Access to finance for forest and farm producer organisations (FFPOs)

Access to finance

For forest and farm producer organisations

ISBN nine seven eight-nine two-five-one three one three two-five. C F A O two zero one eight.

Summary

Introductory points - Forest landscapes are inhabited by approximately one point five billion people. The aggregate gross annual value of these smallholder producers approaches one point three trillion U.S. dollars. Adding value to that production, through financial investment, will be key to delivering the Sustainable Development Goals. Therefore, access to finance is an important issue. The Forest and Farm Facility commissioned this scoping paper to assess what might be done to improve access to finance.

Organisation of forest and farm producers allows finance to be channelled toward value-added investments. But the motivation to form forest and farm producer organisations varies with context, from the desire to secure resource rights for Indigenous peoples in the forest core, to the desire to strengthen economic scale efficiencies in peri-urban forest product processing industries. The scale and type of finance needs vary and span enabling investments (grants or concessional loans) through to asset investments (market-rate capital that requires a return). Access to finance for forest and farm producer organisations requires tailored approaches.

For forest and farm producer organisations, enabling investments in four key areas are needed to create the conditions and necessary track record to attract asset investment: (i) secure commercial rights; (ii) strong organisation for scale; (iii) appropriate technical extension; and (iv) fair market access and business incubation. Enabling investments of this sort make forest and farm producer organisation businesses bankable and affords them access to finance.

Creating the enabling conditions and track record to attract asset investment, however, is not necessarily the same thing as achieving asset investment. To achieve asset investment, an interactive process of accommodation, a 'dance', is often needed between forest and farm producer organisations and financiers that involves, for forest and farm producer organisations, reducing the perceived risk-return ratio and transaction costs; and, for financiers, increasing understanding of the forest and farm producer organisations' value chains and the acceptability of financial terms offered. Access to finance is therefore a dance between these two parties.

A finance gap exists, because in forest landscapes, the capital invested by asset investors (e.g. private sources and capital markets) dwarfs the capital invested by enabling investors (e.g. public sector funds and official development assistance) by a factor of approximately one hundred to one. There is plenty of asset investment finance - but the pipeline of bankable forest and farm producer organisation business is thin.

Moreover, while asset investors are comfortable with the risk-return ratio and transaction cost profiles for microfinance and industrial-scale investments, they struggle with the profile of small and medium enterprises, which are perceived as high risk, low return and with considerable transaction costs. A gap exists in access to finance for small and medium forest and farm producer organisation businesses - and as we have noted, enabling investments are in short supply, and so need to be well-directed.

Filling that finance gap requires three complementary emphases: (i) organisational strengthening that formalises rights and reduces the transaction costs of dealing with forest and farm producer organisations; (ii) more sustainable business incubation that also addresses technical issues to improve the attractiveness of forest and farm producer organisation returns; and (iii) de-risking of forest and farm producer organisation investments for financiers - through concessional finance, guarantee funds, innovative use of collateral and credit reference partnerships. These three complementary emphases to improve access to finance for forest and farm producer organisations require different sorts of partners and partnerships.

From the forest and farm producer organisation side, the organisational strengthening and more sustainable business incubation must recognise the advantages of value chain diversity that can originate from forest landscapes: not just timber, but multiple non-timber forest products and services. Forest and farm producer organisations frequently start with one value chain but then diversify into a basket of products to spread risk and make more productive use of mosaic landscapes. Similarly, because most are democratically controlled, many forest and farm producer organisations are driven by issues beyond finance and are willing to forgo some financial benefits in return for environmental or sociocultural benefits. Both may seem off-putting to financiers - but it is important to articulate that both strategies actually reduce risk of forest and farm producer organisation business failure in the long term.

Two important start-points in improving access to finance for forest and farm producer organisations are to ensure: (i) that forest and farm producer organisation members recognise that they are the most important and accessible sources of finance; and (ii) that there is no financial leakage between the forest and farm producer organisation business and the broader interests and activities of forest and farm producer organisations and their members. No external asset investor will touch a forest and farm producer organisation business that cannot be certain of where its cash is. There can be no grey boundaries between the finance and product of the forest and farm producer organisation business and the finance and product of its members - especially if some of those members are cultural authorities in the broader forest and farm producer organisation domain.

Financial literacy and bookkeeping training for staff within the forest and farm producer organisation business must therefore be a routine part of organisational strengthening for forest and farm producer organisation businesses. Many community groups have experience of managing group savings and loans schemes such as village savings and loans associations, in which collective accountability is a key feature. Those skills and principles can be built into forest and farm producer organisation business finances or may need to be developed from scratch where they do not exist.

Making the leap from physical to virtual records and transactions is a vital step and may require support, such as in helping forest and farm producer organisation businesses to open bank accounts and keep financial spreadsheets. Making use of improving digital banking services can be helpful where these are available, but they need to be accompanied by an internal financial management system that keeps a balance sheet, a profit and loss account and a cash flow analysis to hand. These help to assess past progress, but also to conduct future financial projections.

In terms of future projections, financial managers within a forest and farm producer organisation business need to be able to assess the return on investment or the net present value of an investment - and present such figures to potential investors to show the increase in returns that will come from an investment. Equally important is for the forest and farm producer organisation business to be able to demonstrate broader environmental or socioeconomic returns that will come from an investment.

A thorough understanding of the value chain within which any investment is made is also vital, not only to assess which interventions will have a positive return on investment or net present value, but also to understand how particular interventions will alter the motivation of other value chain partners to engage with the forest and farm producer organisation business.

Once there is clarity about what finance is needed, and that there is a need for external financiers to provide it (although provision should never automatically be assumed) - this needs to be articulated in a business plan. It is very helpful to be armed with such a business plan when mapping external sources of finance that might be able to fill a forest and farm producer organisation finance gap. Options extend far beyond banks, loans or investors (equity) to include family members, savings groups or credit unions, traders or buyers, non-governmental organisations, moneylenders and so on. Mapping who is offering what and on what terms is a critical step in making wide investment decisions.

From the financier side - evidence points to there being serious returns to be had from asset investments into FFPO businesses (e.g., the two billion currently unbanked individuals can make immediate savings of one hundred sixteen billion U.S. dollars per year) and the aggregate gross value of production exceeds that tenfold as noted earlier. Forest and farm producers will form the mainstay of rural commodity production for the future. And while the individual microfinance sector is increasingly well-served, asset investments into FFPOs business (in the five thousand to fifty thousand U.S. dollars range) can create future investment opportunities. Many emphasise (perhaps even overemphasise) the risk of investing in this sector. But with global challenges in view - around climate change, biodiversity loss, food insecurity, and migration to name but a few - we would stress the much higher risk of not investing in this sector.

Clarifying what finance (i.e., asset investment) is available on what terms, and using simplified language to explain it, is one way in which financiers can improve engagement in this sector. Investors also need to lay out clearly how they will assess possible investments - for example, how much they will weigh the logic of the value proposition, what the business stands to lose if the investment fails (i.e., skin in the game), and the overall return on investment. Presenting some kind of assessment scorecard is one way of helping FFPOs understand how to meet the demands of the financier. Being prepared for a process that builds knowledge on both sides is a good start.

But financial literacy work with clients is not all that is needed. Financiers typically prefer big asset investments (low transaction costs) and short timeframes (low risk) - and on average charge small and medium enterprises (SMEs) a median interest rate of thirty-two point seven percent above large firms. But initial FFPO asset investment needs are often small with long-term repayments scheduled as trust within the FFPO is built, and capacity to manage businesses is developed. Financiers may need to revisit their perceptions of risk - since FFPO businesses tend to be rooted locally and committed for the long term. Developing a range of financial instruments that better meet the scale and repayment possibilities of FFPOs can pay dividends in the long run, as repeat business caters to ever-greater FFPO needs.

Apart from expanding the range of financial instruments that are designed for FFPOs, financiers can also bundle different products together to introduce new ones (with which clients may be unfamiliar) that would have a low uptake otherwise. But the bundling of financial products must also go hand-in-hand with the bundling of other services such as extension support, business and financial literacy training.

Improving credit information for FFPOs (e.g., through credit bureaus, registries or credit risk databases) can improve access to formal financial institutions - and allow those institutions to bundle and sell on pooled debt to other lenders (a practice known as securitisation). Improving information on orders, stock inventory, equipment and real estate can also open up new options for collateral that again improves access to formal financial institutions.

Intermediaries can play a critical role in helping bridge the gap between FFPOs and financial institutions - so as to enable mutually beneficial asset investments to take place. These intermediaries include public institutions, such as National Forest Funds, that are capitalised through earmarked taxes, general revenue streams, or even O.D.A. Such intermediaries can make enabling investments (grants or performance-based incentives) to improve FFPO bankability. Support for marginalised groups can be upscaled, including for women, where peer-to-peer mentoring, tailored business incubation, and networking services can build confidence and track records with potential investors.

Blending different sorts of finance can be a very useful activity facilitated by intermediaries. For example, concessionary rate finance from public sources or from O.D.A. or climate finance can be blended with market rate finance. The blending can reduce risk for the lender and make interest rates more acceptable for the client (which is often a key concern in longer-term forest projects).

NGOs can also play a role - especially in the area of connected FFPOs and financial institutions. They can help FFPOs to link to, and improve integration between, the multiple strands of public development and climate finance and private capital markets as these emerge. Exploring how emerging digital connectivity and financial technology (fintech) might better serve FFPOs is another useful area of work - as is facilitating investor-client linking events.

De-risking is another area where intermediaries can play a vital role, including making information more readily available to both sides - about prospective FFPOs to financiers, and about potential financiers for FFPOs. Helping to facilitate group collateral arrangements, and improve liquidity for such collateral, for example registering and using standing trees as collateral, is a useful intermediary role. Similarly, exploring and connecting FFPOs with leasing schemes, guarantee systems, insurance providers and those offering trade credit can improve access to finance. Trade credit is often an excellent solution, as value chain partners stand to gain directly from any improvements in FFPO efficiency.

Concluding remarks - the F.F.F. has an established reputation for channelling finance directly to FFPOs. This direct support can strengthen the role of FFPOs as aggregators of individual producer efforts. In F.F.F. Phase Two, the intention is that F.F.F. support will improve access to finance from six potential sources of finance:

FFPO producer, friend and family finance - through enabling investments for: membership expansion; internal FFPO financial management; women's collective agency; and risk self-assessment and response - to increase the scale of internal finances and the creditworthiness of FFPOs as clients for third-party financiers.

Buyers and trade-chain finance - through enabling investments for: linking with potential buyers; researching and engagement of leasing, factoring, purchase order or warehousing options; exploration of out-grower arrangements; and documenting success - to improve the perceived creditworthiness of FFPOs as clients to third-party financiers.

Semi-formal and microfinance - through enabling investments for: iterative business training that develops internal savings and loans procedures; exploration of potential crowdfunding; the fostering of links between formal and semi-formal providers; and longer-term business incubation and coaching to improve the perceived creditworthiness of FFPOs as clients to third-party financiers.

Formal banking finance - through enabling investments for: the mapping of terms and conditions of different lenders; financial literacy training; brokered design of new financial mechanisms; the promotion of credit risk databases and assessments; and digital banking outreach - to enhance awareness of how to improve the perceived creditworthiness of FFPOs as clients to third-party financiers.

National public finance - through enabling investments for: developing National Forest Finance or incentive schemes; advocacy for tenure, technical extension, business incubation support; financial regulatory reforms and reduced bureaucracy; and development of sectoral guarantee schemes - to upscale public finance that improves the perceived creditworthiness of FFPOs as clients to third-party financiers.

Climate finance and official development assistance - through enabling investments for: linking FFPOs to existing in-country donor programmes; adapting eligibility criteria to be more inclusive of FFPOs; advocacy for targets on FFPO disbursements; and research in support of donor guarantee schemes.