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It is no coincidence that blended finance, an innovative newcomer to the financial world, is called a “structured approach.” The desire to mobilize more investment towards the Sustainable Development Goals depends on the right mix of the right amounts of capital from the right types of sources. You can do more than just pour all kinds of ingredients into a blender and press a button. Blended construction is an art and must fit the challenge. In particular, catalytic capital from public and philanthropic funders is a valuable spice and should be used to the fullest extent possible.
IDB Invest expressed this concern in its 2023 report Beyond the leverage ratio: A strategic approach to blended finance. Importantly, focusing on maximizing the “leverage ratio” (i.e. the ratio of how much capital the catalytic capital portion can raise from commercially oriented investors) It’s not an idea. In the eyes of Mathieu Pegon, Head of Blended Finance at IDB Invest, efficient blended finance is largely about “net social benefits that incorporate broader economic effects and taxpayer costs.” ing.
Catalytic capital from public funds and philanthropic funders is valuable spice and should be used to the fullest extent possible.
To put this into simpler terms, whenever a public guarantee or first loss capital works, the message is that it is worth the effort. This is especially true for so-called “layered” or “blended funds”. The idea behind this type of blended finance: If you want to fund your entire portfolio, such as companies impacting a particular sector, stage or region, you should try to find the sweet spot in each tier. How much guarantee do you really need to sufficiently de-risk your portfolio and make the overall structure work?
For providers of catalytic capital, it is very important not to distort the market. Therefore, too much catalytic capital is ineffective and may even have negative effects on the ecosystem. On the other hand, public funds and philanthropic funders may not be able to use their funds, even if the precise nature of this additionality is still a hotly debated term (as loosely defined here). We want to create as much “additionality” as possible in .
How to blend your funds wisely
Clearly, blended finance is not a panacea, and layered or blended funds are just one tool in the innovative finance toolbox. Here, different types of funders offer different tiers of capital to fund investment portfolios that would otherwise be difficult to raise (sufficient) capital. For example, targeted investments may be early-stage impact companies in the notorious “missing middle” or “pioneer gap.” This stage is too big for philanthropic funders, but too small and risky for impact investors.
The fund’s catalyst layer typically comes in the form of guarantees or first loss capital. This reduces the risk of the entire portfolio up to a certain threshold. Beyond that, there are junior and senior tranches for impact investors, each with their own size, specific risk and financial return profile. If you want to get fancier, tie in side pockets that fund technical assistance or provide impact incentives for proven results. Using blended funds in the context of high-impact companies probably won’t get any better results.
A fund that combines results funding and technical assistance.Source: FASE, Roots of Impact
what actually works
If you are interested in financial engineering, it is easy to get lost in the details. There are many possibilities with blended funds, but it is wise to keep them as simple as possible and cost-effective where necessary.
As an example, the European Commission launched the EaSI Guarantee Scheme to support the socio-economy, in particular micro-enterprises and social enterprises, with this type of catalytic capital. This guarantee, provided by the European Investment Fund (EIF), is intended to be used by European Commissioners for Employment and Social Rights, Nicolas Schmidt, as he explained the intention behind this approach in 2020. This allows companies to fill the funding gap for companies in the market.
The European Social Innovation and Impact Fund (ESIIF) was one of the first impact funds to benefit from this guarantee instrument. Founded as an Impact Mezzanine Fund and launched by FASE, ESIIF aims to fill the gap for many European impact ventures that struggle to attract the right type and amount of funding. Commitments from direct investors are matched 1:1 by ESIIF up to a maximum of EUR 400,000 (matching funds principle). To date, the fund’s 19 portfolio companies have secured a total of €6 million in funding, leveraging an additional €20 million from other impact investors.
As aQysta’s Lennart Budelmann confirmed in 2022, the unique blended structure has proven to be a game-changer for several influential European entrepreneurs. and to complete any ongoing funding rounds at the original target amount. For us, the fact that ESIIF targets our stage of development and is agnostic in terms of geographic focus or sector is something rarely seen in the world of finance. ”
Unique features of ESIIF.Source: FASE, Abesco
Would you like to design your own blended fund?
To dampen the enthusiasm a bit, designing, starting, and financing a mixed fund is neither easy nor quick. FASE learned the following lessons:
- It is very important to have the guarantee means/catalyst part in the structure and the right partners (EIF and avesco).
- the cyclical nature of investors’ risk appetite (timing of financing is important, especially in the event of multiple crises);
- Selecting the right type of patient capital for the target investment (in this case, self-liquidating mezzanines with terms of up to eight years for early stage impact companies);
- The value of technical assistance (in this case, investment readiness support provided by FASE to investees).
So if you’re launching your own venture to design a blended fund, it’s wise to take advantage of the lessons from early adopters. Mixed finance network Convergence offers a wealth of wisdom on its resources page, including many inspiring case studies and best practice examples for all types of structures.
However, be careful as once your enthusiasm spreads, you may be tempted to continue. Currently, FASE is building a follow-on ESIIF II based on convertible financing and equity for European impact ventures. The journey of blended finance continues.
Image credit: Jessica Spengler (CC BY 2.0 DEED)
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