Unlocking Early-Stage Financing for SDG Partnerships

Chapter 3

Partnership Funders and Investors

Many grant funders and investors—including government donors, philanthropies, DFI's, and private sector investors—are starting to deploy innovative approaches to financing that can help overcome the missing middle. This chapter explores several examples of such approaches and features two special sections covering the role of institutional investors and the importance of strong impact measurement and management.

Michael Heiss

Grant funders and investors are starting to expand beyond their traditional funding models, offering alternative financing that is more accessible to early-stage ventures. In this chapter, we discuss some of the newer, reimagined opportunities that come in during Stage 2 funding, which can help commercially driven partnerships find their path to self-sufficiency.

We look at how grant funders and investors—specifically philanthropy, governments, DFIs, and private sector investors—are engaging partnerships through catalytic capital and other newer approaches. We also feature two special sections. Special Section 3.3 provides more insight for partnerships to understand institutional investors, which, as discussed in Chapter 1, are a subset of private sector investors that (indirectly) influence partnerships’ streams of capital. Special Section 3.4 takes a deeper dive into impact measurement and management (IMM) challenges by investors, how these challenges affect partnerships, and new tools and approaches that are starting to reduce fragmentation in IMM across investors.

3.1 Research Methods

Funders and financing opportunities are drawn from a combination of literature reviews, insight from the GIIN, our partnership survey, and the 35 aforementioned interviews with partnerships, partnership-supporting platforms, and funders. More details on methodology and the organizations interviewed are available in Appendix C. The special sections draw on literature reviews and the rich impact investment expertise of the GIIN.

3.2 Partnership Funders

3.2.1 Philanthropy

Philanthropy is thought to be key in spurring catalytic capital (Koh 2020; Ogden et al. 2018; Tideline 2019). Prioritizing impact over financial returns, foundations have far more flexibility with how they manage risk and return compared to private investors (Koh 2020; Lee and Preston 2019) and are thus well placed to make patient investments with a higher risk tolerance. Their grant-making ability may be encumbered by the rules mentioned in Chapter 2, and it can take leadership courage and well-reasoned creativity to break out of grant-making norms dictating timeline and key metrics. But when foundations do pursue such approaches, they can demonstrate that catalytic capital and investment in early-stage, commercially driven partnerships is not as risky as some private sector investors may perceive (Zolfaghari and Hand 2021).

Foundations such as the Shell Foundation, for example, seem to have recognized the value in catalytic capital. The Shell Foundation notes that 75–80 percent of its grants support initiatives that are progressing to scale and sustainability, as compared to under 20 percent during its early years as a conventional grant maker (Shell Foundation n.d.). In 2021, the foundation helped to establish the Energy Access Relief Fund, which provides $68 million of subordinated, low-interest debt to small and midsize energy access companies struggling with disruptions caused by COVID-19 (Gordon 2021). The Shell Foundation is one of 16 government, foundation, and investor partners in the fund, and it also participated in catalytic tranches.

Other foundations have pivoted to allow more flexible funding. The Swiss Re Foundation, for instance, looks to fill a niche for grants that give space to commercial initiatives for learning, prototyping, and scaling. This model enables Swiss Re to absorb the risk of early investment while fostering a pipeline of investable projects (Swiss Re Foundation n.d.b). The Good Energies Foundation follows a similar philosophy, funding early-stage and high-risk projects with potential for transformative change (Good Energies Foundation 2022). Read more about how Swiss Re and the Good Energies Foundation have been instrumental in getting commercially driven partnerships off the ground in Chapter 2.

Additionally, in the last three years, philanthropic programs dedicated to catalytic capital have emerged, such as the MacArthur Foundation’s Catalytic Capital Consortium (in partnership with the Rockefeller Foundation and the Omidyar Network) and the Rockefeller Foundation’s RF Catalytic Capital. Both of these initiatives aim to increase the flow and impact of catalytic capital to unlock more extensive social and environmental progress and can help partnerships scale up funding with additional investment guidance and support (MacArthur Foundation n.d.).

Although foundations’ growing interest in catalytic capital is encouraging, there is still work to be done. As some interviewees noted, many foundations rely on traditional grants, with rigid and specific funding criteria and burdensome reporting. Additionally, few philanthropic organizations are structured to provide equity, an important asset class for early-stage partnerships, and do not have a mechanism to receive money back. Receiving returns can require additional administrative support, for example, which takes resources. Without additional resources, philanthropy might be hesitant to disburse funds in a different manner. The lack of such a mechanism can also inadvertently deprive the early-stage investee (a partnership in this case) of the opportunity to develop a track record of loan repayment or equity value on exit—a track record that is a key factor in due diligence for private sector investors. It is also unknown whether or not catalytic capital from philanthropies has mobilized private sector capital from banks or pension funds at scale. This may very well change, however, as more and more foundations look to disburse catalytic capital and demonstrate what is possible.

3.2.2 Donor Governments

Donor governments offer another critical lifeline to early-stage partnerships. Though this support typically comes as grant funding during Stage 1, governments are beginning to set up specialized programs and funding pools to invest in high-risk, high-impact initiatives (beyond their involvement in DFIs) that extend to Stage 2 funding. Already, approximately half (56 percent) of blended finance transactions involve the participation of a donor government, and more and more specialized funding pools are emerging (Johnston 2019).

Sida, Sweden’s government agency for development cooperation, for example, has been a vanguard in this space, providing guarantees to some of the projects it supports—businesses that would otherwise be unable to attract loans because of their early-stage nature. Oikocredit, a global cooperative and social investor headquartered in the Netherlands, is one such beneficiary, receiving an $8 million portfolio guarantee in 2019 that can absorb up to half the risk for lending to agricultural cooperatives and SMEs in Kenya and Uganda (Sida 2019).

USAID’s DIV takes a slightly different approach to Sida, providing grants to risky, early-stage initiatives with the goal of maximizing social return on investment. Grants are structured using a pay-for-results model and are distributed through milestone payments (USAID 2022a). Since its inception in 2010, DIV’s portfolio returned over $17 in social benefits for every $1 awarded (Kremer et al. 2021).

Donor governments might also fund intermediary organizations, which in turn disburse the grants to smaller projects. Doing so can enable them to provide funding with greater flexibility. Through its platform PREVENT Waste Alliance, for example, the German government is able to fund commercially driven projects and leverage private sector funding to help cover activities that GIZ funding traditionally cannot be used for (because of ODA restrictions), such as product marketing or infrastructure development.2 PREVENT distributes GIZ funding through its “Call for Solutions” to fund the implementation of innovative solutions that contribute to responsible consumption and production in low- and middle-income countries (GIZ n.d.).

Participating in blended finance is still newer territory for governments, especially since public sector bureaucracy can be at odds with the nimbler decision-making process of a commercial entity. This mismatch is even more apparent when working together within blended structures. Governments are also typically accustomed to funding during Stage 1 and less so during Stage 2. However, as one government agency acknowledged, blended finance is worth trying—even if, by government standards, it is a bit unique and experimental—because traditional funding approaches have not yet yielded true impact.

3.2.3 DFIs

As noted in Chapter 2, two of the big challenges that partnerships face in seeking DFI investment are misaligned funding criteria and ticket-size mismatch. They are, however, starting to participate in new approaches that fall in Stage 2 and can help them overcome both challenges.

The first approach involves end-to-end facilities Supporting partnerships by layering in different types of support at various stages of partnership growth, such programs can help to support project pipeline development and an improved understanding of investor criteria for early-stage ventures. . End-to-end programs, or “facilities,” offer a promising solution and are increasingly being developed by DFIs through collaborations between financial institutions and other stakeholders. By layering in different types of support at various stages of partnership growth, such programs can help to support project pipeline development and an improved understanding of investor criteria for early-stage ventures. (It is important to note that the term end-to-end may have different meanings for different parties. Although it broadly suggests continuity of funding, for the purposes of this chapter, it refers to an actual program type). 

One example is the Dutch Fund for Climate and Development—led by FMO, the Dutch DFI—which comprises interconnected subfacilities operating at two different stages of project life cycle. The first is origination, which exclusively focuses on project identification and prefeasibility development activities. The second is land use and water use, which invests in the pipeline created by the origination facility through dedicated investment vehicles (DFCD 2020). The connection between these programs helps to reduce the complexity of the investment process, due diligence, and reporting requirements and can help partnerships navigate the complexities of institutional investments.

The second approach involves early-stage venture funds run by DFIs that enable them to finance smaller ticket sizes than they would normally fund. In the last five years, there has been increased activity in setting up such funds, including the Dutch FMO Ventures Fund and the UK Venture Scale-Up Programme. This has been further boosted by the 2018 transformation of the U.S. Overseas Private Investment Corporation into a new agency called the U.S. International Development Finance Corporation, which comes with several enhancements, including the ability to conduct equity investments. Also, DFI investment has increased slightly in higher-risk countries, in part due to country mandates. In 2019, the concessional capital commitment of DFIs increased by 29 percent compared to 2018, with a greater focus on low-income and lower-middle-income countries (WBG 2021). The total concessional capital commitments on low-income and lower-middle-income countries in 2019 was $1.17 billion compared to $848 million in 2018 (IFC 2019, 2020).

3.2.4 Private Sector Investors

To date, investment from the private sector has been elusive for partnerships. In our partnership pool, for example, only 38 percent received some form of returnable investment. Additionally, private sector investors often provide capital during Stages 3 and 4, not Stage 2. But there has been some interesting movement among private sector actors in Stage 2 that can open up the financing doors for commercially driven ventures.

Early-stage investors, for example, are starting to recognize that they need to do more than make a straightforward investment if they are truly committed to advancing the SDGs. This may include supporting pipeline development, developing business- and investment-related knowledge databases, or even engaging with policymakers. They may partner with other investors, associations, portfolio companies, and stakeholders to advance the ecosystem as a whole. Factor[e] Ventures, for example, was mentioned in the ColdHubs case study and is a venture capital firm that aims to “serve as a conduit between philanthropic and commercial investors” and provides both seed-stage funding and business development support (Factor[e] Ventures 2022). Partnerships in our sample found incubator and accelerator models like this to be highly effective in helping to refine business strategy, building an investment track record, and expanding their network of potential funders.

Institutional investors are also starting to open their doors to partnering. It is rare but possible—the Spark+ Africa Fund is a recent example of successful capital-raising from institutional investors in SDG impact areas; the fund aims to invest debt and quasi-equity in clean cooking businesses in Sub-Saharan Africa. In this case, quasi-equity investments A type of investment instrument that has features of both debt and equity. The characteristics include flexible repayment terms or subordinated debt. This implies that quasi-equity either is unsecured or has lower priority than other debt in the capital structure. An example of a quasi-equity structure is a revenue-sharing agreement. are revenue-sharing agreements in which the fund will receive a percentage of revenues until a targeted financial return is met. A partnership between the Clean Cooking Alliance (nonprofit), Enabling Qapital (Geneva-based fund manager), and the African Development Bank (DFI), the fund will deploy up to $70 million in capital across the clean cooking value chain, with a goal to address access to energy (SDG 7; Clean Cooking Alliance 2022).

The fund achieved first close in March 2022 and is structured as a blended finance facility. It was able to secure commercial capital from four pension funds: Baloise Pension Fund, Caisse de retraite paritaire de l’artisanat du bâtiment du canton du Valais (CAPAV), GastroSocial, and Bank of America Merrill Lynch Pension Fund. This was complemented by mezzanine and first-loss tranches from African Development Bank, IFU, other DFIs, and private foundations. In this case, the mezzanine tranche A layer in the capital structure positioned between senior tranche (typically senior lenders) and junior tranche (typically first-loss or junior equity investors). Mezzanine tranche allows the flexibility to attract specific types of investors that do not fit either senior or junior tranches but have risk-return expectations between these tranches of capital. provided the flexibility to attract specific types of investors that fit neither senior nor first-loss tranches but have risk-return expectations between these tranches of capital.

Additionally, more broadly, local investors—whether early-stage or institutional investors—are an untapped but high-potential source of private financing for partnerships. In Africa, for example, assets under the management of domestic institutional investors are estimated to be $1.8 trillion—an amount that, if mobilized, can dramatically help to close the SDG financing gap (Juvonen et al. 2019). And though global financial institutions with a large local presence in emerging markets have actively participated in SDG financing through blended transactions (contributing 40 percent of commercial investors’ commitments), the role of local financial institutions in SDG financing has been less consistent. A caveat here is that there are cases where local financial institutions are financing early-stage partnerships in various impact sectors, such as energy efficiency, energy access, and agriculture. These investments are not always classified under the umbrella of SDGs but, nevertheless, are contributing to SDG targets. Local investors often have a deeper understanding of the local investment climate and are better able to price risks (Convergence 2021). Their participation in local development projects can also provide comfort to international investors and ensure availability of local currency financing where appropriate.

3.3 Special Section: What Limits Institutional Investors

Given their size, institutional investors may seem nebulous to commercially driven partnerships. Yet as capital providers to the early-stage private sector investors (such as venture capital and private equity funds), institutional investors are important to the partnership financing landscape because partnerships in turn seek financing from these early-stage investors. Additionally, as noted earlier in Chapter 3, there are some instances where institutional investors are providing direct capital to partnerships.

Institutional investors face two notable constraints as they pertain to investing in SDG initiatives: the regulatory context, which they cannot control, and the perception of risk, which is within their control. Both of these are important to understand because they drive the investment decision-making of institutional investors.

3.3.1 Regulatory context

Because institutional investors’ combined assets can have an outsized influence on the markets, governments and other regulatory bodies are compelled to protect economic stability (UNEP FI and PRI Association 2011). In other words, regulations shape what institutional investors invest in.

Traditionally, regulations dictate that institutional investors should avoid high-risk investments to protect the value of their assets over the long term. This might influence an institutional investor to avoid investing directly or indirectly in early-stage partnerships because of the higher risk associated with such partnerships.

Recently, however, there have been some notable shifts in regulatory guidance. Some regulations can stimulate and incentivize investments with social and environmental benefit (Della Croce et al. 2011). The European Union’s taxonomy and legal frameworks, for example, push for consistent labeling of investments in areas that claim environmental impact results, thus directing investors’ focus—though whether they contribute to increasing actual positive impact outcomes that address the world’s climate and social challenges remains to be seen (European Commission n.d.).

Regulation is also starting to encourage investments that prioritize the consideration of long-term environmental risks and benefits because climate change is increasingly viewed as an existential threat. Thus, governments now are considering policy changes that increase incentives for early-stage investments, even though investments in early-stage initiatives or emerging technologies have been historically viewed as being too high risk and misaligned with fiduciary responsibilities (Della Croce et al. 2011).

Partnerships may benefit from prioritizing social and environmental considerations in various regulations because they also focus on the SDGs. This could potentially help them in their journey to get investment at an earlier stage.

3.3.2 Risk

There are two types of risk: actual and perceived. Private sector investors sometimes have a perception of risk that is higher than the actual likelihood of such risk materializing on the ground (Avramov et al. 2021; Barnor and Vivekanandan 2021; Schiff and Dithrich 2017). This inaccurate perception can limit private sector investments in partnerships because investors may believe that anything related to social or environmental outcomes is riskier than it is in actuality. Therefore, ESG investments tend to be centered around protecting the investor rather than outwardly looking to protect/change the very systems that create the social or environmental condition (Simpson et al. 2021). This perception is a significant impediment and does not bode well for investing in novel partnership structures with transformative potential.

In late 2021, USAID’s Prosper Africa program ran a series of workshops with 37 private sector stakeholders to more clearly understand some of their investment challenges (USAID 2022b). Chief among them was the idea that cross-border private market investors do not have the tools to fully consider risks in emerging markets (for example, ways to conduct due diligence on the ground, discover new investable pipelines, understand new markets or technologies, and derive measurement and reporting requirements from investees). Unfortunately, this gap leads to a prejudicial cycle that is difficult to break. If the risk cannot be evaluated, investors are likely to have an even lower tolerance; if they never take the risk, they will never appreciate any difference between the reality and their perception (Khosrowashahi 2021). This observation is similarly noted by other alliances for private sector investors, such as the Glasgow Financial Alliance for Net Zero (GFANZ) (GFANZ 2021).

What these regulatory and risk challenges mean for commercially driven partnerships is that they have to provide additional reassurance to private sector investors before they can secure investment. These investors need to know that partnerships seeking financing can fit within their risk-tolerance framework and offer an attractive return relative to any other (perhaps simpler) investment opportunity. They also need to be familiar with the partnership's business plan to ease the perception of risk, and the resulting deals need to be at sufficient scale to warrant the setup transaction costs. Such reassurance requirements may appear, on their face, insurmountable. However, private sector investors have increasingly committed to substantively driving changes to the financial system to address the dire effects of unchecked climate change, which offers much needed hope.

GFANZ, launched in April 2021, reported at the 26 session of the Conference of the Parties that it had garnered commitments from over 450 financial entities—which together are responsible for assets of $130 trillion—all with the ambition of translating those commitments into investment action by 2050. A key recognition within GFANZ’s 2021 progress report is the vital role that catalytic partnerships can play in unlocking investments from private sector investors (GFANZ 2021). Private sector investor involvement and blended structures are essential to test new financial ventures and instruments. By engaging in such new approaches, private sector investors can better separate out perceived and real risk.

Investors can also lean into regulations favorable to ensuring a sustainable future. Partnerships in which all of the actors share resources, accountability, risks, leadership, and benefits are strongly recognized by this group as a way of achieving sustainability.

3.4 Special Section: Impact Measurement and Management

In Chapter 2, partnerships reported the following financing challenges that relate to how funders and investors measure and manage their impacts:

  • Funder and investor performance measurement metrics are often misaligned with understanding SDG impact.
  • Performance measurement metrics are inconsistent across funders and investors.
  • Market performance data, early-stage financing opportunities for partnerships, eligibility criteria, and other core market data for investors lack transparency.
  • Investors are not staying accountable for their early-stage financing commitments.

Such challenges contribute to concerns over impact washing, the effectiveness of the impact investment market for advancing the SDGs, and a lack of understanding the actual versus perceived risks of investing in emerging markets and in partnerships—all of which amplify the missing-middle problem. These concerns are echoed by investors themselves: a recent survey of nearly 300 impact investors found that the biggest challenges investors perceive for the next five years are the threat of impact washing, the inability to demonstrate impact results, and the lack of comparability of impact results with those of peers (Hand et al. 2020).

As grant funders and investors adopt the newer approaches discussed in this chapter, they can also better measure and manage the impact of their investments to ensure they support the SDGs and commercially driven partnerships. This special section discusses underlying IMM challenges and new tools and approaches to remove these barriers.

3.4.1 IMM Challenges

IMM encourages financiers to identify the positive and negative effects their business actions have on people and the planet and to mitigate the negative while maximizing the positive in alignment with their goals (GIIN n.d.b). Measurement should offer investors insight into how much impact they have achieved at a point in time and over time. Management, on the other hand, should be the practice of adjusting investment approaches based on measurement insights, specifically to optimize impact performance. Investors ideally manage their activities and investments relative to past performance, impact targets, their peers, and the scale of the environmental or social challenge they seek to address. Investors say they also value IMM because it helps them with due diligence—that is, selecting and screening investees (in our case, partnerships)—and setting key performance and reporting indicators with investees (Bass et al. 2020).

The following are several IMM challenges that funders and investors face:

  • Lack of cohesion among IMM tools and frameworks. Impact investors report that fragmentation in IMM tools and frameworks is a challenge for the next five years, which contributes to an inability to compare investor impacts across the market (Hand et al. 2020). Today, more than 150 tools, resources, and methods on IMM are available; however, as discussed below, the industry is starting to coalesce around a subset of these resources (Godeke and Briaud 2020; Hand et al. 2020). A further indicator that IMM practices continue to evolve for greater cohesiveness is that over a decade ago the majority of investors (85 percent) were using their own proprietary frameworks, yet today 89 percent of investors are focusing on a handful of generally accepted external frameworks to measure and manage their impact performance (Hand et al. 2020). Although cohesiveness remains a challenge, these developments bode well for lowering fragmentation and the ability to assess how one investment (or partnership) compares in terms of its relative impact.
  • Impact reporting costs—both financial and reputational. Many investors today are using the reporting of their impact results for fund-raising and marketing purposes rather than for decision-making or to hold themselves accountable for the changes they may need to make in their impact portfolios (BlueMark 2022). Additionally, only 49 percent of surveyed impact investors say they report publicly, whereas 74 percent of investors state that they report only to key stakeholders such as donors (Bass et al. 2020). A recent report acknowledged that there is no standardized format for reporting, which is a major gap in the industry. Additionally, the costs of high-quality reporting (both reputational and financial) often outweigh the benefits for an investor (BlueMark 2022). Finally, private companies generally are not required to report impact performance publicly, and public companies often are only required to report on financial performance (Hand et al. 2020). Only very recently has any obligation or legal requirement been introduced to improve reporting and disclosure requirements, such as the EU Sustainable Finance Disclosure Regulation. It should also be noted that of the 49 percent of surveyed impact investors that report publicly, many are private companies, indicating a trend towards better reporting (Bass et al. 2020).
  • Lack of external accountability. Over half of impact investors surveyed by the GIIN state they are not held accountable by a third party for their impact results (Bass et al. 2020). Yet investors do view third-party verification as a natural outgrowth of a maturing impact investment market, especially where investor accountability regulations are not in place. Third-party verification is still viewed as costly and is currently mostly pursued by market leaders (BlueMark 2022). However, the recent development of industry-wide frameworks that require certification and tools for validation should help to make verification an easier process (Bass et al. 2020).
  • Lack of adaptive management. Investors are failing to integrate IMM learnings into their financial management decisions (Audette et al. 2021; Bass et al. 2020; GIIN n.d.b). This, coupled with the aforementioned lack of cohesion, signifies that investors are not adapting to the needs of investees over time.
  • Lack of capacity for IMM. Average impact investors spend 12 percent of their organizations’ budgets on IMM, with 11 percent of investors stating they invest 0 percent of their budget on IMM (Bass et al. 2020). Investors report that IMM practices such as data collection, external auditing, and reporting are costly in terms of financial and reputational resources (BlueMark 2022; Hand et al. 2020).

3.4.2 IMM Tools and Resources

The good news is that over the past five years, IMM thought leaders and experts have been collaborating to bring more cohesion, credibility, transparency, and accountability to the impact investment space. Some of the leading IMM resources are outlined as follows (Bass et al. 2020; BlueMark 2022):

Principles and guidelines

The following principles and guidelines are designed to increase accountability and transparency by aligning investor missions, behaviors, and processes:

Taxonomies and tools

Most investors use more than one system or framework in their IMM practice to guide practices and measure performance; the average is three. The most commonly used are the SDGs (72 percent of investors), the GIIN’s IRIS Catalog of Metrics (48 percent) and IRIS+ Core Metric Sets (28 percent), and the Five Dimensions of Impact by the Impact Management Project (IMP; 25 percent) (Bass et al. 2020).

  • In 2016, IMP established its Five Dimensions of Impact (what, who, how much, risk, and contribution) to build consensus on how the world measures and manages ESG risks and positive impacts (IMP n.d.).
  • The GIIN’s IRIS+ system, launched in 2019, allows impact investors to efficiently identify and select appropriate evidence-backed metrics, offers guidance to standardize data collection and reporting, and enables data comparability (GIIN n.d.b). The system aligns with the SDGs, IMP’s five dimensions, and more than 50 other frameworks and conventions. A recent (2022) addition is a pilot impact performance benchmark, which enables investors to analyze the impact performance of investments within a sector and to compare their own impact results relative to their peers and the SDGs.
  • In 2021, the GIIN launched the COMPASS methodology to compare impact results in a standard way (Bass et al. 2021). This publicly available methodology offers investors and service providers (for example, rating agencies and benchmark developers) a way to normalize impact performance data such that investors can assess how they stack up to their peers and the impacts required to achieve a specific SDG target.

Impact verification

Investors now have multiple options to improve their accountability, including impact verification services and disclosure guidance. Several options are as follows; the onus is on investors to publicly report on verification results.

  • In 2020, the Tideline company launched BlueMark to provide independent impact verification services for investors on impact performance and management practices. Bluemark aligns with both the IFC’s Operating Principles for Impact Management and the SDG Impact Practice Standards.
  • The Task Force on Climate-related Financial Disclosures was created by the Financial Sustainability Board to develop recommendations on the types of information companies should disclose to support investors, lenders, and insurance underwriters.

Chapter 4 provides recommendations for grant funders, investors, and partnerships related to these frameworks and approaches.

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