Towards the end of July 2005, I moved from the UK to Uganda to start Africa’s first impact investment fund focused on early-stage agriculture-related businesses in East Africa. Agriculture was not new to me (earlier in my career, I had spent time working on CDC’s portfolio of agriculture businesses across Africa) but starting up an investment business was a leap in the dark.

The Gatsby Charitable Foundation and Rockefeller foundation established African Agriculture Capital (AAC) to invest in agriculture-related small and medium-sized enterprises (SMEs), which provided smallholder farmers with improved products, services, or access to markets. AAC was very much a pilot initiative, with initial capital of only USD 7 million, and intended by its founding investors to test the market for risk capital and pave the way for future investment.

As AAC’s first CEO, I was recruited to develop its detailed investment strategy, build a management team, and attract new investors to the fund. AAC invested in 16 early-stage businesses and in 2019, exited its final investment and fully closed in 2020.

Fast forward 15 years, and the Uganda-based impact investment fund manager Pearl Capital Partners (“Pearl”) has published a summary “cradle-to-grave” report of AAC.

The report concludes that AAC was highly successful. Besides delivering a positive gross investment return on capital invested, my colleagues and I established Pearl, which has gone on to raise three separate impact investment funds with total investment commitments of almost USD 60 million from a variety of high-profile international investors. Of AAC’s 16 investee businesses, only four failed, and many of the 12 surviving companies have grown substantially in size and impact since AAC’s investment.

So, what can we learn for designing and managing this kind of vehicle in the future?

Lemons Ripen Faster than Plums

Building profitable businesses takes time and requires patient investment. It is tough to build businesses on short to medium-term debt finance. Growing businesses usually require several rounds of incoming investment and are typically unable to finance debt repayments. In designing investments for early-stage businesses, investors should first consider the best interests of the company and design their investment to meet those requirements.

Investors frequently talk about the critical importance of aligning interests and ensuring that investors, owners, and managers of the business share a common goal and incentive structure. Typically, this means making equity, or equity-like, investments – high-risk products for the investor, but low risk for the business.

It also means that limited-life fund structures are not appropriate as early-stage investment vehicles. Many of AAC’s best-performing investments took many years to develop to the point of profitability. Had AAC been structured as a limited-life investment fund, it would have been difficult to invest in early-stage businesses with any real expectation of achieving a profitable investment exit within a 5-to-6-year timeframe.

Develop Local Presence and Teams

The AAC founding investors made an early decision to build a supervisory board in East Africa chaired by and largely composed of experienced East African leaders. Its first chairman, Hatim Karimjee, was Tanzanian and his successor in 2011, William Kalema, is Ugandan. In building the AAC team, I recruited a high potential young team drawn from talent within the region. AAC was, in essence, a genuinely East African venture managed and governed from its offices in Kampala, Uganda – a far cry from the many impact investing funds focused on Africa, led and staffed by expatriates, often with little direct experience of the region, and governed by remote Boards and Investment Committees.

This ‘fly-in fly-out’ management model has four major deficiencies that we were attempting to avoid by building our local team:

• It does little or nothing to build local and regional investment management capacity.
• It does not address unconscious (or conscious) investment biases; one enduring complaint in East Africa is that impact investors prefer to invest in expatriate founders over local businesses.
• It fails to earn the confidence and trust of potential investee businesses in the good intentions of the investor.
• It limits the ability of the investor to supervise its investment portfolio and continue to build the investor/investee relationship.

Build on Strong Foundations

Private equity investment often aims to achieve phenomenal growth within a limited period. This, combined with the availability of capital, can encourage overambitious growth plans, which firms may not have the necessary management, operations or experience to execute. This can lead to underperformance and in the worst case, the failure of otherwise well-performing small businesses.

Investors have a responsibility to promote sensible growth plans for SMEs that allow time to build management teams and systems to support expansion, are based on tested business models, and are compatible with the owners’ purpose.

It is also essential for investors to actively support their investees to implement their plans and maintain focus on financial controls and business risk management. These are the foundations of all successful businesses. One weakness of AAC’s model was the lack of a dedicated grant-funded Business Development Support facility through which technical assistance could be delivered to its investee businesses.

AAC’s Legacy

Despite AAC’s relative success, there is still a chronic shortage of patient, small-scale, early-stage capital. Testimony from many of AAC’s investee companies highlights that AAC filled a critical gap in this type of capital for SMEs that is not adequately addressed by subsequently established impact investment funds.

Sadly, the trend among impact investment funds has been to try to increase financial returns by moving towards larger deal sizes, and companies with a stronger track record and shorter investment holding periods. To some extent, this is inevitable. Funds investing in smaller enterprises will have high management costs, relative to the value of their investment portfolio, and investors who prioritise financial returns from their portfolios are therefore unlikely to find them attractive prospects for investment.

However, as a consequence, smaller, early-stage SMEs are starved of capital. Many of AAC’s successful portfolio companies would be excluded from consideration in the current impact investment landscape because they were very early stage, and the deal size would have been too small.

It’s therefore very encouraging to see Palladium’s asset management arm, Bamboo Capital Partners, employing blended finance structures to catalyse investment towards early-stage operators in a range of high-impact sectors. AAC’s experience has proven how transformative small-scale, genuinely early-stage capital can be.

Alongside blended finance, another solution to this challenge is for donors to accept a higher management fee than industry norms and introduce fund management incentives linked not only to financial targets but also to the achievement of impact targets.

Through its finance and economic growth teams, Palladium is well-placed to advise and design impact investing strategies that build on practical experience and optimise the alignment of interests between investors, intermediaries, and businesses to get the best possible results.

Tom Adlam is team leader for the Palladium-implemented FCDO Impact Programme, which supports the growth and development of the impact investing sector with a particular focus on Africa and South Asia. For more information, contact info@thepalladiumgroup.com