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305. The water interviews: Finance

2012 September 24
by Michael Sheridan

Root Capital was established in 1999 to serve the grassroots enterprises that occupy the “missing middle” of financial markets in less-developed countries: they are too big for microfinance organizations and perceived as too small and risky by commercial banks.  The organization’s success suggests that the scope of the need and opportunity in the missing middle is indeed great: as of this writing, Root Capital has made more than $435 million in loans to impact over 2.5 million people around the world.  Along the way, the non-profit that thinks like a for-profit has attracted investments from the world’s leading coffee brands and philanthropists: StarbucksGreen MountainThe Bill and Melinda Gates Foundation.  It has been featured in the pages of the most prestigious publications: The New York Times.  Wall Street Journal.  Harvard Business ReviewStanford Social Innovation Review.  It has garnered recognition from the biggest names in social capitalism: AshokaAspenSkoll.

In sum, Root Capital has been arguably the most important Fair Trade coffee actor most consumers have never heard of, quietly making Fair Trade work by providing the trade finance that coops need to make good on their contracts.  Now it has set its sights on less traditional financial instruments: loans to increase the adoption of clean and appropriate technologies.  Elicia Carmichael is leading Root Capital’s effort to promote eight “triple-win” technologies, including the water-efficient wet-mills that we have profiled here as part of our coverage of water resource management in the coffeelands.  Today Elicia talks to the CRS Coffeelands Blog today to explain more about Root Capital’s pioneering work on the next frontier of rural finance.

  • Let’s begin at the beginning.  Tell me about the Clean and Appropriate Technologies effort you are leading at Root Capital.  When did it get started?  And why did Root decide to go in this direction?

As Root Capital works toward growing rural prosperity, we must take context into account; in an agricultural community, producers’ dependence on the land for their livelihoods is inextricably linked to the health of the local environment. The agricultural smallholders we work with are already noting the effects of climate change through alterations in their harvest cycles and in the health of their crops.  Many of them lack the tools and information necessary to adapt to these changes and reduce their own environmental impact.

Root Capital has actually been financing clean and appropriate technology investments for rural small and growing businesses (SGBs) for a number of years, so this is not an entirely new direction for us.  Since 2002, we have extended 28 loans totaling over $2 million for clean and appropriate technology investments including solar panels, fuel-efficient motors, water-efficient coffee washing stations, irrigation systems, and micro-hydro electricity generation.  In 2011, we decided to more proactively promote our offerings for clean technology financing by engaging our existing clients in conversations about their long-term needs and the environmental sustainability of their businesses.  There are many cases in which clean and appropriate technologies provide a solution to a business challenge while also addressing an environmental or social concern or providing added resiliency to climate change.  We wanted to more systematically ensure that our clients had the information, support, and access to capital they needed to make these investments.

  • What technologies are you promoting, and why did you decide to prioritize these particular technologies?

We have identified a handful of technologies that we believe are most relevant for our agricultural client base; solar panels, solar dryers, irrigation systems, biodigestors, water-efficient coffee mills, and small-scale hydro and wind turbines are all at the top of our list.  Each of these technologies contributes either to the enterprise’s bottom line or to its producers’ quality of life in the home, and also conserves natural resources or lowers carbon emissions.  These technologies are all also relatively affordable at a small scale and can often pay for themselves with productive benefits within a few years.  We generally aim to finance investments made at the enterprise level, but where our clients have well-managed internal credit systems, we have also made loans that are then redistributed to producers for household-level impact.

  • How do you help expand the adoption of these technologies? 

Experience has taught us that agricultural SGBs could often benefit from implementing clean and appropriate technologies but that their managers or members may lack the time, access to information, or expertise needed to identify and act upon these opportunities.  These businesses also typically lack the capital needed to make multi-year investments and the collateral they might need in order to access finance from conventional banks.  We have found that these factors have a significant slowdown effect on rural demand for clean and appropriate technologies; while a technology may be useful or even necessary in a given context, it may take a while for that need to be translated into demand.

By offering our clients access to information and to the contacts in our global network, preparing our loan officers to help clients identify investment opportunities, and designing novel loan structures with customized grace periods, repayment schedules, and unconventional loan guarantees, we seek to help clients understand their options and lower their barriers to investing in clean technologies.

  • So Root Capital is focused primarily on addressing the issue of finance for new hardware – a critical contribution that helps farmers overcome a huge obstacle to adopting new technologies.  But what has your experience been in terms of “software” – the new knowledge and skills necessary to use the hardware effectively?

This is a great question.  As with anything that requires new knowledge or a behavioral change by the user, there is certainly a learning curve associated with many clean technology investments.  After careful consideration, we have determined that our current role as finance provider is to connect our clients to our network of third parties (often NGOs like CRS or academic institutions) that can guide them in analyzing the costs and benefits of specific technologies for their particular applications and environmental contexts. These collaborators can also provide vendor recommendations and facilitate the adoption process by setting up demonstration sites and offering technical assistance.  Root Capital’s core role in the process is therefore confined to determining whether an investment is financially beneficial to a client and, if so, how best to structure a financing package.

  • Help me understand better how this fits into Root Capital’s model.  Root Capital is a leader in trade finance for smallholder coffee cooperatives.  These loans make financial sense to me – they are tied to contracts with leading U.S. coffee buyers and a clear revenue stream from which the loans can be repaid.  Some of the technologies you are promoting – solar energy, for example – have a huge impact on the planet, and generate gradual cost-savings over time for users, but nothing like the revenues that are generated from the coffee trade.  How do you make these loans work?

Another great question.  When we are presented with an application for financing one of these technology projects, we consider whether it offers increased incomes, cost savings, or simply improves quality of life.  Wherever we can, we will structure a loan around the production or cost saving benefits of the technology, adjusting grace periods and payback schedules accordingly.  In some cases, the technological costs are still relatively high compared to the client benefits, and for those cases we try to find partners like CRS that might offer a subsidy to lower costs and make the investment more realistic given client cash flow.  In this way, our clients have invested enough to encourage their continued use and careful maintenance of the equipment, but they are not burdened with unrealistic payment expectations.  As for the mechanics: most of our clean technology clients in the coffee industry are already borrowing from Root Capital to finance the fulfillment of their contracts to buyers, so we can simply bundle their payments into their trade finance obligations by associating them with specific buyer contracts. While this streamlines loan repayment processes and lowers the risk to our portfolio, it also means that it is crucial for us to have a deep understanding of the long-term relationships between our clients and their buyers.

In Nicaragua, for example, we recently financed the purchase of solar panels for the homes of 98 coffee producers through the internal credit mechanisms at two of our existing client cooperatives.  To make the solar panels more affordable and adoption more likely, we partnered with an international NGO that offered a 25-30% subsidy on each panel purchased and organized household-level technical assistance in cooperation with the vendor and cooperative management.  The producers who benefited are now allocating a small portion of their annual coffee submission to the cooperatives as repayment on their loans for three years.  The cooperatives, in turn, pledge a corresponding amount of their annual coffee contracts to Root Capital for the repayment of the loan.  As such, coffee, rather than cash, can become a more accessible form in which producers can pay for many of these investments.

  • One of the clean technologies we have promoted in our coffee work in Latin America is the ecological coffee mill with a demucilager – it radically reduces water use and virtually eliminates wastewater.  We have been distributing these on a grant basis because while we love the environmental impact and do see it as a technology that can contribute to improvements in coffee quality, we don’t necessarily see it as a technology that will drive income gains.  Has that been your experience?

Water-efficient coffee mills are actually a great example of a possible environmental and economic win-win for a coffee enterprise.  In our experience with one cooperative in East Africa, our client reported that the coffee they processed with these machines fetched double the price they could receive for home-processed coffee because they produced more uniform beans of higher quality and experienced lower losses in volume.  Even after deducting the operating and financing costs of the machinery, this client reported being able to pay their member farmers 70% higher prices for their coffee than they could previously.

In scenario like this one, we would probably not seek a subsidy for the technology because the payback equation is so favorable to our client.  However, we might consider that an associated filtration system or biodigestor for treating the wastewater produced from milling would be an attractive use of a partner institution’s grant funding, as these technologies do not produce a direct cash flow but do offer significant environmental impact.

It is important to note that there is great diversity in how coffee is processed in smallholder agriculture.  As was the case with our East African client, some cooperatives may commercialize coffee milled at producer homes and gain great quality improvements by investing in professional milling equipment, while others may already be receiving high prices for quality and simply want to reduce bottlenecks in their systems.  Root Capital’s role is to gain an understanding of how a technology will help a specific client given their existing operations, market context, and buyer relationships, and structure lending packages accordingly.

  • At the 2012 SCAA Symposium Liam Brody, Root Capital’s Senior Vice President of Value Chain Relations, challenged industry stakeholders to be “pathologically collaborative.”  The phrase lit up the Twitterverse and was among the more memorable of the event.  It sounds to me like some pathological collaboration is necessary for this work.  What kinds of organizations are you partnering with to advance this exciting agenda?

“Pathological collaboration” perfectly describes Root Capital’s approach to engaging other stakeholders, and there is no better term for what we must do to advance clean technology adoption in the coffee industry.

There is no one-size-fits-all clean technology solution to the variety of environmental challenges faced by rural SGBs and their producer stakeholders, and no one actor or sector in the value chain can act alone to address these challenges.  The solutions we identify will be extremely context-dependent, and each one will draw from the competencies and offerings of our partners across sectors.  Root Capital is enthusiastically aiming to join forces with the NGOs, buyers, government initiatives, clean tech entrepreneurs, and academic institutions that can lend expertise, offer subsidies, provide loan guarantees, implement technical assistance, manage demonstration projects, and connect SGBs to markets.

There are roles for all of these actors and more in building a cleaner, greener, and more resilient coffee value chain.  I hope this blog post will encourage experts and novices alike to reach out to CRS and to Root Capital and lend their voices to this evolving conversation.

 

 

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