London Business School Coller Institute of Private Equity

Tim Gocher’s Blog

PRIVATE EQUITY AS AN ANTI-CORRUPTION FORCE IN DEVELOPING MARKETS

The usual government anti-corruption toolbox in developing nations contains think tanks, policy reviews and anti-corruption commissions. These are necessary but rather blunt instruments. In bringing the first impact private equity fund to Nepal (the Dolma Impact Fund: www.dolmafund.org/dif/) we have found a much sharper and more direct tool – that of commercial negotiation.

Corruption in Nepal, as in many developing nations, is prevalent. It spreads like a cancer and reaches a critical mass where honest businesses struggle to compete without it. It promotes a lack of transparency and poor corporate governance which deters responsible foreign investors and minimises tax revenues even during times of economic growth. This compounds a nation’s fiscal problems and leads poorer nations down two dangerous paths – increased debt and foreign aid dependence that can, in some cases, crowd out private sector-led growth. This is a vicious cycle that must be broken if such nations are to grow themselves out of poverty through sustainable job creation. Here’s a shocking statistic from Nepal that highlights how imperative this is – of the 400,000 people entering the job market each year, 350,000 leave for work abroad according to the National Unemployed Youth Society.

I recently attended an anti-corruption conference in Malaysia (a far more prosperous country than Nepal of course) organised by the impressive Institute for Democracy and Economic Affairs (IDEAS - http://ideas.org.my/). As I listened to a former Prime Minister, various academics and policymakers discussing approaches ranging from the legal to the moral finger-wagging, it struck me that no-one was approaching this from the commercial perspective that we practise in Nepal.

First, I should explain a bit of background. Our investors are mainly sovereign investment vehicles of European nations that demand both market returns and a high level of compliance in terms of ESG, corporate governance and zero-tolerance on corruption. Furthermore, as an impact investment fund, we have elected to go further and proactively set and measure social and environmental development targets for each investment. We will start to deploy capital this year and are already advanced in pipeline development and negotiations. We work closely with the UK Department for International Development (DFID) who have been invaluable in helping us navigate regulations and other hurdles that can deter foreign capital. And our voice has been welcomed by local regulators actively looking at ways to streamline procedures and attract FDI. In DFID’s words, we are a “capital bridgehead” into a nation blessed with natural assets, including hydro-power generation potential of 83,000MW that could fuel much of South Asia’s growth with clean energy. If successful, we expect plenty of private foreign equity capital to follow once we establish a track record for the nation. However, if we run into issues that play to Nepal’s stereotypical capital deterrents (corruption, corporate governance, etc.), not only may we not succeed but the nation will struggle to secure international private equity for the foreseeable future. We have to get this right!

So what is our so-called “commercial approach” to tackling these issues in our pipeline companies? It all comes down to value, dollars and cents. First, our pipeline is somewhat self-selective. Only those businesses with the most solid reputations are considered. Second, they must be willing to implement an overhaul of corporate governance and accountability that includes full payment of applicable taxes and unified reporting standards (including social and environmental). This will inevitably incur a cost to the business. As one of the only capital providers in the market fully aligned with the growth of our investments, we switch the story away from cost avoidance to growth potential. In negotiations we mutually develop a growth plan and agree a set of realistic milestones and projections. At the other side of the table are impressive business people. In many cases they have survived, even thrived through a civil war that ended in 2006. They are risk management experts par excellence, using methods that I certainly didn’t learn at London Business School! They will evaluate the cost of compliance to our standards and their calculation is simple. If they believe the growth potential outweighs any savings they make without the implementation of our standards, they will do the deal. If it doesn’t, they won’t. Legal threats, morality and anti-corruption bodies may have an influence, but ultimately it comes down to the value proposition we offer. And risk management is part of the value proposition in our favour. Strong governance reduces potential future liabilities, and smart entrepreneurs get that.

The benefits of this sharper, commercial approach are not lost on Nepal’s regulators. At a recent due diligence visit to Nepal by one of our sovereign investors, both the Governor of the Central Bank (Nepal Rastra Bank) and the Secretary of Industry gave speeches indicating that the value of the Dolma Impact Fund to the nation is far greater than the $40m we hope to deploy in the first fund. And incidentally, if the presence of such individuals at investor meetings doesn’t show a national willingness to attract responsible foreign capital, then I don’t know what does! They cite the real strategic benefit of our fund as the knowledge transfer of corporate best practice with an active influence on growth plans that use strategic positioning, efficiency and technology as the pillars of competitive advantage, and not methods more traditionally associated with such economies. We have found plenty of companies and entrepreneurs willing to use these tools to spur their growth and create the jobs that the economy so badly needs to bring its young people back. And our investors, during their due diligence, have been as impressed as we have about the quality and willingness of these individuals.

Corruption is an organism that feeds off itself. It takes a range of tools to battle it. In my experience, a willing coalition of responsible foreign capital, enlightened regulators and entrepreneurs form an incisive, commercially-driven tool that is apt to cut back the problem, especially in the poorer nations where governments are weakest.

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From Charity to Private Equity – The Inevitable Path?

When the Dolma Development Fund was founded in 2003 to invest in sustainable businesses in Nepal and Ethiopia, we first attempted to raise a commercial fund. However, due to political instability, civil war in Nepal, and the absence of international deal success stories in such markets, it quickly became apparent that the only money available was philanthropic. Thus the Dolma Development Fund was born as a non-profit organisation taking donations and deploying capital using the private equity model, but with social and developmental targets baked into the mandate.

How times and funding options have changed! Witness the rise of Impact Investment and related funds – a growing subset of Private Equity which invests for both a financial and developmental outcome. Particularly relevant for us is the growth of developing market SME impact funds. These funds straddle the increasingly blurred line between for-profit and non-profit. They include pioneers such as Acumen Fund and Omidyar Network who operate funds on both sides of the line, as well as purely commercial funds including Pragati focused on India’s poorest states ($70AUM); Aavishkaar focused on rural regions of India (~$200m AUM); and Leopard Capital investing in Cambodia, Laos, Myanmar, Bangladesh and other frontier markets. The list goes on and on.

And as track records build, so the shape of the Limited Partner (LP) market is changing. The first funds were backed by big foundations and Development Finance Institutions such as IFC, CDC and FMO whose mandates were designed to shoulder the risks. But more recently, purely private and for-profit capital providers looking to combine returns with purpose have moved in. These include professional family offices, large corporate investment arms such as Cisco, and major financial institutions including J.P. Morgan and UBS.

Simultaneously, at the other end of the charity-commercial spectrum, NGOs and aid organisations are establishing impact funds of funds. These include names you might never have envisaged being associated with private equity. For example, charity icon Oxfam this year announced its $100m Small Enterprise Impact Investment Fund (SEIIF) managed by asset managers Symbiotics and focused on developing markets. DFID is planning a fund that would see it become an LP in impact funds for the developing world as part of its Private Sector Development strategy. And I couldn’t write a blog for the Coller Institute without mentioning plans at London Business School (OK, not a philanthropic charity but a non-profit nonetheless), to establish the LBS Social Venture Fund.

It is this apex, where NGO and private funds meet, which will define not only impact investment, but the core strategies of NGOs themselves. Private capital and businesses in developing markets have often been wary of NGO activities crowding out private sector potential. I recently heard of a British fund that had invested in a clean-tech business in Nepal founded by local entrepreneurs. Shortly after the investment, an NGO started giving away similar products and destroyed the market. This is a common story, but now private enterprise is just as likely to collaborate and co-invest with NGOs as compete with them. With DFID leading the way in private sector stimulus and others joining them, these organisations are becoming an important source of both funding and technical support to the commercial and impact investment sector. And they bring with them essential skills if such funds are to maximise their impact objectives.

South Asia is a major target for this burgeoning LP community. International capital committed to impact-related SME fund managers in the region now exceeds $2.3bn, with dedicated funds for India, Sri Lanka, Bangladesh and Pakistan – but not Nepal.

With six years of durable peace and solid economic growth in Nepal, yet a chronic lack of growth capital, the Dolma Development Fund is traveling what is becoming a well-trodden path for non-profits. It has launched Dolma Impact Fund I – a $20-40m for-profit Impact Investment fund. It is the first such fund ring-fenced for Nepal and will help fill the “missing middle” in SME capital, technology access and management skills, particularly for companies that can expand across the relatively free-trade border with India. The launch event took place last month at the Embassy of Nepal in London and was hosted by His Excellency Dr Chalise, the Nepalese Ambassador to the UK and Ireland.

The very fact that funds are able to successfully launch in such markets is a testament to the growth of the impact funding base, the complementary skills of the for-profit and non-profit sectors, and the increasing maturity of the Impact Investment asset class.

To watch the Dolma Impact Fund I launch event video, click here

For more information on any of the topics above, please contact tim@dolmafund.org.

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QUOTED IMPACT INNOVATION FUNDS - SOCIAL INVESTMENT'S NEXT STEP?

Can public equity markets provide the step-change needed in capital supply to the Social Impact sector?

I’ll never forget sitting in an LBS classroom ten years ago when a visiting KKR executive (who shall remain anonymous) was asked the question “how does social good factor into your investments?” His chiselled expression, etched by years of hurdle rate decisions, didn’t flinch as he offered his standard response. “The regulators take care of that stuff. We stick within the law and focus on returns.”

I wonder what his response would be today? Maybe he’d say that their funds now comply with their Environmental, Social and Governance (ESG) guidelines. That’s better, but what would it take for the answer to be: “We have launched a range of funds targeting Base of Pyramid-focused enterprises that promote and measure social and environmental impact.” The answer is obvious. It will take data and track record.

As the red pen of Western austerity inevitably slashes through aid budgets, this is the hour for Social Investment to come of age and prove that it is a far more sustainable solution to poverty alleviation at the Base of Pyramid segment than the often dependency-creating aid model. But to do this, we need to create a step-change in the supply of capital and how it is managed.

Publicly-listed funds need to be part of the answer – I call them Quoted Impact Innovation Funds. They would invest in scalable enterprises that sell products or services to the high growth Base of Pyramid market and in doing so further a positive social and environmental impact. Because they would not be closed-end funds, as with most VC/PE funds, they would have greater timeline flexibility that is sometimes required to bring such portfolio companies to profitability. But perhaps more importantly, they will provide real-time prices for risk and return models in a sector that is stuck in the endless debate between whether there is a positive or negative correlation between returns and social and environmental good. A critical mass of such funds, and the listed enterprises they could spawn, will create a body of data that will drive financial innovation and portfolio theory so that we may even approach the holy grail of a portfolio model whose efficient frontier is a factor of risk, return and impact.

“Utopian idealist!” I hear you all cry. “Public markets are no place for early stage investments, let alone the political and operational risks inherent in Base of Pyramid investing.” But before you pass judgement, I ask you to take a look at a successful sector that, give or take a bit of license, has a profile not too dissimilar.

Various listed IP commercialisation funds have sprung up that are effectively early-stage funds taking often university-originated research to market. The profiles of their investments feature long-term payback, highly risky future cash flows, high regulatory risk and other hurdles that require funding and timeline flexibility. And yet AIM-listed Imperial Innovations plc raised a secondary offering of £140m in Dec 2010 and LSE-listed IP Group plc raised a further £55m in the choppier waters of June 2011. There is appetite for such risk. The key to success is 1) securing a credible pipeline of deals/innovations, 2) risk management and business building skills, and 3) superior investor relations and communication.

These investment firms often secure partnerships with universities to prime the pump. Similarly, there is no reason why Quoted Impact Innovation Funds couldn’t tie up similar partnerships with the many academic collaboration projects underway between Western and developing world institutions with a view to investing in and commercialising the output. If such a pipeline was combined with organisations such as Omidyar and Acumen Fund who already have on-the-ground networks experienced at managing political and operational risk, and some existing success stories to line the fund with track record and even cash flow, there is no reason why such structures couldn’t tap the public markets. They would form the thin end of a wedge – a funding source which could rapidly grow as institutions realise the true diversification provided by the Base of Pyramid consumer in a world of horribly correlated global asset prices.

There are already various initiatives underway to create social stock exchanges. This could be a key component to the capital mix of Social Investment, but we need to be careful that we don’t create “sub-exchanges” that fail to drive the liquidity necessary for this asset class to achieve its potential. If the liquidity isn’t there, neither will the accurate price data that will form the basis of financial innovation necessary to attract the mainstream investors.

The growth of Quoted Impact Innovation Funds will inevitably require the initial support of the large foundations and philanthropists currently sponsoring many other Social Investment models. But in time, the public market transparency of such funds, combined with the use of impact reporting standards such as IRIS and GIIRS, will provide institutional and eventually retail investors with the benchmarks needed to enter the market. The sooner we start collecting real-time price and risk data in the Social Investment space, the sooner will be the explosion in the supply of capital.

I’d like to end this note with a more profound idea than simply boosting capital provision to the Base of Pyramid. By creating Quoted Impact Innovation Funds, we are also providing the opportunity for the retail investor to contribute and more importantly connect to the efforts of the poor as they work themselves out of poverty. It is my experience, as Chairman of Dolma Development Fund investing in Nepal and Ethiopia, that Base of Pyramid entrepreneurs are the most dedicated I’ve come across. There is little agency cost – failure can mean starvation! These funds would not only provide investors with transparency of both return and impact data, they will provide a sense of participation and knowledge in the issues of the poor –a dynamic partnership that could stimulate the true globalisation of opportunity and human dignity. In the world of aid, too often the donor is removed from the impact. Quoted Impact Innovation Funds will provide direct, real-time feedback on impact and could pave the way to democratise Social Investment while proving the maturity of the asset class.

And so it is my hope that the graduating MBA class of 2015 hosts the proverbial KKR executive whose array of social and environmental impact funds are teaching the regulators how to attract and deploy capital for good.

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About me

Tim Gocher

Chairman of Dolma Development Fund

Tim is a venture capital and clean-tech executive who is also founder and Chairman of Dolma Development Fund – a non-profit impact investor in Nepal and Ethiopia. He is also Chairman of Dolma Impact Fund I – the first commercial impact fund ring-fenced for Nepal. After nine years at Deloitte and J.P. Morgan, and an MBA from London Business School, Tim became Managing Director at listed merchant bank Interregnum plc. He has worked across the energy, renewables, technology and urban development sectors. His projects include launching E.On’s Community Power renewables business and advising governments and private groups on sustainable urban development and inward investment strategies in countries including Portugal, USA, Malaysia, China and India. He is co-founder and partner of Academy IP – a New York-based VC investor partnering with major, US research universities to invest in spin-outs.

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