Whether for profit or social motives - and often both - an increasing number of investors are targeting opportunities in African agriculture. At the same time innovative approaches for deploying aid to support farming businesses linked to smallholders are emerging. This blog provides a snapshot of who is doing what, where and how.

6 May 2014

Financing smallholder farmers - the working capital challenge

AgDevCo invests patient capital in small and medium sized agriculture businesses in Africa. We work with companies that are too small to attract private equity but have outgrown microfinance. They typically need long-term investment of between $250k and $5 million to expand their farming or agri-processing operations. Our investment is used to install irrigation equipment, build storage facilities and factories and buy machinery. We expect to have to wait 5 – 10 years before we see a return on our investments.

What we are finding is that all of our investees – and many other companies we come across – are starved of short-term working capital finance. They need finance to invest in their own seasonal production, to provide inputs to networks of outgrowers, and to buy crops from smallholder farmers for processing. Even for relatively small businesses those working capital needs can run into the millions of dollars annually.

Some banks are lending in this part of the market but it is high risk activity, which is reflected by high interest rates. For many small and medium sized agribusinesses which do not have a long track-record or the ability to provide collateral, there is simply no availability of credit. The lack of finance for SMEs makes it very difficult for smallholder farmers to access loans. The African Green Revolution Forum estimates that only 10% of farmers have access to the credit they need to increase their productivity and incomes.

The result is a low-productivity trap for millions of smallholder farmers. Without credit there is limited availability of improved seeds and fertilisers. That constrains yields and quality, making it more challenging for smallholders to access formal markets. Low and unpredictable incomes make it difficult for farmers to invest in their land. And without being able to demonstrate a track record of steady income farmers find it almost impossible to access loans…and the cycle continues.

One way of breaking out of the low productivity trap is to link smallholder farmers to formal markets through a trusted aggregator business. The aggregator can be a Cooperative or a for-profit SME.

Its role is to manage a network of smallholder farmer producers, providing them with finance, inputs and technical support through an equitable contractual arrangement which guarantees a fair price for their production at the end of the season. It then stores and/ or processes the crop and arranges logistics. The aggregator may be able to negotiate long-term sales agreements with commercial buyers – who might be Grow Africa partner companies – for example breweries, food companies or trading groups. Management must understand the market’s requirements on quality and volumes and be able to deliver consistently.

These aggregator businesses are vital to link farmers to markets. They need long-term patient capital investment; but they also need short-term working capital finance to extend loans to small farmers and to have the ability to buy the crop at the end of the season.

A success story in Mozambique is ECA, a smallholder farmer commercialisation business that started three years ago with AgDevCo’s support. AgDevCo invested equity to allow ECA to build its collection and storage infrastructure and buy vehicles. Later AgDevCo finance a Buhler maize mill for on-site processing. ECA management negotiated a three-year offtake agreement with a local brewery, part of the SAB Miller group, to sell maize grits for use in Chibuku beer. It also sells maize flour and bran for consumption in local markets.

ECA provides a full package of finance, agricultural inputs and extension support to its farmers, many of whom have seen their yields and incomes increase by 3-4 times as a result. Last season ECA purchased maize and soya from more than 4,000 farmers and this year it plans to scale up to 10,000 farmers.
In the first two years AgDevCo had to provide the short-term working capital to allow ECA to buy the smallholder production. Last year however, after two successful seasons when there had been 100% recovery of smallholder credit and ECA had repaid its seasonal loans, a local commercial bank was willing to lend to buy the crop. This year ECA is able to borrow at affordable rates both for the smallholder input finance and for the crop purchases.

The lesson of ECA is that it is possible to build commercially viable and scalable agri-businesses that benefit large numbers of smallholder farmers. But those businesses will not be able to attract commercial finance in the early years before the business model is proven.

We believe there is a role for a publicly-back working capital facility to give businesses like ECA the kick start they need.

Working with Grow Africa partners, AgDevCo is raising a pilot working capital facility of $25 million to allow SMEs to work with tens of thousands of smallholder farmers, boosting their productivity and incomes and linking them to profitable markets.

The facility needs a mix of commercial loans and grants to enable it to take the risks of lending to early-stage businesses. Grants and equity will act as a first-loss cushion which could absorb foreign exchange losses, and other risks. A separate technical assistance fund will make available grants to help establish and monitor smallholder farmer outreach schemes, like the ECA model in Mozambique. The facility will focus, but not exclusively, on food crops for local and regional markets.

In time the facility can be increased to $100m or more, with the target of linking 1 million farmers to profitable markets. By proving that smallholder farming can be profitable and commercially viable, the working capital facility aims to leverage in a lot more commercial debt and equity into the sector, helping agriculture thrive as a business, with benefits for all.