what is entrepreneurship

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.

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Modern Times 2.0

Changemaking through the 21st century

I’ve been writing about the role of entrepreneurship in the creation of value and prosperity for many years. This is a natural deduction for me, having spent about half my career working as an economist and the other half starting and running businesses.

In fact, looking back in history, there is enough evidence to support this. The countries that have prospered the most – Netherlands in the XVII-XVIII centuries, nineteenth century England, twentieth century U.S. and, more recently, places like South Korea and Israel – were the ones where people with good ideas had access to capital, under systems that promoted accountability (see here for full discussion).

That said, in today’s world, I’m convinced this vision needs refinement.

Recently, I’ve had the privilege of spending a few hours talking to Bill Drayton, the founder and CEO of Ashoka. Bill enlightened me with his vision of “frame change” and “everyone a changemaker” (EACH) world. During our conversation, it became clear to me that the original model of “entrepreneurship + access to capital” alone is no longer sufficient to promote wealth and prosperity.

In the twenty-first century, the success of people, organizations and countries alike depend on the understanding and implementation of a new framework.

The new model for problem-solving at all levels requires a rupture with the old way of doing things. From the Industrial Revolution through late twentieth century, value was created with efficiency gains, mostly through specialization and repetition. The roles of leadership and innovation were confined to a handful of people, who also benefited disproportionately from the system. The majority of the workforce was limited to dully specialized labor.

As satirized in Charles Chaplin’s “Modern Times” (1936), depicted above, a typical worker would spend most or all of his time doing the same job. Each person would have a defined task, compatible with the education and training received, and would follow orders according to a strict hierarchy. Decisions were made from the top down, by those who controlled information and knowledge.

Nowadays, there is a new game, which is driven by change, not repetition. And everyone wants to be a player.

Information is no longer the privilege of few. Enabling technologies are cheaper and more accessible. Almost anyone, anywhere, has the ability to gather the resources needed to be a changemaker – in their communities, institutions, and country. In this context, the rate of change becomes exponential.

Twenty-first century problems are increasingly being solved by (social) entrepreneurs, who are strategically positioned to come up with the best solutions. People no longer wait passively for others to solve their problems. As the changemaker mantra goes: “everything you change changes everything”, and that’s contagious and unstoppable.

What does this mean for businesses? In such scenario, old structures are doomed. Companies that are not able to adjust will lose relevance and eventually die.

There is no coming back. Institutions must reform and embrace the new world. Leading firms can no longer expect people to work in silos, perform monothematic jobs, take orders at face value, remain detached from the organization’s vision and decision making. Walls must come down.

Teams need to be formed – and dissolved – quickly and seamlessly in order to tackle problems and innovate continuously, under a fluid “team of teams“. This requires embracing a new framework, where every person is offered the resources, networks and tools to become a co-leader in the respective team. Leadership and innovation are no longer the privilege of few, but the responsibility of all.

The EACH framework and the team of teams system reinforce each other and bring the best out of each player.

The new paradigm relies on pro-activeness, empathy and collaboration. Top-down leadership, rigid hierarchies, and aggressive behavior towards others become liabilities. The same values one applies at home, with family and friends, become vital in the work environment. Measures of character and success at work and life are no longer distinguishable. Empathy, teamwork, and leadership become the norm. Those who don’t embrace these values will fall behind.

Make no mistake: changing the way societies think and operate is one of the greatest challenges imaginable.

However, we live in a historical moment. We have the resources to take on this challenge, transforming mindsets and behavior. How exactly? Well, that’s the “seven-billion-people question”. Breaking this code, however, I’m convinced is the key to a more prosperous and peaceful world.

Like Chaplin in the 1930s, Bill Drayton is telling us that there is something fundamentally wrong with our current values and system. And this is no laughing matter.

Andre Averbug is an entrepreneur and economist.

Not All Angel Investors Are From Heaven

angel investor

On Angel Investors

As entrepreneurs, in the initial stages of the startup, we often think that the answers to our problems will come in the form of an angel investor. By definition, angels are high-net-worth individuals who get involved early in the company’s life, bringing capital, sector knowledge and network, and relevant expertise.

Angel investors usually invest anywhere between $20k-$300k and take on 10-30% ownership. They spend some of their time coaching entrepreneurs, opening doors, helping the company build the team and product, participating in strategic decisions.

Not all angel investors are the same

However, not all angel investors are the same. Reality has “expanded” the definition of an angel and many times what we see is well-off folks with no particular value-add (beyond the dough) playing the angel role almost as hobby. This is particularly true in less developed markets, such as Brazil (which I know from experience) and the rest of LatAm. Being rich and successful doesn’t necessarily make someone a good angel.

As an example, a retired C-level executive from a large pharmaceutical company may easily have a couple of hundred thousand dollars to spare and decide to invest in a startup. Why not help a couple of smart kids with a brilliant idea for a new technology or web business? What better way to stay busy and motivated!

The problem is that often these investors often have no idea what they are getting into. They just don’t know the real challenges and risks of starting a company. As time goes by, the product doesn’t launch as planned, the bank account gets thinner, and the investor gets nervous.

Entrepreneurs also get frustrated because they had expected miracles from this angel. After all, he is the older, successful mentor, who’s been there, done it all.

But it turns out the guy you looked up to actually doesn’t know much more than you when it comes to building a tech company from the ground. His rolodex only has contacts of retired people from irrelevant sectors. And as he sees his investment going down the drain, he doesn’t think you’re that cute and inspiring anymore.

Of course, I’m painting a pretty extreme scenario here. But the point is that you shouldn’t necessarily accept the first person who’s willing to invest in you. If the angel investor is not a good fit, it’s better to hold your horses, bootstrap the business a bit further, until you find someone who can actually add value to the company.

Originally posted on the Entrepreneur Academy (NEN). Image: nenonline.tv. See also Time To Start a Company – or Not.

What’s your experience with angel investors? Leave us a comment!