Explore finance solutions more in-depth
The financial and non-financial tools listed below will help you to discover the benefits and challenges of each tool from both the financier and enterprise perspective. The objective is to create mutual understanding among financiers and entrepreneurs when utilizing certain financial structures, be it for funding or credit enhancement.
Funding
DebtCarbon finance
An additional source of revenues accessible by projects that generate or are expected to generate verifiable positive climate change related outcomes. Energypedia
- Incentivizes environmentally friendly activities that can contribute to national objectives for carbon emission reductions.
- If carbon finance is used as a tool for loan repayment, the ability to pay-back the financier is dependent on the sale of credits. As the sale of credits is dependent on market demand and other external factors outside their control, it may not be easy to forecast the timing of payments.
- Uncertainty about the future of the carbon market.
- Potential for the sale of credits to become an additional, continuous source of income if estimated emission reductions are achieved and the criteria for certification are met.
- Certifying and issuing the credits requires technical knowledge (often externally- sourced) and the process can be tedious and costly.
- Potentially long lead time between the certification of carbon emission reductions and the issuance of carbon credits.
Equity, DebtCo-investment
Investments provided by investors alongside other investors, generally a private equity fund manager or venture capital firm, in order to provide a larger sum of funding for a specific project or enterprise. Investopedia
- Risks are shared among more players.
- Allows funders who can only come in with smaller ticket sizes to participate in larger deals.
- As more investors or co-financiers come on board on a transaction, the investment process could become more complex or take more time as it becomes more difficult to achieve consensus.
- Access to more funders who could participate in future funding rounds.
- Potential to raise a larger amount of capital.
- More investors in a transaction can be viewed as a positive signal by other potential funders and could lower the perceived risk of the enterprise.
- The fundraising process can become tedious and take longer to complete with more people on board.
- More equity funders in early funding rounds could make succeeding equity rounds a lot more complex if the terms of these rounds do not adequately prepare for further investment into the enterprise.
DebtConcessional finance
Loans with more lenient terms than those of regular loans: typically below-market financial conditions (e.g. lower interest rates, longer grace periods, low or no collateral requirements). Investopedia
- Increases lending capacity for local partner institutions thus facilitating loans to SMEs.
- Concessional finance primarily flows from a financial institution (often public or multilateral) to a local intermediary that then manages loans directly with enterprises. This tool is therefore dependent on sustainable partnerships, i.e., the intermediary and financial institution would agree on pre-defined loan conditions to well-defined target enterprises.
- Often tied to the provision of dedicated loans (with a specific sectoral focus i.e., clean energy), which benefit enterprises that may otherwise have difficulty accessing credit.
- Potentially difficult to access the loans due to requirements set by the local intermediary.
Equity, DebtDedicated funds
Funds allocated to financing enterprises in specific sectors (e.g. investments in renewable energy), stages of the enterprise life cycle, or geographies or to fund the acquisition of specific products or services.
- Conditions for dedicated loans can be adapted to the specificities of the sector.
- No flexibility to invest outside of the fund’s mandate; the loan is dedicated to a specific type of investment.
- The financial tool is dedicated to supporting a specific sector or interest thus increasing the chances for enterprises operating in that sector to receive financing that otherwise may not be available.
- Dedicated funds are often tied to specific terms (e.g. purchase of specific equipment) which might not always align with the needs of enterprises.
Crowdfunding, Equity, DebtFundraising platform
Funds are raised from a pool of smaller investors via online platforms. Mechanisms include crowd-sourcing platforms (for individual investors) or private placement platforms (for institutional investors). Investopedia
- Access to a more diverse range of projects that could potentially meet their personal investment criteria.
- More transparency on how a particular fundraising effort is progressing.
- Risk sharing with more investors and ability to invest much smaller amounts.
- Limited protection in the case of non-payment or project failure.
- Opportunity to appeal to and attract a broader range of investors not only for the specific fundraising campaign but also future fundraising exercises.
- A fundraising campaign can also serve as marketing tool and could potentially allow an enterprise to attract more customers and gain more traction for their product.
- Enterprises should anticipate high expectations for public transparency and be aware of the reputational risk in case the fundraising campaign or project fails.
EquityMajority or significant minority equity stake
Active involvement of investors in an enterprise’s governance primarily via voting rights as set out in shareholder agreements. Investopedia
- Management oversight and closer involvement in the operations of the enterprise.
- Ability to influence decision-making.
- Limited exit opportunities in frontier and emerging markets could mean investors are left holding shares of companies much longer than initially expected.
- The investee can benefit from their investors’ experience, managerial support, and networks.
- No fixed payment obligations to investors.
- Entrepreneurs have to give up some decision-making power over their venture. This can potentially be challenging and jeopardize the enterprise if the investor-investee relationship does not function as intended.
DebtMezzanine finance
A debt instrument with equity features such as the option of conversion into equity in the event of a loan default (generally after venture capital companies and other senior lenders are paid) or that promises equity if certain milestones are achieved. Investopedia
- Lender can receive equity on top of interest and repayments if the startup’s valuation goes over a threshold amount.
- Higher returns (high risk, high reward).
- Higher risk since mezzanine financing ranks last among debt obligations – payments to more senior loans need to be made first before any payments to a mezzanine lender can be made.
- Mezzanine finance offers an opportunity to receive debt financing in an early phase and the possibility of converting that finance into equity if repayment is not possible at the preferred time. This is particularly beneficial for early-stage enterprises that have not been valued or are between equity funding rounds.
- If the enterprise performs poorly and is unable to repay the loan, it may have to give up partial ownership of the business to investors. Depending on the terms of the loan, investors could gain control over management decisions of the enterprise.
- Higher interest rates.
Equity, DebtPatient capital
Long-term investment made to support the development of an enterprise and usually provided by investors who are willing to sacrifice short-term returns for more substantial returns in the future or for non-financial returns. Financial Times
- Potential to play a significant role in management decisions.
- Achievement of non-financial goals such as specific impact targets.
- Lower potential for high financial returns.
- Opportunity cost of foregoing shorter-term investments that could potentially yield better returns.
- Flexibility and time for an enterprise to define and refine their business strategy to build a more sustainable business rather than focusing on the delivery of better financial returns in the short-run.
- More time to prove enterprise bankability which could unlock funding from more traditional financiers such as:
- equity from commercial private equity funds that are more willing to invest in an enterprise knowing that longer-term investment has already been secured.
- loans from commercial banks that assess a borrower’s ability to pay based on their ability to demonstrate stable cash-flows for debt service.
- While patient capital is what all entrepreneurs want, available funding of this type going to innovative renewable energy projects remains low.
DebtProject finance
Used primarily for capital-intensive investments such as infrastructure projects, project finance loans are non-recourse or limited recourse structures where loan payments are tied solely to the assets of and cashflows generated by a specific project. Investopedia
- Financier has increased oversight of how the enterprise uses the proceeds of the loan.
- In an event of default, lenders can only chase the specific project’s cashflows and assets but not the borrower’s other cashflows and assets.
- Potentially longer tenors than other loans.
- Limited or non-recourse so funders can only go after the assets of the specific project or entity they lent to in the event of default.
- Typically more expensive than regular loans.
- Only offered to projects that use tried-and-tested technology and can demonstrate stable cashflows (e.g. signed power purchase agreement) over the duration of the loan.
GrantResults based financing
A form of payment-for-results model where a financier disburses funding upon verified delivery of pre-determined outcomes and outputs. Energypedia
- Donors have a high level of oversight given that funding is tied to verified results.
- Achievement of non-financial goals such as specific impact targets.
- Potential misalignment of how outputs are defined and measured. For example, it is easier to define and measure quantifiable outputs (such as the volume of cookstoves sold) than general development impact (e.g. health improvement or reduction in indoor air pollution).
- Quantifiable outputs do not necessarily reflect the targeted impact (e.g. number of units sold doesn’t guarantee usage).
- Positive signal to other investors that the enterprises can successfully carry out their projects, and thus other investors may be attracted to invest in them.
- Can help enterprises achieve the level of scale they require to run sustainably without the need for subsidies or further grant funding.
- Working capital requirement – since enterprises are paid only upon achievement of certain milestones, they would need to shoulder the upfront costs required to achieve the expected outputs.
- Reporting requirements could be more onerous than what would be required by other funders.
DebtSyndicated loan
A pool of lenders invest together to provide a larger loan to a single borrower. Investopedia
- All financiers share risk under the syndicated loan structure with liability limited to their share of the total loan.
- Increasing the number of lenders might increase the complexity involved in managing the investment and achieving financial close.
- Increases the amount of accessible finance for enterprises by promoting partnership between smaller and larger financiers to jointly invest in emerging sectors.
- Tends to be used for larger-sized projects, not necessarily well suited to early-stage enterprises with limited financing needs.
- May be more difficult to manage the financing process without the help of a strong lead arranger.
Credit Enhancements
Debt, Equity, Guarantee, GrantFirst-loss capital
Capital provided by an investor or grant provider who agrees to bear first losses in an investment in order to catalyze the participation of co-investors. Global Impact Investment Network
- Ideal tool for impact investment in SMEs operating in sectors/segments perceived as high-risk by investors since first-loss capital lowers the risk of lending to projects for more risk-averse financiers.
- Most investors would not be willing to provide first-loss capital as they would rather be the recipient of credit enhancements that would protect their investments.
- Improves the risk and return profile of the investment to attract further investors.
- It is difficult for smaller enterprises to find and access such financing as first-loss capital providers are more likely to provide credit enhancements to funds or more established enterprises.
GuaranteeLoan guarantee
When a third party (guarantor) takes on the responsibility to repay the borrower’s loans in the event of non-payment or default. A guarantee is a funder’s insurance policy against non-payment should their borrower not be able to pay in the future. Investopedia
- Lowers the perceived risk of enterprises whose projected cashflows a funder cannot confidently assess given a lack of familiarity with the sector the enterprise operates in or with the technology the enterprise is developing Potential challenges from the financier perspective
- Due diligence is not only required on the borrower but also on the guarantee provider (if not universally accepted).
- Can boost enterprise access to both short-term and long-term credit. Could encourage more risk-taking funders to consider lending to sectors that they are less familiar with or that they would otherwise not lend to.
- The guarantee can be used in lieu of collateral.
- This type of financing requires a cooperative relationship between guarantors, lenders and investees.
- Less common and harder to access for SMEs.
Technical assistance Technical assistance
Non-financial support provided to the enterprise (e.g. capacity building, training, pre/post-investment support on legal structure, financial reporting, business plan). UNESCO
- Technical assistance provided to help an enterprise with specific components of their strategy or operations could make a previously un-bankable project investment-ready.
- Implementation of “best practices” that do not necessarily suit local contexts and/or reliance on external consultants that do not adequately know the local market.
- Specific enterprise improvements – e.g. internal process improvements, strategy reviews, operations optimization, accounting – can be outsourced to more knowledgeable third parties instead of the SME setting aside time and effort to do these tasks in-house.
- Time-bound assistance.
- The process of applying for technical assistance facilities can be just as time-consuming as applying for funding.
This initiative has been made possible with the support of Wisions.
