Root Capital: Pioneering Finance for Rural Communities

Competition Finalist

This entry has been selected as a finalist in the
The G-20 SME Finance Challenge competition.

Root Capital is a nonprofit social investment fund that is pioneering finance for grassroots businesses in rural areas of developing countries. We provide capital, financial education, and market connections to small and growing businesses that build sustainable livelihoods and transform rural communities in poor, environmentally vulnerable places.

About You

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About You

First Name

William

Last Name

Foote

Your Organization

Root Capital

Country

United States, MA

About Your Organization

Organization Name

Root Capital

Organization Website

Organization Phone

617.661.5792

Organization Address

955 Massachusetts Ave. 5th floor, Cambridge, MA 02139

Organization Country

United States, MA, Middlesex County

Organization Type

Non-profit/NGO/Citizen-sector Organization

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Your solution

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Name Your solution

Root Capital: Pioneering Finance for Rural Communities

Describe Your Solution

Root Capital is a nonprofit social investment fund that is pioneering finance for grassroots businesses in rural areas of developing countries. We provide capital, financial education, and market connections to small and growing businesses that build sustainable livelihoods and transform rural communities in poor, environmentally vulnerable places.

Country your work focuses on

n/a

If multiple countries, please list them here. If your solution targets an entire region, please select it below

Region(s) your solution focuses on:

Africa, Latin America and the Caribbean.

Range of turnover in your target firms, in USD

Less than $1 Million, $1-5 Million, $6-10 Million.

Average turnover in USD of your target firm

$2 Million

Number of employees in your target firms

Fewer than 5, 5-24, 25-49, 50-74, 75-99, 100-150, More than 150.

Average number of employees of your target firm

22

Specify the size, average and range of expected loans or investments in each target firm

We provide various types of loans ranging from $25K-$2.3M, with the average loan size approximately 370K.

What stage is your solution in?

Operating for more than 5 years

Innovation

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What makes your innovative solution unique?

Root Capital’s three-pronged strategy—Finance, Advise and Catalyze—is designed to respond to market failures and inefficiencies that exclude rural grassroots businesses from affordable capital. Our lending methodology uses fixed-price forward contracts as loan collateral, thereby shifting the traditional paradigm from one in which risk is borne solely by the most vulnerable producers to one in which risk is shared and minimized in direct trading relationships. This change harnesses the inherent potential of rural small and medium sized enterprises (SMEs) into increased production, profits to the producers, and product supply to global markets.

As we grow, Root Capital is proving that rural SME lending is viable and that this kind of innovative lending can reach scale and achieve meaningful impact. Through this demonstration effect, we aim to “crowd in” local banks and financial institutions to address rural poverty in the long-term and improve the livelihoods of farmers and artisans and their families.

How does your proposed innovation leverage public intervention in catalyzing private SME finance?

Historically, Root Capital has relied on public intervention in limited but strategic ways, seeking out these resources as short-term springboards for our growth in the following ways:

a) In early 2010, the Overseas Private Investment Corporation (OPIC) invested $10 million in Root Capital’s loan fund. By placing its confidence in Root Capital, OPIC is enabling us to build up a broad base of long term supporters. Today, OPIC is joined by more than 80 other investors—foundations, corporations, and individuals—and the average investment size from private sources is increasing each year.

b) In 2005, Root Capital launched a multi-year initiative with the Inter-American Development Bank to develop and deliver intensive financial management training for small and growing businesses in seven countries. By the project’s close in June of 2010, Root Capital and its partners had delivered financial training to nearly 6,000 individuals representing 55 businesses and created replicable financial training modules, including cash flow analysis, internal credit fund management, and the development of financial statements. Leveraging the learning from this pilot project, Root Capital currently has six privately-financed training initiatives across eight countries. Furthermore, we see the methodology and curriculum as highly replicable and are currently translating all of the materials into English and French, while also adapting them for different cultural contexts.

c) Finally, we recently secured a $22.5M credit enhancement from USAID to support exploratory due diligence in seven countries where Root Capital has not previously focused but where we see the potential for significant investment and impact. For example, this guarantee is instrumental in helping Root Capital explore our first opportunities in Haiti. More important than the financing we project leveraging with the USAID guarantee is the fact that this instrument will facilitate long-term investment by Root Capital and others in new geographies and new political, social, and environmental contexts.

Beyond these specific examples, public investments in Root Capital play a catalytic role by helping to demonstrate the viability of lending to rural businesses and thereby spur the development of a capital market that serves them. Root Capital’s theory of change is premised on the idea that through the demonstration effect of our fund, other financial institutions - banks, non-bank financial institutions, venture capital, and private equity - will enter the market to lend to SMEs that were previously locked out of the banking system. By helping Root Capital finance SMEs, public institutions are contributing to this demonstration and to the potential for lasting change.

What barriers does your proposed solution address?

Lack of collateral, Lack of financial capacity, Lack of SME access to skills / knowledge / markets, Unavailability of financial products tailored to SME needs, High transaction costs for financial intermediaries to serve SMEs, Underdeveloped local capital markets (term local currency funding, exit options for SME equity), Lack of financing to women entrepreneurs.

If you checked any of these barriers, describe how your solution addresses them

Lack of collateral: The majority of our loans employ a form of value chain finance whereby the main security is future sales contracts from buyers, primarily in North America and Europe. We use factoring agreements, or signed purchase contracts between grassroots businesses and their buyers, for both short-term and long-term loans. The purchase agreement serves as a substitute for traditional collateral as it represents a discrete, future revenue stream pledged to repay our loan. When the product is shipped, the buyer pays Root Capital directly for interest and principal payments due on the loan, thus decreasing the risk of default.

Lack of financial capacity / Lack of SME access to skills / knowledge / markets: Root Capital addresses these barriers through our Advisory and Training (A&T) program. This begins with our investment officers providing targeted on-site technical assistance to potential borrowers. We also offer a multi-module training curriculum to cohorts of organizations in specified geographies and industries. For example, we recently concluded Porvenir Financiero (PorFin), a four-year project across five Latin American countries that strengthened the financial management of 55 grassroots businesses, representing 26,000 smallholder rural producers. The possibilities for replication, scalability, and adaptability make Root Capital’s A&T programs an effective tool for improving the financial capacities of SMEs throughout the world. In another example, we are currently conducting beta testing of an online platform, Hazlo Con Cla@se, which is based on PorFin materials and methods and would enable us to easily share these resources globally.

Unavailability of financial products tailored to SME needs: Root Capital offers a variety of loan products for SMEs. These include: Trade Credit Loans (to purchase products from producers and meet operating expenses; Capital Expenditure Loans (to purchase or maintain fixed assets such as equipment or real property); Long-Term Working Capital Loans (to meet general business capital needs); Pre Harvest Credit Loans (to support individual producers’ production capacity through the purchase of inputs such as seeds and fertilizer); and Buyer Finance Loans (to finance purchases from community-based suppliers and provide working capital to borrowers).

High transaction costs for financial intermediaries to serve SMEs: We address this issue by developing deep industry knowledge and expertise that allow us to develop long-term lending relationships with the majority of our borrowers, aggregate demand in specific sectors, and generally scale our portfolio.

Underdeveloped local capital markets: To encourage banks and other financial institutions to enter the rural SME market, we continue to scale our operations. In addition to serving as a demonstration fund, we actively share our lending model with local banks and others to enable them to adopt our model.

Lack of financing to women entrepreneurs: Gender issues are formally valued in our credit evaluation system so that organizations with strong gender programs and a high number of women suppliers, employees, and managers are prioritized in the loan analysis.

Impact

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Provide empirical evidence of your proposed solution's success/impact at present. If your project is in the idea phase, please provide evidence that speaks to its potential impact

Root Capital provides capital and financial training to SMEs operating in poor, environmentally vulnerable places. By doing so, we enable SMEs to expand their operations, generating higher and more stable household incomes for small-scale producers and supporting sustainable rural communities. Over time, we aim to demonstrate the financial viability of rural SMEs and catalyze dynamic capital markets to serve them at scale.

Since our inception in 1999, we have disbursed 805 loans totaling $213M to 292 SMEs, with a cumulative repayment rate of 99.7%. Between 2007 and 2009, our disbursements in dollar terms grew at an annual rate of 44%, and our growth through Q2 2010 has maintained this pace. These 292 SMEs provide market access, employment opportunities, and enhanced incomes and quality of life to over 400,000 smallholder producers.

Root Capital’s loans enable our borrowers to maximize revenues (thanks in large part to access to international premium market prices) and improve the livelihoods of their farmer and artisan suppliers. In the first half of 2010, our 124 borrower enterprises generated $235 million in revenue. They purchased $170 million in coffee, cocoa, sesame, honey, spices, shea butter, handcrafts, fruits, and nuts from more than 120,000 rural producers, contributing an average of approximately $1,400 in annual income to farmer and artisan households. In addition to economic benefits, our borrowers improved their surrounding landscapes by supporting 215,000 hectares of sustainably cultivated crops.

While tracking our key metrics is important, we are currently developing a new impact assessment framework that embraces the multi-dimensionality of Root Capital’s impact and the unique impacts of our borrowers on their farmer suppliers. For example, one loan might have exceptional impact because it enables a small cooperative to grow, while another loan supports an enterprise with very effective social programs, while yet another supports a cooperative that provides non-drug-related employment opportunities in a region that has historically produced coca. This framework will help us to identify each type of impact, track how often it occurs in our portfolio for both reporting and strategic purposes, and draw lessons that enable us to improve our services and loan evaluation processes to maximize our impact on rural businesses and smallholder producers.

How many firms do you expect to reach?

By 2013, we expect to finance over 365 SMEs annually (650–700 unique SMEs over time), representing a compound annual growth rate of 19% from our 2010 target of 224 SMEs.

What is the volume of private SME finance you aim to catalyze?

In 2013, we expect to disburse over $140M, representing a compound annual growth rate of 25% from our 2010 target of $74M. This accounts for our direct lending only and does not include the additional external financing that we plan to catalyze through other financial institutions.

What time frame will be required to reach these targets?

Because demand for financing from bankable rural SMEs far exceeds supply, we project continuing to grow our disbursements at an aggressive rate of 25% annually for the foreseeable future. We anticipate that our lending model will achieve sustainability (e.g., interest income and fees more than cover the fully loaded operating expense of our lending activities) beginning in 2013.

Does your solution seek to have an impact on public policy?

Yes

What would prevent your solution from being a success?

The greatest risk that threatens the success of our solution is if commercial financial institutions, both in developing and developed countries, do not follow our lead in providing capital to rural SMEs. On the supply-side, many traditional and community-based financial institutions perceive our work as higher risk. In addition to this perception, the opportunity cost in applying our model is a challenge given that they could seek higher returns in different markets. Furthermore, banking laws and regulations in some countries may actually prevent financial institutions from lending without fixed assets as collateral.

Through our finance, financial education, and field-building programs, we are working to mitigate these risks to provide the clearest possible demonstration effect to commercial financial institutions, and to leverage this demonstration effect through targeted outreach, advisory, and training to commercial and community-based financial institutions and small and growing businesses. As we continue to build out our approach in the coming years and as we reach sustainability with our lending model, we believe that we will further demonstrate the viability of our work and supporting SMEs and a path towards sustainable development.

Describe the social impact of your innovation. Please include both numbers and stories as evidence of this impact

By 2013, we project disbursements totaling approximately $140 million to 365 rural enterprises representing nearly 525,000 farmer and artisan suppliers. We estimate that these disbursements will support $1 billion in revenues, representing an average of more than $1,500 in income to each individual farmer/artisan household.

The story of Hai Tanzania exemplifies the kind of impact that Root Capital’s intervention can have. Hai was formed in 2007 by Tanzanian cocoa experts who recognized the tremendous opportunity to harness the potential of Tanzanian cocoa to address some of the social and environmental challenges in the region. Despite good management experience and interest from Swiss, Dutch, and American companies, Hai lacked sufficient working capital and access to credit. In 2008, Root Capital learned of Hai and was impressed with their business acumen and the export interest in their product. The challenge was that the organization's financial and operational infrastructure was not yet creditworthy. After four days of training in finance and accounting, we approved a $80,000 loan to Hai and after one year, Root Capital was able to disburse over $1M in two additional loans to them. Most important, the company's sales have grown seven times over the same period improving productivity, product quality, and the livelihoods of their employees.

Sustainability

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List all the funding sources that are required for the sustainability of this solution

Root Capital’s model relies on both debt and philanthropic capital. We seek both senior and subordinated debt and provide a range of terms and rates, while striving to maintain a cost of capital of no more than 2.5%. By 2013, we project achieving 100% self-sufficiency in our lending program. To do this, over the next three years, we require $47M in additional senior debt capital, $5.2M in additional subordinated debt, $9M in permanent loan capital. In addition, we require $16.7M in philanthropy to fund our remaining activities. At present, the growth in Root Capital’s operations and impact is most challenged by the need to raise permanent loan capital sufficient to maintain a debt to equity ratio of no more than 5:1. This is an area where we believe public institutions could play a truly catalytic role.

Demonstrate how your proposed solution has the capacity to graduate from dependence on public finance. What is the time frame?

As mentioned before, Root Capital does not rely on public funding as a long-term source of capital. Rather, we have approached financial support from public entities such as OPIC, IDB, and USAID, as a way to build the institutional capacity (systems, staffing structures, and intellectual capital) needed to attract long-term support from private sources. For example, Root Capital has taken advantage of the significant investment made this year by OPIC to strengthen our business development processes, systems, and staff. As a result, we project effectively matching the $10M from OPIC dollar-for-dollar with new sources of private capital in 2010, while building a strong pipeline for 2011. We raise this private capital from foundations, individuals, and corporations. More recently, we have worked with wealth advisors who aggregate multiple investments to us from their client pools (in 2010, we project raising $3-4M in new debt through such relationships).

In the long-term, Root Capital aims to reach sufficient scale to be an attractive investment proposition to a larger pool of supporters, including some that are more commercially-minded. The first major milestone towards this goal is achieving self-sufficiency for our lending operations. For 2010 we project a self-sufficiency ratio of approximately 73%, well on our way to the 100% we anticipate achieving in 2013. With demand for agricultural products projected to increase by at least 50% over the next two decades and similar growth in markets for natural products, Root Capital is confident that it can continue the trajectory of 25% growth in disbursements we have experienced in recent years. The next milestone would be achieving sufficient volume (with improved economics that allow us to offer a greater variety of investment products) and having sufficient track record that we will be able to tap into larger pools of capital from mainstream capital markets, thereby negating our need for public support.

Demonstrate how your proposed solution will survive a potential loss of its largest private funding source

Root Capital is a financially secure organization with a broad and diverse funding base. Contributing to our 2010 goals, we have over 80 current investors and 38 donors. In addition to maintaining our relationships with existing funders, we are also adept and building new partnerships as demonstrated by the 108 investors and nearly 300 donors that Root Capital has had since our founding in 1999. Our funders range in size and background and include individuals, families, foundations, investment firms, private corporations, and government agencies committed to our cause of creating sustainable livelihoods in rural communities. Therefore, even if Root Capital were to lose our largest private funding source, we would be able to rely on our large support base.

Additionally, we are always making efforts to expand and grow our support base. One such example of this effort is our recent focus on standardizing our terms and offerings for both investors and donors. Since the release of our Private Offering Memorandum in 2009, we have seen an influx of larger donations and investments from new funding sources. The average investment has increased by $360,000 (or 180%) and the average donation has increased by $29,000 (or 60%) since the release of this document. As we continue to hone our business development strategies, we expect our funding base to grow ever stronger.

Please tell us what kind of partnerships, if any, could be critical to the greater success and sustainability of your innovation

In order to efficiently channel capital to support market-based solutions to social and environmental problems, partnerships that build the field to validate the impact investing market will be critical. As a founding member of the Aspen Network of Development Entrepreneurs (ANDE) and the Global Impact Investing Network (GIIN), Root Capital has worked diligently to raise the profile of small and growing businesses and their catalytic role in promoting improved livelihoods and environmental sustainability. These networks have also worked to not just dramatically increase the amount and effectiveness of capital and technical/business assistance for entrepreneurs in developing countries but also address the systemic barriers that hinder the impact investing industry's efficiency and effectiveness. Engaging these field-building partners in addition to directly working with various financial institutions will be important for ensuring that SMEs have access to the financing they need to reach scale and sustainability.

Are there non-financial issues that could threaten the sustainability of your proposed solution?

Three categories of non-financial portfolio risk—credit, context, and counterparty—relate to Root Capital’s ongoing work and are addressed on a continual basis through our organizational structure, policies, and processes. These risks all have to do with the performance of borrowers, markets, and buyers. We have developed and implemented strategies to mitigate these risks in our pre-investment credit evaluation process and our post-investment monitoring system.

Types of credit risk include issues with production and delivery, SME operations, and SME liquidity. These are common risks associated with agricultural products and SMEs. Root Capital mitigates these risks by using selection criteria that require successful sales history and buyer references, conducting due diligence visits to inspect operations and have management meetings, evaluating an organization’s price risk management system, reviewing key staff qualifications and internal controls, and analyzing financial statements, seasonal cash budgets, and key ratios.

Types of context risk involve issues with the market, the country, and the currency. Root Capital addresses these risks by lending against forward contracts, looking for premium pricing (i.e. certification premiums), limiting advances, reviewing country legislation on lending regulations and currency controls, avoiding countries or regions experiencing conflict, and matching currency of loans to revenues.

Counterparty risk involves issues of integrity and liquidity. We mitigate these risks by lending against forward contracts with reputable firms (preferably buyers with long-term relationships with clients and/or Root Capital), incorporating financial statements into credit decisions, running credit reports on new buyers, and assessing a business’ outlook in the context of market trends.

As a lender, managing portfolio risk is critical to our core business. Although there are a number of non-financial risks associated with Root Capital’s business, we have demonstrated our expertise in managing these risks by maintaining a 99.7% repayment rate from SME borrowers and a 100% repayment rate to our investors.

Please tell us if your proposed solution aims to scale up through a high growth sector, expand immediately to multiple sectors, and/or scale up geographically

Over the past ten years, we have demonstrated the effectiveness of our finance model in countries where the rural poor have little access to capital. While Latin America has been our “proving ground” to show local banks that rural enterprises can become viable players in the world market with the right support, our portfolio in Africa is an increasingly important driver of our overall growth. Indeed, the growth in our Africa portfolio closely tracks that of the Latin American portfolio in its early years. In 2010, this growth trajectory has picked up and we are surpassing our goals. As part of our overall Africa expansion plan (2009 – 2013), Root Capital aims to scale lending capacity to disburse millions to rural SMEs by hiring staff to support our lending and advisory and training (A&T) activities, identifying and effectively disbursing funds to borrower enterprises, and providing targeted financial management training so they can put capital to use effectively. We also aim to mobilize additional capital from third party financial institutions by forming partnerships with social and commercial investors and by preparing borrowers for commercial finance with targeted “transitional” post-investment technical assistance.

In addition to expanding geographically, Root Capital is building our research and development capacity to pursue adjacent markets for new and innovative investments. Root Capital has disbursed $213 million throughout Latin America and Sub-Saharan Africa with a repayment rate of 99.7%. Approximately three-quarters of this $213 million has been disbursed as short-term trade credit loans to coffee cooperatives. Over the years, Root Capital has diversified our core industries and financial products, but because of the additional due diligence and learning required, there have been relatively high costs that have come with innovation. Within a recently formalized structure, we will be able to document the knowledge from our ten years of experience in value chain finance and advance Root Capital’s mission by incubating new financial products and services and piloting replicable models. Our initial focus will be on extending our proven financial products and services to new industries, in addition to focusing on a high-growth model for those SME borrowers that have a proven track record. Institutionalizing innovation and increasing our capacity for research and development will increase our ability to incubate new financial products and services, pilot replicable models, measure impact and share learning, and ultimately scale our operations for the communities we serve.

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205 weeks ago Matt Guttentag said: On October 27, 2010, the judges reviewed entries for the Changemakers G-20 SME Finance Challenge competition and would like to pass on ... about this Competition Entry. - read more >
207 weeks ago said: I used to work for Root and know first hand the HUGE impact this organization has on farmers, families and entire communities. Brings a ... about this Competition Entry. - read more >
207 weeks ago Root Capital: Pioneering Finance for Rural Communities has been chosen as a finalist in The G-20 SME Finance Challenge.
215 weeks ago updated this Competition Entry.
216 weeks ago submitted this idea.