By Lade Araba, Africa Region Representative at Convergence - Originally published on the African Private Equity & Venture Capital Association blog
The 2017 African Economic Outlook predicts that Africa’s average growth is expected to reach 4.3% in 2018. The private equity (PE) and venture capital industry in Africa continues to witness strong performance across diverse sectors. Returns to investors are expected to remain strong with considerable growth in robust asset classes such as infrastructure, which provides stable, long-term cash flows.
Despite the prevalence of lucrative deals, investors in Africa face high transaction costs stemming from unique risk factors, such as exposure to market volatility, as well as political and credit risk. The insurance and credit enhancement products required to offset these risks lead to higher transaction costs.
Delivering new market opportunities with blended finance
Adequate risk buffers are critical to attracting commercial capital to African deals. Blended finance is a means of improving the risk-return profile of transactions, while enabling PE to access attractive investment opportunities in the region.
Blended finance is a structuring approach that uses catalytic capital from public or philanthropic sources to scale up private sector investment in emerging markets. As such, it is a useful method for de-risking and lowering the high up-front cost of investing across sectors. In these transactions, concessional and/or philanthropic funds act as risk capital that is subject to first losses or that provides credit enhancement through guarantees and insurance products.
In its subordinated form, it serves to lower the weighted average cost of capital, thereby improving the deal’s overall profitability. Blending is therefore a welcome addition to discerning investors in search of new market opportunities through well-diversified portfolios.
Achieving the SDGs with an eye on returns
Blending also contributes to the attainment of the Sustainable Development Goals (SDGs) by leveraging public funds to significantly increase the pool of capital available for investment into SDG related sectors. Our recently published “Who is the private sector?” report finds that public and philanthropic funds that are strategically deployed through blended vehicles can leverage 3 to 4x of private capital. This is further aligned with the 2015 United Nations Addis Ababa Action Agenda, which issued a global call to increase the flow of private capital to support implementation of the global sustainable development agenda.
In this way, blended finance offers win-win options for private, public, and philanthropic investors. Private investors can earn risk-adjusted returns, while being protected from transactional risks. Public or philanthropic investors on the other hand can leverage their limited funds for greater development impact.
Blended finance in practice
An example of a blended finance structure is Alina Vision (earlier known as GlobalVision). In June 2017, Convergence, the global network for blended finance, awarded them a grant to fund early stage work that will lead to the establishment of a global network of more than 60 eye-care hospitals over the next 10 years. Through a holding company structure, GlobalVision will set up commercially viable, for-profit hospitals with a target capital raise of US$300mn that blends grants, equity, and debt. In this structure, donor funds will be used to de-risk the startup hospitals and will subsequently attract impact investors followed by private equity. This will ultimately improve the risk-adjusted returns to private investors while boosting the development impact sought by donors.
Convergence facilitates each step of a blended finance transaction. In addition to providing grant funding for the design of early stage transactions like Alina Vision, we also host a curated online deal platform that streamlines dealmaking by providing our global members with access to quality blended finance deal flow that reduces the overall cost and time spent on origination. At the same time, we are building the evidence base for blended finance by generating proprietary data and intelligence on deal structuring and market trends to inform the investment decisions of our members.
The potential of blended finance to both de-risk transactions, and funnel capital into development objectives, makes it an invaluable tool for strengthing the economies of African countries. It further presents a compelling approach for PE and venture capital seeking attractive returns by investing in well structured transactions with good quality underlying assets.