Peak II (Providing Employment and Knowledge)

Report: Catalytic First-Loss Capital

Peak II engages in equipment finance lending in Tanzania.

Provider

The government of the Netherlands; program managed by FMO, the Dutch development finance institution.

Recipients

The fund has three investor classes: A, B, and C. Investors in A & B classes benefit from the protection. These investors include foundations, charities, impact investing funds, and high-net-worth individuals.

Amounts and Instruments

EUR 1 million (USD 1.2 million) provided as grant to shareholders in Equity for Tanzania Ltd. (EFTA), then converted into equity (class C shares). EFTA is the fund manager for Peak II.

Structure and Terms

The fund has three investor classes: A, B, and C. Any losses are completely borne by class C investors first, then B class investors and then by A class investors. Investment proceeds will be distributed first to class A investors, then class B investors, and finally class C investors, until all have received a return of capital + 10 percent. Further proceeds will be shared by class B and C investors. To date usd 4.8 million has been raised from investors in all three classes, so the CFLC comprises 25 percent of the fund. Because the target fund size is usd 10 million, the CFLC will dilute to 12 percent of its fully capitalized amount.

Motivations

The government of the Netherlands sought to be catalytic, and to support this objective they are also offering technical assistance for underlying Investees in addition to the grant converted to equity for CFLC purposes. For Lundin Foundation—an investor—the fund manager’s micro-asset leasing approach presented a “compelling” impact, but it had limited track record and the nascent space was seemingly high risk. The CFLC allowed Lundin to gain experience in the new market with some downside protection.

The fund manager reflects that the structure has worked very well for this fund, firstly because the CFLC is also utilized for investment, and secondly because, despite the fund manager’s track record, there was still some uncertainty around the exact return levels this relatively young business model would be able to deliver, which this structure cushions.

Negotiations

The government of the Netherlands provided Equity for Africa, Equity for Tanzania’s parent, with a EUR1 million grant, which was administered by FMO. The grant was restricted to being invested in the fund’s C class commitments. Once the grant was provided, it was a meaningful enough size for Equity for Tanzania to finalize a variety of investors, some of whom invested in both classes A or B to achieve target risk-return profiles. Lundin Foundation made its commitment conditional on the first-loss capital provision. The foundation determined that the ratio of first-loss to fund size was acceptable based on the fund manager’s track record and its own projections. The capital raise took a long time, and the fund manager reflects that there would also be merits to a “plain vanilla” guarantee with a more recognized structure, which in some cases would have made it easier to market to investors, as it was challenging for investors to categorize the risk.

Highlights

INVESTEE DETAILS
Fund Manager	Equity for Tanzania Ltd. (EFTA)
Inception Year	2012
Geographic Focus	Tanzania
Term	7 years
Impact Focus	Reduce poverty in Tanzania by empowering entrepreneurs to deliver sustainable employmentintensive growth.
AUM	Current: USD 4.8 million; Target: USD 10 million
Fund Capitalization	Private equity fund with three classes, one debt-like and two equity like (of which one takes first loss)
Investment Period	Up to 7 years
Investment Size	Varies
Target Return	24-28% (Tanzanian Shilling)
Management Fees	PEAK II pays 2% management fee to Equity for Tanzania
INVESTMENT APPROACH
Investment Instruments	Standardized equipment finance product-financial leases
Investment Period	3 years
Investment Size	USD 10,000-50,000 (in local currency equivalent)
Track Record	26 deals approved so far; 15 disbursed, as of October 2013

Catalytic First-Loss Capital details the motivations, benefits, considerations and suitable scenarios behind the use of catalytic first-loss capital in impact investing transactions. Catalytic first-loss capital refers to socially- and environmentally-driven credit enhancement provided by an investor or grant-maker who agrees to bear first losses in an investment in order to catalyze the participation of co-investors that otherwise would not have entered the deal. Catalytic first-loss capital has gained recent prominence in impact investing dialogue as more investors look to enter the market.

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