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Decision and Policy Analysis Research Area – DAPA

Unleashing Investment in Small Scale Agriculture: New Methods for Managing Risk

The Alliance of CGIAR Centers recently highlighted the need for increased investment in agriculture with a publication titled, Investing in Agriculture Science.  Interest in this area has surged as of recently, sparking the interest of investment funds and firms who are looking to merging development goals with business growth. Along with a renewed focus from foundations and development entities, agriculture has been spotlighted for it’s potential to reduce hunger, employ billions of small farmers, and create opportunity for business development and growth in emerging markets.

Agriculture lends itself to unique risks for lending and financing. For social investors looking to lead in this area, uncovering new ways to share, hedge, and address risk is critical.

A Risky Business

  • Agriculture faces a number of production, financial, market, regulatory and time-frame risks. While the food giant conglomerates of the world can take steps to mitigate these risk on their own, small farmers and social enterprise operations starting up in the developing world are often unable to cope. Mitigating the risks that these small holders and social entrepreneurs face, in light of their entrance into an often tumultuous spot market, is the particular focus of this article.
  • Production risk.  By nature, agriculture is susceptible to the wishes and whims of extreme weather, disease, predators and pests.  To complicate things even more, climate change continues to be a wildcard; giving us an even foggier vision of how future food production will fare.
  • Financial risk. While some agricultural products (mostly commodities) are sold in the futures market (i.e., product is sold prior to harvest, price is agreed upon in advance), most small holder produce is sold on variations of a spot market .  The spot market reflects the buying prices in relation to current demand / market conditions, even if those prices have significantly changed from when the farmer initially planned and planted his/her crop.  This complicates a few things, including the farmers’ ability to understand how inputs on various crops will affect final budget and corresponding profits, and if investments (like irrigation, new seed varieties, etc.) will profitably pan out in real market conditions.
  • Market risks: Endogenous and exogenous shocks frequently rock the value chain.   Fresh produce goes through a number of different distributors, processors, and handlers before reaching a retail outlet.  Perishable products often can suffer in this process, their quality and value compromised by delivery, transport, and processing.  Prices can, and often do, operate on a sliding scale.  Distributors face the sobering reality of daily product rejection when it arrives to retailers, often left with aged product that they have to try to scramble to sell or destroy. Farmers face a similar risk upon delivery to a distributor or processor, often susceptible to changes in consumer or distributor preference on arbitrary measures of aesthetic beauty and quality.
  • Time risk: With the product window for delivery and sale being so short, the business of perishable produce operates at a breakneck pace.   Because price continues to be negotiated throughout the chain (each actor dependent on the next to ascertain product value), product races from the farm to the warehouse, to the truck or plane and finally to the retailer with final payments being transferred at a later point.   A standard month or two is often typical.   This can complicate cash flow, exacerbate capital or financing needs, and leave members vulnerable to being left empty handed. For small farmers, this manifests most intensely through added sales pressure. Having perishable product on hand and needing bridge income needs quickly means small farmers are often at the mercy of buyers to accept a low price so they get something for their yield.
  • Regulatory risk: Agriculture faces significant governmental and legislative regulation, in addition to private rules and standards like GlobalGAP.  Import/export changes, forced recalls, food safety and transparency regulations and the like can contribute to lower economic returns, and make compliance difficult.

The perception might be to assume that investments in agro-enterprises are riskier than other industries and there is truth to this assumption.   But with the potential for such high returns, a range of public and private investors with a variety of motivations and capital, have created new mechanisms, embraced unlikely partnerships, and created unique tools to support success.

1.  Use of Targeted Mechanisms for Risky Lending in Agriculture:

Pooled investment funds offers the ability for multiple investors to distribute risk amongst other partners, but still succeed in extending large amounts of capital for big-impact projects.   Those interested in finding investment funds topically focused on agriculture would find a few scattered around the developing world, often targeting a specific region and be of a particular asset class (bonds, derivatives, listed securities, etc).

Guarantee mechanisms offer another innovative way to share risk.  Guarantee mechanisms are often backed by a public entity or are supported wholly or in part by a foundation.   In this scheme, Guarantors back debt capital and help offset risk from lenders by offering a safety net and a way to feel more secure in addressing collateral problems.  In turn, this reduces transaction costs, and allows for a smoother agriculture enterprise start-up.

2.  Supportive Services Tied to Financing

Supportive services can be tied to financing and this generally takes the form of technical and business support, although the type of support offered ranges.  Because most investors are not working directly with local communities, this tends to open up a new opportunity for local partners and organizations to offer targeted, skilled assistance in enterprise connections that straddle business development and social impact.  Trainings and business development services can bridge the gaps between expectations from investors for performance and offer both expertise and insight best business practices.

3.  Unlikely Partnerships to Share Risk

As mentioned above, the inherent risks in agriculture often opens the door for specialized actors to assist with business enterprise to assist with success.  But these partnerships often are more than just contractual and service-based.  A diverse group of investors, those ranging from large institutional investors to private funds and firms and governments come together to create public/private partnerships (PPP) for capitalization. In addition to PPP’s, guarantee mechanisms through foundations and other organizations, as well as supportive NGO help (either through capital or services), creates partners for progress as opposed to enemies with unrelated objectives.

Investing in Agriculture and Harvesting the Benefits

By using creative financial mechanisms and finding new partnerships through services or funding, risk in agriculture, even in the developing world, can be managed.  Capital and credit for this sector (agriculture) is limited, and an opportunity to fund enterprises that will address the growing concern to address food security for non-agrarian, developed nations, promote more environmentally responsible methods for production, and feed a future world of 9 billion people (in 2050).  On the social impact side, the 3 billion impoverished people who get their food and livelihoods from agriculture can finally be integrated into a global economy that will provide jobs and income for the world’s poorest.

Agro-enterprises present opportunities for stable and reasonable returns, most dramatically in emerging markets.  With development financiers (foundations, etc.,) , NGO’s, banks, and a mobilized public sector, a bridge between social impact and emerging market growth creates a case for the continued creation of the mechanisms and partnerships to promote investment.

Further Reading:

Selected Bibliography, Social Investment

Global Impact Investing Network (GIIN)

Harnessing Profits to Drive Development to Scale: Impact Investing

 Access to capital and credit for SMEs, especially in the agribusiness sector, is
limited in emerging markets. This is a result of underdeveloped or risk-averse local
financial sectors, a lack of knowledge of agribusiness in traditional banks, unfamiliarity on
the part of agri-entrepreneurs with western business practices, and other business
 Agribusinesses present opportunities for stable and reasonable returns. Focusing
on investment of agribusinesses (meaning processors, aggregators, and exporters)
presents viable opportunities for investment in emerging markets. This sector typically
offers stable and consistent returns, assuming proper management and expertise is in
place. Though weather risks and global commodity prices/demand impact primary
agriculture, the impact is softened for businesses higher in the value chain given greater
flexibility in the market and the ability to reflect input price changes in their products. The
sector is also less exposed to other market factors than are other sectors. However,
because returns are not typically extremely high, development finance institutions and
other donors can help fill this space, as the pure private sector would typically seek
greater upside. As such, DFIs and other donors can utilize an Agribusiness Development
Fund to achieve or enhance a strategy for agricultural development.
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