Emerging markets are developing regions that display high rates of economic growth and industrialization, along with the potential to reach the status of advanced economies.  Investors tend to find these markets lucrative due to prospects of high financial returns attributable to high economic growth.

Sowing the seeds of impact enterprise uncovers that impact enterprises, which are financially sustainable and scalable business ventures that solve critical problems, lack proper development and financing tools in the emerging markets of Latin America and Central Europe.

The magnetic pull of impact investors and supplementary business development services is not very strong there because of issues like dearth of legislation, long term investment horizon, and uncertain investment exits.

The publication discusses such challenges, and proposes solutions based on international best practices and NESsT’s own operational experiences in emerging markets.

Regulatory and Policy Vacuum

Due to the lack of specific regulation, most impact enterprises and their investors do not benefit from any tax exemptions.  Moreover, the absence of legal recognition creates some doubts about the impact enterprises’ initiatives in the community’s minds.

Some possible solutions to this situation include widespread implementation of the B-Corporation legislation and government procurement program for impact enterprise funding.

Funding Impact Enterprise

Many donors are hesitant about providing significant support to early stage impact enterprises.  The main investor concerns are covering operational costs and waiting for long periods to gain returns.

To deal with this issue, corporations should determinedly create and support new impact enterprises. Furthermore, family foundations and high-net-worth individuals should continue to provide flexible funding which is critical for impact enterprise incubation.

Pioneer Donor Best Practices

Patient capital is an effective form of funding because of its long term investment horizon.  The long time period provides impact enterprises the time to recognize and overcome risks, and thereby earn profits prudently.

In addition to that, tailoring financial instruments based on impact enterprises’ needs is an increasingly common practice adopted by successful donors.  Other donor best practices include provision of non-financial capacity support such as business advice, market access, and governance support.

Incubators

There are not many impact enterprise focused incubators in the emerging markets.  Considering the low maturation stage of this field, particularly in Latin America, incubators are advised to assist more young impact enterprises through provision of capacity support and patient capital.

Incubators can also aid impact enterprises by creating a communication platform to facilitate the process between impact investors and businesses.

Scaling

When expanding an impact enterprise, the management should be clear about what exact aspect of the business is being scaled.  The impact enterprise should also ensure that its expansion plan is compatible with its existing business model.

In addition to that, developing an amicable relationship with the incubator, collecting required financial resources beforehand, and determining future capacity support needs can also aid impact enterprises in the scaling process.

Mixed Financial Instruments

Financial institutions do not consider impact enterprises as a good business opportunity due to insufficient due diligence tools and the small size of the impact enterprise industry.  The stringent bank criteria, which include collateral and high interest rate, also dissuade impact enterprises from approaching banks.

The most common form of financing for impact enterprises in emerging markets is grants.  While the least common form is equity financing.  Reasons for this trend include limited high return investment options and low investor appeal towards capacity support.

Equity financing for impact enterprises is also unpopular because of legal constraints that forbid dividend payments.  The absence of a secondary market, where impact enterprise shares could be sold for capital gains, further worsens the situation.

To deal with these market gaps, investment intermediaries can take on initiatives such as investment readiness programs and interest rate determination for different transaction types.  The intermediaries can also aid impact enterprises by providing guarantees for the enterprises’ mainstream debt applications.

Early Stage Impact Enterprises in Latin America

Latin America’s economic growth rate has been comparatively higher than United States and Europe.  Due to the stellar economic performance, many aid organizations have moved away from Latin America despite the existence of several societal problems.  This presents an interesting development opportunity for impact investing.

To increase the impact investing profile of the region, case studies displaying successful exits, best practices and innovative investment vehicles should be crafted.  Moreover, the emergence of new incubators, government policies and investment funds should further facilitate the development of impact enterprises in Latin America.

Like the B Corp, Sistema B evaluates and certifies companies (called “Empresas B” in Spanish) who combine profit with positive social and environmental impact in their business model.  In most cases, the social mission is their reason for existence and profit is simply what they use to keep the business running.

Last month, B Lab, the creators of the B Corp, and Sistema B have announced a partnership with aims to certify 100 B Corps in Latin America by the end of next year.

“Certification is useful but we’re also focusing on the creation of an ecosystem,” tells Maria Emilia Correa, co-founder of Sistema B, of more ambitious goals to The Financial Times.  “The goal is not just to have a lot of certified B Corporations – our real goal is to help these companies become significant enterprises that can achieve scale and impact.”

What she’s referring to is building legislative infrastructure to support social enterprises.  In the US, B Corps pioneered and paved the way for the benefit corporation legislation that is currently introduced in 11 states.  It provides registered companies with legal protection to pursue social and environmental missions alongside profit.  The Financial Times reports that the same legislation is expected to be in place in Latin America.  In Chile, for instance, Sistema B is in discussions with the government to introduce the legislation.  The first draft will be presented in December.  Colombia is also showing interest.

“The legal framework is important because it defines you as a different corporation,” says Correa.  “It gives you credibility and helps investors to identify you.”

“What’s clear is that there’s a global movement of businesses using capitalism to create change,” says Bart Houlahan, co-founder of B Lab.  “So the need for this infrastructure exists globally.”

Both Gage and MacCombie had a bright future ahead.  One had a job offer in consulting and the other had a Fulbright grant.  But their hearts were in Ecuador, the country they met and learned to appreciate during college.  They would also learn that indigenous farming communities struggled to meet financial needs and preserve their heritage.  Many development projects in Ecuador had all the good intentions with little financial stability or buy-in from communities.  Over 3% of the Ecuadorian Amazon is cut down every year with little signs of rejuvenation.

When the two of them met in an entrepreneurship class at Brown University, they put together a business plan that would turn Ecuador’s cultural heritage into an income generating opportunity for farming families.  After leaving Brown University and dropping “the speech” on their parents, they left for Ecuador in January 2009 and eventually launched the business in December 2009.

“Both of us called them on the phone when we’d made the decision, and they’ve been some of our biggest supporters since inception,” said MacCombie.

Their social enterprise Runa is a business built on an Amazonian tree leaf called guayusa, native in the Upper Amazon regions of Ecuador, Peru, and Colombia.  Traditionally, indigenous families wake up together at dawn to drink guayusa while the village elders teach the youth about ancestral myths, hunting techniques, social values, and what it means to be “Runa”, or “fully living human being”.

Every day, Runa pays three different indigenous farmers $35 each for fresh guayusa leaves to make guayusa tea products sold through their online store to the US and Whole Foods stores in the Mid-Atlantic region.  So far they raised the income of 300 farmers by 25% each, whose family income averages $30-70 per month.  Sales are expected to surpass $1 million for 2012.

The United States Agency for International Development has given Runa a grant to reforest 1200 acres of degraded lands with guayusa.  Guayusa requires the shade of other trees in order to grow and thrives in a biodiverse forest ecosystem.  For these reasons, they will be planting food crops, medicinal plots and hardwood trees to ensure healthy, steady growth of guayusa and as a bonus, to supplement farmers’ income and rebuild forest ecosystems.

“It’s more fulfilling, more sustainable, more exciting, and more participatory,” said the founders in regards to the company operating a triple bottom line.  “Wain Collen, Education Director of Fundación Pachamama, emphasizes that ‘NGOs who aim to help indigenous communities most often end up causing more problems than they solve’.  Our advisors and industry experts continue to remind us that above all, we need to run a successful business, regardless of how social it is.  Without a strong, successful business we can’t generate any benefits for anyone.”

When asked about some challenges of running the social enterprise, the founders mentioned the process of acquiring knowledge as a big obstacle.  “As university students we were accustomed to the ready availability of any and all knowledge any time all the time.  However, in Ecuador concepts like ‘email’ and ‘the Internet’ are still very, very new.  We find conflicting information about export logistics and registrations, large amounts of haze in the Ministry of Environment’s land management regulations, and strange requirements for selling products in Ecuador, among endless other informational jungle gyms.”

Today, their parents are less skeptical of their work as they put it, and if one thing is for sure, navigating uncertainty is a daily requirement for social entrepreneurs.  But if they didn’t take the first step to do something they can’t fully explain or make what seems to be the worst decision of their life, nothing would have changed.  No increased farmer income, no restoring the Amazon, and no Runa.

Photo from Runa.

Public sector efforts to eradicate coca planting and replace it with other agricultural activities were unsuccessful.  Financial and technical support, property land titles, and seeds and markets for substitute products were unavailable.

Around the same time that Bill Drayton founded Ashoka in 1980, arguably the world’s largest supporter of social entrepreneurs today, Palmas del Espino – a private company of conglomerate Grupo Romero – started a win-win business to shift the sector away from coca planting to cultivate oil palm and cocoa trees instead, and in the process create a genuine opportunity for families to rise out of poverty.

The company is based in the district of Uchiza inside the region of San Martín, Peru where part of the Amazon stands.  Today, it has over 12,300 hectares of oil palm and 250 hectares of cocoa, and manufactures products such as cooking oil, shortening, soap, and chocolate.  Employing more than 1,500 people, it plays a significant role in the livelihoods of many.

But the beginnings of the company were tough.  First there was the competition for labour from the lucrative coca trade.  It is difficult to get farmers to abandon coca planting and opt for an alternative that takes four years of financing and cultivation to bear fruit and generate income.  They could not wait and no financial institution would give credit to poor farmers.  A hostile political climate, heavy security measures, and price subsidies from imported cooking oil almost threw the company into bankrupt.  It was not until the 1990s that the company started to recuperate its losses following military defeat of the Shining Path and the easing of price controls.

To help farmers shift to cultivate oil palm, Palmas del Espino supplies seedlings at cost, offers technical assistance and training in oil palm management, and provides guaranteed markets at fair prices.  To ensure sustained income for farmers, the company fought to secure them land titles and credit.  It negotiated a loan of $1,090,000 with Peru’s largest financial institution, the Banco de Credito, for families who wanted to grow palm, which would be guaranteed by their land titles and managed by Palmas del Espino.

A properly managed palm tree can be harvested for 25 years.  Even though annual generated income is less than that of coca leaf, planting palm trees has its advantages: it is legal, has low risk and maintenance costs, and provides steady income over time.

The Problem With Philanthropy

In 1986, at a time when the terms “social entrepreneurship” and “social enterprise” only started to surface, Ashoka Brazil became Ashoka’s first program in Latin America and is currently the largest of its kind.  The early adoption is unsurprising.  Contrary to many economies, charity was never a method that existed to create a stronger society in Latin America.  According to Alexander Kliment of the Financial Times, there is the cultural aspect of countries in Latin America that believe social welfare is the responsibility of the church and the state, not private individuals.

Secondly, there is little tax incentive for people to donate and even when they do, there are many loopholes in the system that prevent taxing well and fairly.  In Mexico, individuals can write off 7 percent of taxable income as donations to officially registered non-profit organizations.  In Brazil, individuals can write off 6 percent and companies can list donations of up to 2 percent of their net income as business expense.  The number is lower in Argentina at 5 percent.  Colombia is an exception, allowing write offs of up to 30 percent.

Finally, there is the argument that incentives alone are not enough to entice people to give.  Professor Cynthia Sanborn from Peru’s Universidad del Pacífico, and expert on Latin American non-profits and philanthropy, explains that giving is based on “personal experience, family circumstances, religious faith, or even effective fundraising”.  If an individual decides to give, tax incentives may only influence how much is given.  There is simply not enough philanthropy to go around the region.

Fostering Social Enterprise

A weak social sector and absent philanthropy give space for companies like Palmas del Espino to fill the void.  Rhett Morris, Endeavor’s Director of the Center for High-Impact Entrepreneurship, believes that limitations of government social programs and philanthropy in Latin America are the reasons entrepreneurs play an increasingly important role in delivering essential services.  Many including some of Latin America’s biggest tycoons believe it is a legitimate solution to poverty.

“Poverty doesn’t go away with charity, social services, paternalism or speeches,” Carlos Slim, Mexican billionaire and the world’s richest person, told the Financial Times.  “You can only defeat poverty with jobs and with people who create jobs.”

“Philanthropy makes a lot of sense for some things,” said Maria Emilia Correa, an expert in sustainable entrepreneurship.  “But when you can make a business out of solving a social or environmental problem, you have sustainability in the real sense, because it’s going to work even if you have no donations.”

Today, progress in the sector is apparent.  Correa is working with a team on Sistema B, a project that aims to replicate the third-party “B-Corporation” certification model popular in the United States.  The Social World Enterprise Forum will be held in Latin America – Rio de Janeiro, Brazil – for the first time in October 2012.  It will be hosted by NESsT, a non-profit that promotes social enterprise in emerging markets.

Latin America is increasingly turning to market-driven models to solve social and environmental problems.  The Aspen Network of Development, Avina Foundation, and Potencia Ventures conducted a survey of 140 Brazilian social enterprises and found that 64 percent were operating as conventional businesses, with no reliance on donations.  The remainder partly relied on donations but intended to become financially self-sufficient.  Enova, a social enterprise that provides quality education for low-income communities in Mexico by building small, cost-effective educational centres, is an example of how market models can drive development rapidly.  It began in 2005 and there are currently 70 schools set up across Mexico and over 62,000 graduates to date.

What’s Needed

Social enterprise plays a critical role to tackle social and environmental problems in Latin America.  Over 30 years ago, Palmas del Espino took a big step forward in creating sustainable businesses for low-income farmers.  But as experience shows, running a social enterprise is not an easy task.  Farmers need not only steady employment, but technical support, access to credit, and land titles to ensure sustained income.  There needs to be a strong ecosystem that allows the enterprise and its beneficiaries to flourish.  Without widespread market-linked crop substitutions and effective efforts to reduce international demand for the coca leaf means it will still be grown Peru, Bolivia, and Colombia.  It may come as no surprise that the U.N. Office on Drugs and Crime reported a 3 percent increase in coca leaf production over the last year in Colombia, with Peru regaining its former distinction of world’s top cocaine producer.

Families in Latin America still try desperately to look for livelihood alternatives.  Argemiro Melo, whose four of five sons left to search for work after having stopped coca production, is one of them.  “I want to bring my family back together.  Growing cocoa means a fresh start for us,” he said.

While the transition can be tough, farmers are positive.  “After coca, we tried peanuts, but many people’s crops failed.  Then we turned to a starch-rich tuber known as malanga, and finally we began to plant cocoa.  We see that this is our future,” said José Cundar, a community leader of a town in Colombia.

“We have more peace of mind now.  People have a fresh, more positive outlook,” said Fabio Portilla, owner of a cocoa farm.