disruptive technology

Development finance institutions and private sector innovation

innovation development dfi

Post originally published on IDB’s Sustainable Business blog.

Development finance institutions (DFIs) can play an important role promoting innovation for increased competitiveness and sustained development in their client countries. Properly executed programs and projects can leverage private investment placement, develop local capital markets, improve resource allocation, as well as avoid moral hazard.

As laid out in the document “MDB Principles to Support Private Sector Operations,” endorsed by the heads of multilateral development development banks (MDBs), private sector operations should seek to include: (i) additionality; (ii) crowding-in; (iii) commercial sustainability; (iv) reinforcing – and avoiding distorting – markets; and (v) promoting high standards in governance and conduct. More details can be found here.

With this in mind, there are three types of interventions that work particularly well because of their intrinsic role in crowding-in private investments; providing additionality to high-impact businesses; and planting the seeds for continuous innovation.

1. Catalytic first-loss capital (CFLC)

This form of financing occurs when the financier takes on more risk than other investors by providing concessional equity, debt, grant or guarantees that lower the level of risk for other investors. This form of blended finance has been carried out by select DFIs since the late 1990s and has gained momentum in the past decade, especially with the growing presence of impact investors and large donors working with DFIs. One example is the Clean Technology Fund (CTF), which provides concessional funding for large low-carbon energy projects through multilaterals, including the IDB.

CFLC provides credit enhancement and mobilizes more risk-averse sources of capital. It supports innovation by financing projects otherwise difficult to finance and by leveraging complementary investments, typically at a rate of 4 times – often, significantly more. To illustrate this, $6.1 billion is allocated under the CTF for 134 projects and programs, expecting total co-financing of $51 billion from other sources. The approach supports projects of different sizes, from large geothermal plants to social entrepreneurship interventions.

CFLC adds the most value when it is part of a long-term strategy of continuous crowding-in of private investors – such as private equity funds and commercial banks – and phasing-out of the concessional funding. By supporting innovative (and often risky) projects, it generates significant demonstration effects, lessons learned, and promotes market development. Also, the very providers may participate in later rounds, directly benefiting from the initial risk taken. For example, a DFI may offer an early CFLC tranche, and then come back in a few years with a market-priced loan after the project has reached maturity and needs financing for additional growth.

2. Limited partnerships (LP) in select funds

Venture capital (VC) and private equity (PE) funds are key players in the creation of high-growth businesses and the dissemination of their innovations. In turn, impact investment funds are strategic supporters of innovations that bring about, not only financial returns, but also social and/or environmental benefits. Impact Assets showcases such funds.

Because these funds are specialized and typically operate locally, they know their markets, technologies, entrepreneurs and clients. They are better suited than DFIs to source deals and manage portfolios. Therefore, DFIs could spur innovation by increasing their presence as investors in these funds, providing technical assistance, coordination and cross-fertilization.

Understandably, DFIs worry about risk exposure and ratings. That said, efficient due diligence and strong diversification across markets, fund sizes and maturity, may well allow for a significant growth in DFI presence in this space within acceptable risks. Also, part of the funding may be mobilized through external donors, minimizing the impact on the DFI’s balance sheet.

3. Strategic support to incubators, accelerators, angels

Besides supporting larger projects and early stage businesses mature enough to receive VC/PE funding and CFLC, DFIs could pollinate the innovation ecosystem by spreading entrepreneurial seeds and fostering a change-making culture. One of the best ways to do this is to support the growth of business incubators and accelerators, as well as those who are most prone to invest in the ideas that come out of this fertile soil: angel investors.

Incubators and accelerators play an important role in the development of startups and their innovations, by providing office space, administrative support, mentorship, networking, access to capital, clients, among other advantages. Companies that are born in these platforms have much higher rates of success than lone-wolves. This type of support is especially important in developing markets, where information asymmetries and inefficiencies are high.

In this space, DFI support would come less in the form of financial resources and more in terms of technical cooperation, dissemination of knowledge and best practices and development of networks and systems. Institutions such as IDB’s Multilateral Investment Fund (MIF) and the World Bank’s infoDev work in this space.Finally, from the angel side, DFIs can promote a culture of early stage investing, for example, by supporting the creation of angel groups, business plan competitions with clear objectives, and even by providing matching grants to angel exposures (through donors, if need be).

Innovation is a broad and complex topic and one that should also involve discussions on policy, regulations, education, R&D, and the role of the public sector. That said, as far as private sector interventions go, the three described above, while by no means exhaustive, are bound to bring important progress from the bottom-up.

Andre A. is an economist and entrepreneur.

With Disruptive Innovation, Customer Is Not Always Right

disruptive innovation

Disruptive innovations and customer feedback

A recent study by ChubbyBrain.com listed the top 20 reasons why startups fail. The #1 reason, ahead of funding, product quality, pricing and other popular ones, was “ignoring or not seeking customer feedback”. However, there are two sides to this.

If your company is launching a disruptive technology, or a at least a truly innovative product, and you really believe in it, taking initial customer feedback at face value may not necessarily be the best way to go. A classic example is the walkman. When Sony was building the product in the 1970s it reached out to potential customers to learn what they thought of it. The most common reaction was to say that the walkman was a stupid idea! Who would walk around listening to music, instead of enjoying it while sitting back in the couch? How would you run errands or even jog with “speakers” on your ears, not hearing what’s going on around you? Had Sony been discouraged by this feedback, it would have probably discontinued the project and missed out on this huge hit.

If not a disruptive innovation, follow the rules

Now, if your product, like the vast majority, is not starting a new market or doesn’t require change in attitude or lifestyle, then of course the story is different. You should adapt to your clients as much as possible, not expect them to do so. This sounds intuitive, but many entrepreneurs (including myself in the past) think their product is so great that the problem, really, is with the rest of the world that doesn’t want it the way it is. Distancing yourself from your “baby” and taking client feedback into consideration is fundamental, both in the product development stage and thereafter.

At the end of the day, it is a judgement call. Do you believe so much in what you are doing – and how you are doing it – that you are willing to risk ignoring customer feedback? Are you breaking a paradigm of sorts to expect to be right over the majority of people you are supposed to serve? Only a very small percentage of startups would fall in this category. If you are one of them, you will have an uphill battle to change people’s behaviors; but one that can have a huge payoff.

See also Not All Angel Investors Are From HeavenImage: pocketcalculatorshow.com

What’s your experience with disruptive technologies? Leave us a comment!