How to Finance the Missing Middle
Feature from Friend of FINISH and Finance Expert (WASTE), Jacqueline Barendse
Until recently, WASH has been notoriously difficult to finance. Why? It is capital intensive, high-risk, has small margins, and lots of regulations. Combined, these make the sector rather unattractive for investors. This is also why the supply of water and sanitation has been in the hands of the public sector for so long. In the two decades I have worked in this field, however, I have witnessed truly astonishing developments. According to the recent Global Impact Investing Network’s (GIIN) Report, the water, sanitation, and hygiene (WASH) sector has become one of the fastest growing segments for investment. And this comes as no surprise to me. We now have some magnificent sanitation businesses paving the way: building toilets, emptying containment pits, and converting the waste into valuable, nutrient-dense products like fertilisers, and biofuels, etc.
But we also still have many puzzles to solve. While under the FINISH Mondial programme, we feel that we have “cracked” the microfinance side of financing sanitation (see our latest blog on microfinance as an enabler of business development), we still face difficulties supporting small businesses beyond those earlier stages. From our decade of experience growing the FINISH programme and understanding the needs of small businesses, the programme’s founder, WASTE, has launched the new Take-a-Stake Initiative to contribute to solving the challenge of financing beyond microfinance.
The sanitation business landscape comes in many colors and shapes
Sanitation businesses encompass a very wide range of enterprises. A majority of WASH businesses are very small (one person, one family) and informal, meaning they are not registered (officially they do not exist). While this has the advantage for the individual that they can avoid difficult regulations and taxes, it also means that no formal organisation will lend you money.
Why are small WASH businesses important? These businesses are those usually catering to the needs of the poor. Within the FINISH Mondial programme, promising informal companies are identified and supported to professionalize and become formal businesses. The programme usually links them to microfinance institutions since accessing €5,000-10,000 can already be immensely helpful to them.
Soon we run into a problem, though: as demand for toilets increases, these businesses quickly outgrow the framework of microfinance institutions. This is where things get difficult. They are too big for microfinance and yet too small for 100% commercial investment. These businesses are doing well, they grow, have customers, and earn income, but still have limited staff, their bookkeeping is sub-standard, and lack proper governance. These businesses require €20,000- €1 million, but investors won’t touch them. Why? Assessing their potential is seen as too much work, they still need too much support, and they are simply too risky, in the eyes of investors. Although it would be in everyone’s interest to see these businesses grow, many don’t make it, because of a lack of investment at this stage of business development. This is a shame!
Ensuring the sustainability of FINISH’s support to small WASH businesses
In the FINISH Mondial programme, we concentrate our efforts on supporting small WASH businesses. The key to expanding this effort and ensuring the sustainability of our support is to find financial instruments that innovatively blend public and private funds. This is something the Take-a-Stake initiative is working on so there is a system ready to catch the small businesses supported under the FINISH programme.
Today, public financiers understand the importance of private funds or “leverage”, but European laws on “state aid” are a complicating factor. Simply explained: public entities still often consider the combination of public and private funds an unfavorable mix. They are afraid that it could result in accusations of “state aid”, “market distortions”, “favoring one company over another” and so forth. The laws on “state aid” work well in the context of creating “one European market”, but complicate development aid and the creation of new markets elsewhere.
What we learned along the way: let companies face the market, but provide an enabling environment
It takes a long time! When supporting businesses, many factors must be considered apart from the company itself. Among them, local and international legislation is imperative to the process, which can either help or greatly hinder business processes). This makes a strong enabling environment so important to success.
Just a little chunk of investment money would be enough
About US$200-US$300 trillion is swirling in capital markets worldwide (stock markets, savings, etc). There is plenty of money in the world for investments! If we could re-direct only a small part of this to the small and growing businesses serving the bottom of the pyramid, especially for basic needs services, we could make astounding progress towards the hugely underfunded SDG 6 (clean water and sanitation). Together with the great collaborations under the FINISH Mondial programme, Take- a-Stake initiative, and elsewhere, we are working on it!
Jacqueline Baredse has over 25 years of hands-on experience in business and finance and about 15 years in the development cooperation space. She feels these two worlds can and should come together. Jacqueline spoke with the FINISH team at the Stockholm World Water Week, about how to support businesses and innovative sanitation financing. To hear more about this topic and from Jacqueline, you can watch the recording of the Talk Show (25 mins) “Sanitation Financing: Creating market segments for more efficiency” here.