Mike McCreless Reveals the Secrets of Root Capital's Success

 

By Marta Maretich

Root Capital is one of impact investing’s success stories.This nonprofit social investment fund grows rural prosperity in poor, environmentally vulnerable places in Africa and Latin America by lending capital, delivering financial training, and strengthening value chains for small and growing rural businesses. Since 1999, Root Capital has disbursed more than $500 million in loans to more than 425 borrowers representing nearly 750,000 farmers and artisans in 40 countries in Latin America and Sub-Saharan Africa while maintaining a repayment rate of 98% for borrowers and a 100% repayment rate to investors.

But what lies behind this impressive record? Mike McCreless, Root Capital’s director of strategy and impact, talks to Maximpact about the importance of agriculture, the secrets to Root Capital’s success and what’s coming for agricultural impact investing in the future.

Maximpact: Why is agriculture such a key sector for impact investing?

Mike McCreless: The first reason is that the need is so great. There are 2.6 billion people living on less than $2 a day, which is the international poverty line. 75% of these people live in rural areas and most of them are involved in agriculture. If you want to reach these people, agriculture is a good place to start

The second reason is that agriculture has been a neglected area for decades in international development circles. Beginning in the 80s and through the 90s there was a trend of disinvestment in agriculture. Foreign aid for agriculture dropped from 18% in 1979 to 3% in 2004. Root Capital began work in1999, when investment in agriculture was near its lowest ebb.

Today, investment in agriculture is making a resurgence. Foreign aid agencies and commercial capital are getting back into the picture—the New Alliance for Food Security, Feed the Future and World Bank Global Food Crisis Response Program are some examples. Policymakers are beginning to realize the power of agriculture to both to achieve food security at a national level and to transform livelihoods for the rural poor. At the same time, it’s becoming clear that any approach to mitigating climate change must involve agriculture given its large carbon footprint, especially as practiced in many developed countries. Finally,better agricultural practice is needed to feed a global population that will reach 9 billion by 2050.

Maximpact: You say the funding picture is improving for agriculture. Is there still a role for impact investors?

Mike McCreless: The funding, both public and private, is beginning to come back. However, the private capital is drawn primarily to the bigger deals, for large-scale commercial agriculture. Most of that money is not reaching down to the 2.6 billion living on $2 per day, mainly smaller farmers with one to four acres of land. This means there’s still an important role for impact investors to play.They can place their money with the agricultural businesses that engage directly with those smallholders who may not be benefiting from the large-scale influx of agricultural monies.

Maximpact: There are many ways of doing impact investing. How does Root Capital do it?

Mike McCreless: We invest in emerging agribusinesses that have the potential to connect smallholder farmers to markets but cannot access loans locally because they are considered too small, too risky, and too remote by commercial banks. Many of our clients are cooperatives, owned and managed by the farmers themselves. Others are private businesses that source product from smallholders or sell them agricultural inputs such as seeds.

In most cases, the businesses we invest in aggregate the harvests of 100, 1000 or even a few thousand farmers. With access to credit,they can purchase more volume from farmers and more reliably supply their buyers, which often leads to larger purchases the next year and, over time,price premiums tied to improved quality. When farmers can connect to markets in this way they’re able to get a higher share of the end price than if they sold to a local trader.

We don’t establish new agricultural businesses ourselves. Rather,we build on the strength of pre-existing, locally-driven initiatives. Where there is already momentum for change and a market-based approach but a financing constraint, we can unlock latent potential with our loans and financial management training. We have found that capital by itself is often not enough. Fledgling agricultural businesses also need support in managing cash flows, assembling financial statements, and building a credit history, and our financial advisory services team helps businesses to these things.

Maximpact: What are the special challenges for impact investing in agriculture?

Mike McCreless: There are a lot of not very glamorous specifics that are key to making it work. There’s a lot of technical knowledge related to agricultural risk and small-scale farming —harvest cycles, perish ability, quality standards in the market. An investor needs to understand these.

You also have to be able to scope the whole agricultural value chain from the farm to the end buyer. You need a good feel for who the buyers are and for the relationship between buyers and a given agricultural business. Likewise, you need a sense for the strength of the relationship between the agricultural business and the smallholder farmers whose harvest it purchases. This informs how much of that product it makes sense to finance and how to structure the finance to support the business and mitigate risk.

Maximpact: Root Capital has been very successful as an impact financier. What are the keys to your success?

Mike McCreless: Honestly, the financial tools are not complicated. The key for us is choosing the right businesses to invest in. The way our model works from an impact and finance perspective is that we are able to identify clients in an early-stage sweet spot, where they’re ready for external capital but not yet able to access it, and we provide the capital they need to grow. We look for agricultural businesses that really can’t get a loan anywhere else because they’re too small or because local banks often don’t lend to agricultural businesses. Then we give them that first loan that helps them achieve their potential.

Having the right personnel is also key. A lot of our loan officers, our founders and early employees came from backgrounds as farmers. Others came out of a farmer cooperatives or agribusiness, often in the finance function. Their expertise makes it possible for them to assess the risks and the credit worthiness of agricultural businesses. Today we still hire loan officers who have that combination of agriculture and finance backgrounds. We favor people who grew up in the country where we’re operating, who have local knowledge, know local languages, and are familiar with the agricultural businesses in that region.

There’s been an interesting evolution over the course of the last several years where intuitively “knowing how to pick ‘em” has been translated into formal systems and processes that can guide people how to do that on a larger scale.

Right now we’re trying to formalize and crystallize the process of how to pick businesses to invest in. We’ve developed a social and environmental due diligence process that is embedded into our credit evaluation process. Our social and environmental due diligence is based on what our most mission-driven and perceptive loan officers knew intuitively to look for, buttressed by additional research and consultation with outside experts. We are preparing our first issue brief on the topic.

Maximpact: What’s in the future of impact investing for agriculture?

Mike McCreless: We think there will be a formalization of what’s been happening in this sector over the last ten years, a re-emergence of a formal sector around agribusiness investing and smallholder agricultural finance. For instance, just last year the Dalberg Group published an important report that suggests several paths forward for this sector. This report has gotten great traction and we anticipate that increased collaboration will follow as a result.  

We also see an extension of impact investing to new frontiers such as longer-term investments linked to increasing productivity. An example: coffee rust in Central America is wiping out coffee crops. This is a bigger problem than Root Capital can tackle alone so we’re working with a range of partners that can bring different types of expertise to address the problem.

Fundamentally, the idea is to provide finance for farmers to“renovate” their coffee farms or replace aging and often sick plants with young, healthy ones. Although many of Root Capital’s loans are for one year or less, we are increasingly offering long-term loans, for instance for major capital expenditures.  Coffee renovation loans would be even longer-term investments because it takes three years for a coffee tree to start to produce coffee, and longer to reach full productivity.

A lot can happen in that time. It’s a riskier but a higher impact investment, because without renovation the farmer would eventually be left without any income from coffee as the trees age and die. To stay on the leading edge we need to find new ways to bring financial tools to meet new challenges. Even as we keep on offering familiar products in familiar sectors, finding the next frontier of unmet needs is key for the sector.

Maximpact: Who do you admire in this sector?

Mike McCreless: Good question! Financiers such as Root Capital can always improve practice by learning from organizations on the sourcing and production side. We learn a lot from organizations like Catholic Relief Services who have been very active in tackling the coffee blight. They understand the cutting edge of best practice in terms of production methods, processing and farmer engagement. They are finding new ways to help farmers re-invest in themselves and contribute the time and the money to capitalize their cooperative for long-term success. These are all things we need to understand to be successful.

We also admire—and learn from—many of our buyers. For this reason identifying the buyers that deliver benefits to smallholder farmers is the way forward. Good buyers are, for us, the best value chain partners. 

As for buyers we admire? One company that springs to mind is Theo, an ethical chocolate company. We admire their progressive sourcing programs and ways of engaging with farmers. Green Mountain Coffee Roasters has led the way in raising awareness of the problem of chronic hunger among coffee farmers, and in investing in programs to address the problem. Sustainable Harvest has done a lot to strengthen the livelihoods of farmers it buys coffee from. Falcon is doing great work sourcing from difficult, often post-conflict environments. And of course, folks like Equal Exchange and Coop Coffees were at the front of the ethical sourcing movement. Engaging with buyers and other partners in the value chain is always an educational opportunity for us.

Find out more about Root Capital and how their approach works.

For impact investing opportunities in agriculture, login to Maximpact  and navigate to Deal Search. Or register today.

On September 15, 2013 in Agribusiness, Agriculture, Impact investing, Interview, Issue 05, Newsletter.

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