Why Africa’s off-grid energy start-ups need investors

With 600 million Africans hungry for electricity, off-grid energy is poised to take off — if local entrepreneurs can get the capital they need to scale their business.

Getting electricity to the 600 million people across Africa living without it is a major undertaking, and building large power plants to supply energy to national grids is only part of the solution. With much of the population living in remote areas, the off-grid energy sector in Africa is poised for takeoff.

African entrepreneurs are stepping up to help fill the gap in off-grid power generation. However, such growth can only be achieved if these companies can raise the capital — both debt and equity — to support such aggressive expansion.

As part of President Obama’s Power Africa initiative, my organization, the U.S. African Development Foundation (USADF), teamed up with GE and USAID to provide  $100,000 seed capital grants to African entrepreneurs that develop renewable off-grid energy solutions. But while this early-stage funding has been essential to support entrepreneurs in building out their business models, as the one-year grants come to conclusion, they are asking: “Where can I raise the capital I need to grow my enterprise?”

Traditional models of energy financing don’t work for off-grid projects.

Financing for small and medium-size enterprises in Africa has historically been a challenge — and capital is even harder to raise in new sectors like renewable energy.

Under well-established global parameters for financing power plants, power generation companies sell power to utility companies, who then transmit and distribute it to consumers through a grid. Usually the government will stand behind the public utility’s commitment to purchase energy at a certain volume and price. This kind of guarantee is especially attractive to investors — making it much easier for developers to get financing for the project.

However, to get power to consumers without grid access — beyond the reach of the utility company — this model doesn’t work. With most off-grid energy projects, a single company will generate, distribute and sell the power directly to the people.

Investors see this as much riskier; not only is there no government backing, but a single company needs to successfully generate the energy, deliver it to consumers and also collect from them. This creates a level of financing risk historically unheard of in the energy sector — and so traditional energy sector investors have been slow to finance off-grid energy.

Will banks gain more risk appetite?

There was hope that commercial banks would replace conventional investors to provide the necessary financing to grow the off-grid energy sector. And African entrepreneurs are inventing plenty of new solutions for them to work with; the business models of Off-Grid Energy Challenge grantees alone range from mini-grids, to home solar-systems, to bio-gas, to mini-hydro installations.

Yet it is easy to see that local off-grid energy companies are pretty risky in the eyes of commercial banks — which are typically looking for companies with a successful track record, a history of profits and assets to be pledged as collateral. Moreover, the relatively high interest rates of loans in the local currency mean that entrepreneurs would need to demonstrate robust profit margins to comfortably service the borrowing costs.

Even a partial or full risk guarantee would be unlikely to address the basic mismatch between the “model” banking client and the energy entrepreneur. What financing options remain?

Enter the impact investor.

A growing number of investors have emerged over the past decade who are seeking both financial returns and social impact. Increasingly, these “impact investors” are looking at the renewable energy sector as an attractive investment — one that allows them to earn a reasonable return while catalyzing benefits for the world’s poor.

USAID has identified more than 43 impact investors to participate in its Beyond the Grid initiative, committing to place $1 billion in emerging energy enterprises despite the associated risks. A quick survey of four of these financing sources — a microfinance lender, a social investment arm of a major bank, a private equity fund and a faith-based investor cooperative — reveals a considerable appetite for renewable energy investments.

While each may have different underwriting criteria and risk appetite, this new breed of impact investors might be the best option for local renewable energy companies.

Because, while at first blush energy entrepreneurs need access to working capital to scale their business, they will also need funding to build out their equity base as credit lines become tapped out. Fresh equity creates the means for increased leverage and growth — which in turn fuels a demand for another round of equity. A virtuous cycle emerges.

As energy entrepreneurs seek to grow and benefit more consumers, access to financing becomes the critical ingredient to bring energy to Africa’s underserved.