Investors Shed Light on Barriers, Opportunities and Effective Financing Mechanisms for Climate Startups

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• What are the primary barriers preventing capital flow to climate and social startups in low- and middle-income countries (LMICs)? 
• What role can regulations play in overcoming financing barriers? 
• What are the most effective financing mechanisms for startups in LMICs? 

Small and medium enterprises, which include startups, represent about 90% of businesses and more than 50% of employment worldwide. In emerging markets, most formal jobs are generated by SMEs, which create 7 out of 10 jobs. However, access to finance is a key constraint to their growth. 

It is against this background, that a leading panel of impact and institutional investors discussed key barriers and effective financing mechanisms for startups at the P4G National Platforms Gathering on June 20, 2024. Jock Geselschap, Head of Climate Team at the Ministry of Foreign Affairs in The Netherlands moderated the discussion. 

The Importance of Adapting to Local Contexts 

“We look for too much,” with those opening words Stanley Anyetei, Lecturer at TIAS and Investment Officer at Triados Investment Management, challenged investors to pare down their requirements of startups in LMICs. 

A sentiment shared by Thelma Brenes Muñoz, Evaluations and Knowledge Management Manager, FMO, who reminded the room that ecosystem building takes time – between 5 – 10 years. It’s an endeavor that requires technical assistance and concessional finance, most of which may not get returns. She also raised the point of European taxonomy not working for emerging markets and how it needs to be adapted to the local markets. Muñoz shared how FMO worked with banks on ESG management to help them understand why climate risk management was important to their portfolio. These conversations brought together multiple stakeholders, including regulators, associations of national banks, CEOS and leaders of banks to identify effective solutions. 

"I'm a big proponent of building communities. I think that’s the driver for people speaking to each other, people learning from each other - that's really the key for any development," said Rune Theill, CEO and Co-founder of Rockstart an early-stage investor. 

Theill shared how Rockstart focuses on very early-stage companies and is often the first investor in these companies. He spoke about their 12-month acceleration program where entrepreneurs from all around the world applied and how that was a wakeup call for Rockstart. The firm realized that what they knew about European markets didn’t apply to other countries. As a result, they created a program in Colombia that was designed for the Latin American region. He mentioned how financing was very challenging in the beginning and they were offering an investment product financed by European investors. But with time and community building, they are now able to offer products that are fully financed locally. 

The Role of Regulation 

"Shouldn't let regulation stop us from going to those countries because that means we are indirectly creating the haves and the have nots" – Stanley Anyetei. 

Dr. Brenda Pennell, Fund Manager, BID Capital Partners, spoke about how she saw a big variation between countries when it came to regulations. She mentioned the challenge of a country like Ethiopia where they haven’t been able to establish a footprint because they can’t repatriate capital readily to investors. Pennell said that blended finance structures that bring not just technical assistance but also risk mitigation would be an effective way at bolstering investor confidence in such regions. 

Anyetei suggested that policy discussions should occur at a bilateral level when governments are discussing overseas development assistance funding. 

Muñoz shared that since FMO only invests in the private sector, it is very intentional about the countries it invests in. She gave examples of lessons learned from their work with Honduras and Paraguay where they brought regulators and bank champions together to co-draft guidelines for the banking sector. She also spoke about a new project they’re working on called market creation in Ethiopia. As part of the project, they are inviting other development financial institutions to show them the success of this approach in other countries. 

The Most Effective Financing Mechanisms 

"Blended finance in the global south is probably the best way to go - anything else in isolation is a waste of time" – Stanley Anyetei. 

Panelists were generally in agreement that blended finance mechanisms were a much-needed financing mechanism for startups in LMICs. Pennell spoke about the greater availability of guarantee schemes like the African Guarantee Find that helps derisk investments. She raised the issue of exits being a challenge with equity investments and mentioned their solution of mezzanine financing to catalyze projects and have an exit strategy. She also acknowledged the shortage of such financing in sub-Saharan Africa. 

Muñoz shared insights into how FMO’s structuring through thematic funds complements the features of specific project needs from climate adaptation to forestry. The funds tend to have different facilities depending on project needs and maturity – early stage, construction and finance. An additional learning she shared was that FMO found that forestry projects require equity instead of loans because they take time to mature. 

Theill brought a private investor perspective to the conversation when he mentioned the increased amount of deal flow Rockstart is seeing in Latin America – about 6000 to 7000 companies – as compared to the number of companies they look at in Europe, which is around 1000 – 2000. However, he admitted that unlike in Europe that has incentives like tax benefits for equity investments, Latin America doesn’t have an incentive structure for local investors to invest locally. He shared that as an energy and agrifood-focused investor there is a significant opportunity in carbon credits that can be traded on the global market and that climate impact tends to be a big factor for any investment they make. 

Anyetei mentioned how convertible debt, grants and recoverable grants were better avenues for LMICs and would mitigate risk without placing an undue burden on them. 

The panelists came back to the importance of ecosystem building as they closed out the session. They cautioned stakeholders against trying to replicate or expect the same reporting requirements and structures that are present in the global North and urged people to consider local context and needs. 

As Anyetei concluded, “This is a global problem, but we need local solutions.”