A new report prepared by NESsT for The Rockefeller Foundation explains the current condition of impact enterprises in the emerging markets of Latin America and Central Europe, and suggests ways to improve the situation.
Emerging markets are developing regions that display high rates of economic growth and industrialization, along with the potential to reach the status of advanced economies. Investors tend to find these markets lucrative due to prospects of high financial returns attributable to high economic growth.
Sowing the seeds of impact enterprise uncovers that impact enterprises, which are financially sustainable and scalable business ventures that solve critical problems, lack proper development and financing tools in the emerging markets of Latin America and Central Europe.
The magnetic pull of impact investors and supplementary business development services is not very strong there because of issues like dearth of legislation, long term investment horizon, and uncertain investment exits.
The publication discusses such challenges, and proposes solutions based on international best practices and NESsT’s own operational experiences in emerging markets.
Regulatory and Policy Vacuum
Due to the lack of specific regulation, most impact enterprises and their investors do not benefit from any tax exemptions. Moreover, the absence of legal recognition creates some doubts about the impact enterprises’ initiatives in the community’s minds.
Some possible solutions to this situation include widespread implementation of the B-Corporation legislation and government procurement program for impact enterprise funding.
Funding Impact Enterprise
Many donors are hesitant about providing significant support to early stage impact enterprises. The main investor concerns are covering operational costs and waiting for long periods to gain returns.
To deal with this issue, corporations should determinedly create and support new impact enterprises. Furthermore, family foundations and high-net-worth individuals should continue to provide flexible funding which is critical for impact enterprise incubation.
Pioneer Donor Best Practices
Patient capital is an effective form of funding because of its long term investment horizon. The long time period provides impact enterprises the time to recognize and overcome risks, and thereby earn profits prudently.
In addition to that, tailoring financial instruments based on impact enterprises’ needs is an increasingly common practice adopted by successful donors. Other donor best practices include provision of non-financial capacity support such as business advice, market access, and governance support.
There are not many impact enterprise focused incubators in the emerging markets. Considering the low maturation stage of this field, particularly in Latin America, incubators are advised to assist more young impact enterprises through provision of capacity support and patient capital.
Incubators can also aid impact enterprises by creating a communication platform to facilitate the process between impact investors and businesses.
When expanding an impact enterprise, the management should be clear about what exact aspect of the business is being scaled. The impact enterprise should also ensure that its expansion plan is compatible with its existing business model.
In addition to that, developing an amicable relationship with the incubator, collecting required financial resources beforehand, and determining future capacity support needs can also aid impact enterprises in the scaling process.
Mixed Financial Instruments
Financial institutions do not consider impact enterprises as a good business opportunity due to insufficient due diligence tools and the small size of the impact enterprise industry. The stringent bank criteria, which include collateral and high interest rate, also dissuade impact enterprises from approaching banks.
The most common form of financing for impact enterprises in emerging markets is grants. While the least common form is equity financing. Reasons for this trend include limited high return investment options and low investor appeal towards capacity support.
Equity financing for impact enterprises is also unpopular because of legal constraints that forbid dividend payments. The absence of a secondary market, where impact enterprise shares could be sold for capital gains, further worsens the situation.
To deal with these market gaps, investment intermediaries can take on initiatives such as investment readiness programs and interest rate determination for different transaction types. The intermediaries can also aid impact enterprises by providing guarantees for the enterprises’ mainstream debt applications.
Early Stage Impact Enterprises in Latin America
Latin America’s economic growth rate has been comparatively higher than United States and Europe. Due to the stellar economic performance, many aid organizations have moved away from Latin America despite the existence of several societal problems. This presents an interesting development opportunity for impact investing.
To increase the impact investing profile of the region, case studies displaying successful exits, best practices and innovative investment vehicles should be crafted. Moreover, the emergence of new incubators, government policies and investment funds should further facilitate the development of impact enterprises in Latin America.
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