in creating investment products that are affordable. Blended finance, quite simply, is the combination of multiple types of capital (e.g. grants, private investment, guarantees, etc.) into one investment. It often starts with an initial, concessionary investment from a philanthropic capital source that is then used to catalyse further private investment.
This also helps reduce the price for the borrowers. Without philanthropic participation, that loan may be priced at 20% interest per annum but after blending in the philanthropic capital, it might be reduced to 10%. Investors are appropriately rewarded for the risk they undertake while borrowers are not suffocated by extortionate interest rates. Philanthropists, once repaid, can use that capital to catalyse further investments, multiplying the reach and impact of their money: it’s a win-win-win scenario.
This also helps reduce the price for the borrowers. Without philanthropic participation, that loan may be priced at 20% interest per annum but after blending in the philanthropic capital, it might be reduced to 10%. Investors are appropriately rewarded for the risk they undertake while borrowers are not suffocated by extortionate interest rates. Philanthropists, once repaid, can use that capital to catalyse further investments, multiplying the reach and impact of their money: it’s a win-win-win scenario.
Philanthropy, as the most risk-tolerant form of capital, can be used to incentivise private funds to enter high risk markets. This creates options that reduce enterprises’ long-term reliance on grant capital so they can unlock traditional financing and compete in an international arena against multinational corporations. It also comes back to the macroeconomic shifts that we as society need to make in order to achieve the SDGs. We must find ways to create positive change that also make commercial sense in order to unlock the scale of capital we need to tackle these complex global challenges.
“We must find ways to create positive change that also make commercial sense in order to unlock the scale of capital we need to tackle these complex global challenges.”
Blended finance can make investments affordable and commercial. It can channel investment into geographies and founders that have been historically overlooked by private markets, building local economies and promoting equitable access to finance. It can unlock hoards of untapped private wealth to advance global social and environmental goals by making it financially viable to invest in purpose-driven projects. Through blended finance, philanthropic capital providers have the opportunity to not only extend the reach and impact of their money, but also to drive the transformation of an unjust capitalist system into one that actively protects people and the planet.
You can see the official article in Philanthropy Impact Magazine here!
