Climate Technology Program | In Brief No. 7 Designing an Innovative Financing Model for Early Stage Clean Technology Companies: Kenya Climate Ventures A great number of clean energy, water supply, and climate-smart agriculture business models are emerging to address climate challenges in developing countries. While encouraging, many of these businesses lack the access to appropriate early stage patient and risk financing, as well as bespoke post-investment business support to further validate their business models and scale up. To bridge the financing gap for such promising startups, the World Bank Group’s Climate Technology Program (CTP) has designed and launched the Kenya Climate Ventures (KCV). This In-brief examines the KCV design to inform similar efforts addressing the ‘financing gap’ for climate innovation in developing countries. Financing Gap funding is limited and not adequately tailored, and the available business development services are insufficient to Early stage clean technology companies in developing support growth. countries typically turn their own innovative technology At the same time, while commercially minded investors are into a new product or service, or adopt and adapt proven interested to invest in the clean technology sector, the majority technologies or business models from other markets. In both of them focus on established companies with a proven track cases, customer discovery and verification, business model record. In case of bank debt financing, the companies are also validation, confirmation of the product commercialization required to offer collateral. For these investors, early stage strategy, and efficient distribution channels are essential for clean technology companies in developing countries are not success. During this transition stage — from ideation to scale attractive due to their small investment size, need for intensive up — companies require both access to capital and a strong management support, and a low likelihood that the investment management team with access to the information, talent, and would meet their expectations within an acceptable time knowledge. frame. Unfortunately, in many cases, the needed capital and the As a result, many early stage clean technology companies in business development support are not always available developing countries are stuck in the “valley of death” (see for early stage clean technology companies in developing figure 1) where they require a significant amount of cash countries. These companies can often find support through over time to test their product in the market, validate their grants and business incubation programs, but too often business model, and scale. The valley of death is particularly Figure 1. Valley of Death – Financing Gap in a Firm’s Life Cycle in Kenya Initial SEED CAPITAL: Early Stage Growth Stage Capital VALLEY OF Capital Capital Project/Busines DEATH line revenue • Founders, • Impact investors • Later stage VCs family and • Very few and early stage and PEs. friends. financiers invest VCs. between $100K • Grants of and $1m. • Investment size up to $350K usually greater Across the stages, from KCIC • KCV aims to than $1m. invest between sources of capital may or other also include corporate incubators. $300K and $1m. internal funding and other inward strategic / industrial investors outside Kenya / Africa. Time In Brief No. 7|Page 2 problematic for clean technology companies because: (i) they more developed business models, in sectors where market often require higher upfront capital; (ii) take a significantly uptake is easier to gauge. longer time to realize returns; (iii) need to develop a new The Kenya Climate Ventures (KCV) is defining a new model market themselves; (iv) rely on infrastructure that may not for investment in clean technology. It is the only Kenya- exist or is weak; (v) compared to other technology sectors, are focused fund bridging the gap in the early capital needs of heavily affected by government policy. clean technology companies. By identifying and executing In Kenya and similar countries, clean technology companies good investment opportunities and realizing near commercial can usually obtain grants up to $350K for ideation and returns at the portfolio level and/or attracting a significant incubation, while more established companies can secure follow-on investment, the KCV helps demonstrate the approximately $2M and up from venture capital and private attractiveness of early stage investments in Kenya’s clean equity investors. However, companies seeking investment technology market. from $100K to $1M have a difficult time accessing appropriate As illustrated in figure 2 , if successful, the KCV can function financing and are at the risk of stalling in the valley of death. as a bridge for companies coming out of the Kenya Climate Although the number of impact investing venture funds Innovation Center (KCIC), other incubators, or entrepreneurs focusing on the Sub-Saharan Africa region has increased in who have self-incubated. The KCV would also serve as a source recent years, these funds typically target companies with for attractive deal flow for later stage commercial investors interested in climate sectors and growth stage companies Figure 2. The Role of the KCV Technology KCV Focus Area Proof of concept Development, scale up Commercial Company Individual Startup/Early Stage Growth Established Market No interaction Market identified Initial interaction Early sales Sales growth Later stage commercial investors and corporate KCV: the only Kenya-focused sponsors interested Companies supported fund bridging the gap in the in climate sectors and by KCIC and other “early missing middle” capital seeking growth stage incubators or needs of clean technology companies that survived entrepreneurs who companies. the valley of death have self-incubated. In Brief No. 7|Page 3 that survived the valley of death. Furthermore, it could demonstrate to new funds and investors that there is a Box 1. Kenya Climate Innovation Center model, approach, and a viable opportunity to accelerate the The Kenya Climate Innovation Center (KCIC), launched in flow of commercial capital into early stage companies and Nairobi in September 2012, was the first Climate Innovation that such model and approach could be replicated in other Center (CIC) to be established by the World Bank Group’s sectors and geographies. Climate Technology Program. The KCIC was originally managed For the prospective investees, the KCV will be the only by a consortium of local and international institutions and Kenya-based fund investing in Kenyan shillings focused later evolved to a local, independent, non-profit company on early stage climate companies. Kenyan early stage by guarantee. The KCIC in 2016 is supporting more than entrepreneurs will also take advantage of tailored technical 130 startup and early-stage Kenyan companies based on assistance, such as support for supply chain development innovative technologies and business models in climate- and improvement of information systems, management, and related sectors, such as renewable energy, bioenergy, recruiting processes. climate-smart agriculture, water, and low-carbon services. Designing the KCV Support services provided by the KCIC include business advisory, access to finance, access to information, access to facilities and enabling envrionment promotion. For more Origin of the Idea information, please see CTP In Brief No.2 The Kenya Climate In 2012, the World Bank Group’s Climate Technology Program Innovation Center: How it Operates and Lessons for Clean Tech (CTP) established the Kenya Climate Innovation Center Incubation. (KCIC) ( see box 1 ) to provide promising clean technology companies with business development advisory services and proof-of-concept grants. While many KCIC clients are at the proof-of-concept stage, some are more advanced management professionals, a board of directors, and with established distribution partners and supply chain an investment committee, all of which mimic the infrastructure. These companies require additional financing governance structure of a typical fund. The team also beyond grants to further validate their business model. developed linkages between the fund and other ecosystem intermediaries, such as the KCIC. Refining the Vision and Objectives The team also increased emphasis on intensive, or To address the early stage financing gap, the team proposed ‘high touch,’ business advisory assistance for investee to establish a 10-year impact fund — the Kenya Climate companies, recognizing that, in the scale-up stage, Ventures (KCV) — focused on investments between $500,000 they require not only financial resources but also high and $1 million. Managed by a private fund manager, its engagement management and technical support. success is defined both by its return on investment and Moreover, to meet the varying needs of early stage clean- impacts on the environment and the local economy, tech companies, the team refined the KCV investment including greater access to energy and job creation. strategy, using public and private funds to invest patient During the design and consultation process, the team capital between $250,000 and $1 million in the form of refined its approach to respond to the need for more patient, equity, debt, and related instruments. flexible, tailored, and risk-tolerant capital for early stage companies. The team revised the concept of a ‘fund’ into a permanent ‘investment company’ with no fixed time horizon Establishing the KCV for liquidation. With this vision and value proposition, the KCV was established in 2016 by the KCIC with an initial World Bank Although the KCV is not a fund, it has a team of investment grant of US$4.9 million. The KCV Board and Investment In Brief No. 7|Page 4 Committee, with deep local knowledge and investment supply chain infrastructure for initial service delivery and experience, has been established and the Chief Investment market penetration at an appreciable pace. Furthermore, Officer, Paul Ohaga, who has an investing and private equity the investee should have a competitive advantage background, was hired in mid-2016. to allow the company to continue growth, or be an Hiring staff was challenging due to the relatively small pool attractive acquisition target over time. of professionals with experience in early stage financing z z Investment size and instrument: The KCV plans to raise and clean technology sectors. Moreover, while Kenya has a additional capital for a total fund size of approximately pool of top-quality finance professionals, the depth of talent $8 to 10 million and make about 16 to 20 investments in the seed, venture capital, and private equity areas is still of $300,000 to $1 million each, in the form of debt, evolving and investing in clean technology is very new. equity, and/or related instruments. The expected average A quality management team and advisors with the required initial investment will be about $250,000. For successful technical and industry expertise are critical to the success companies, the KCV expects to provide follow-on of the KVC. Therefore, the team was very selective during investment. Over time, the KCV expects an average of the recruitment process of key staff and the members of $400,000 to 450,000 investment per company. To mitigate the Investment Committee (IC), and is actively working risk, investments are to be milestone-based, with smaller to assemble a support team of coaches to guide the initial capital and subsequent capital injections tied to development and evolution of the KCV. performance milestones and growth outlook. The KCV also expects its portfolio to have unsuccessful companies Since late 2016, the KCV has been originating potential where it either loses or only recoups the money invested. investee companies, including those supported by the KCIC or other intermediaries in the ecosystem. While many clean z z Investment Company structure: The current legal technology companies are looking for support and financing, structure of the KCV is a private company limited by selecting investment opportunities that align with the KCV shares, which is wholly owned by the KCIC. Additional outlook and aspiration requires time, effort, and calibration. funding from new funders could be provided either Selected companies have been presented to the Investment directly to KCV or channeled through KCIC. Committee and a handful have been taken into formal due z z Co-funders and investors: The KCV will engage with diligence. a range of different types of funders — commercial The KCV is expected to execute its first investments in 2017. investors, consisting of financial investors (banks, funds) This initial experience will inform the KCV strategy and and strategic investors (corporates from Africa and approach to deal origination and investment assessment and elsewhere), donors, philanthropic, or impact investors — processing. to assess options and test the investment opportunity at both portfolio company level and KCV level. To attract Below is a summary of the current KCV business model and build confidence among potential co-investors, the architecture. The investment company structure and KCV seeks promising investment deals in the early phase business model may be refined as the KCV gains more of its operation and develop a strong pipeline of potential experience with Kenyan early stage clean technology investment opportunities. companies and collaborates with funders, intermediaries, and other stakeholders. z z Technical Assistance (TA): TA required by investees will vary and the KCV team may recommend additional z z Investment thesis: KCV targets renewable energy, support based on investee needs. Some of the areas climate-smart agriculture, and water management for management/technical assistance include: talent companies that are generating revenue and developing development (mentoring/coaching for entrepreneurs, a customer base. The investee is expected to have and building a core team), strategy and business identified credible distribution models and suitable model development, financial and operational systems In Brief No. 7|Page 5 development, market intelligence and marketing capital scarcity among the three segments of the “frontier support, government linkages and assistance on getting capital” opportunity, as defined by the Omidyar Network. regulatory approvals, access to finance linkages (with Frontier plus companies have unproven business models banks, donors, other investors) for companies, value- that may be asset-intensive, serve only lower-income groups chain players, and end-consumer financing, and new or underserved communities, and/or operate in countries business development and partnerships. with less-development capital markets. There is also little precedence on how similar early stage funds make exits from Moving Forward their investments and what kinds of returns can be achieved. Figure 3 shows the three types of companies operating in As the KCV moves forward with investments, its operation and frontier markets. results will provide further insights on how to fill effectively the financing and technical assistance gap for early stage Given the high risks and long time horizon for early stage clean technology companies in developing countries. Two clean technology companies to scale, the KCV may not be areas will be especially important. fully compensated for risks it takes over a seven to ten year investment horizon. At the same time, the success of the KCV Can the KCV Build A Financially Viable Portfolio? will be measured by not only financial returns but also by the lessons learned on the financing instruments deployed and TA Early stage clean technology companies are considered provided, the volume and type of follow on investments that “frontier plus,” which pose the highest risk and face the most Figure 3. Three Types of Companies in Frontier Markets “Unproven business models that may be Risk asset intensive, serve only lower-income groups, and/or operate in countries with less-developed capital markets; this segment “Unproven business models that are requires investors to more creative with the asset light and serve both lower- tools they use, but offers tremendous impact and middle-income population; FR potential. ” this segment represents under- ON tapped opportunity that can be T unlocked using conventional VC IE R structure.” PL Fr o US nt ie Re r “Proven business models, where the bulk of existing VC money is & A pl d ica pt already flowing.” a te Capital Scarcity Source: Omidyar Network (2015, October). Frontier Capital: Early Stage Investing for Financial Returns and Social Impact in Emerging Markets. In Brief No. 7|Page 6 KCV portfolio companies will be able to receive, and what kinds of early stage clean technology companies have most Looking Forward potential to scale. The KCV represents an exciting venture for the Climate Technology Program. The financing gap for early stage clean technology companies is significant and considerably How Will the Combination of an Incubator and limits economic growth. This gap can be also seen as a huge opportunity to transform the development of clean Seed Fund Model Work? technology sectors, if the mechanism for effectively and The KCIC is closely linked to the KCV. The KCIC is expected efficiently deploying early stage capital and technical to vet companies and help them become investment-ready, assistance — and subsequently de-risking the sector for reducing transaction cost and deal execution timelines for later stage investors — can be unlocked. the KCV. While the KCV is considering both KCIC and non- The lessons learned from KCV’s success, as well as failures, KCIC client companies, a significant portion of the initial will provide stakeholders — from investors to development pipeline of companies is expected to come from the KCIC practitioners — with valuable insights on how to refine and portfolio. On the other hand, the KCV’s role is to provide adjust their approaches in investing and supporting the commercial capital to its investees that were incubated growth of the clean technology sector in Kenya and beyond. by the KCIC, as well as technical assistance tailored for the scale-up phase. In terms of legal structure, the KCIC is the anchor shareholder of the KCV — although as the KCV raises funds from public and private investors, the KCIC shareholding may be diluted — but the KCV is operationally independent. This combination of an incubator purposefully aligned to a seed fund is fairly new phenomenon. In the United States, 1776 started off as a startup incubator and later established a $12.5 million seed fund to provide funding to its startups with the potential to disrupt and scale. Y Combinator provides seed funding to a large number of startups and put them through an intensive acceleration program. To date, Y Combinator has provided $125,000 each to 105 companies. Both programs have been in place only for a couple of years and it is too early to evaluate the results of this combination. . The KCIC-KCV combination will be the first application in the clean technology sector in developing countries. The management teams behind these two organizations hope this unique combination will bring transformative changes to the growth of the clean technology sector in Kenya. To achieve this, the teams will test various modalities to support their clients, analyze their effectiveness, and course-correct them by rapidly responding to what works and what doesn’t. In Brief No. 7|Page 7 Climate Technology Program In Brief About Us The Climate Technology Program (CTP) In Brief series is a publication of the World Bank Group’s Trade and Competitiveness (T&C) Global Practice and infoDev. infoDev’s CTP is managed by the Innovation and Entrepreneurship Unit of T&C. CTP focuses on the growing opportunities of the clean technology sector in developing countries. Through a global network of seven Climate Innovation Centers, the program provides local entrepreneurs with the knowledge and resources they need to launch and scale their innovative business solutions to climate change. CTP In Brief is a series of knowledge briefs highlighting important aspects of the CTP global and in-country operations and research. Learn more at www.infoDev.org/climate. © 2017 The World Bank Group Acknowledgements 1818 H Street NW This brief was prepared by Jin Lee with contributions from Aun Ali Rahman, Masood Shariff, and Paul Ohaga. More on the CTP’s Washington, DC 20433 programs in Kenya can be found at www.infodev.org/climate and Website: www.infodev.org www.kenyacic.org. Email: info@infodev.org Twitter: @infoDev Facebook: /infoDevWBG