Simon Desjardins

The Need for a Smarter Funding Ecosystem

Innovations Case Commentary:
Husk Power Systems

Most people don’t realize how difficult a challenge Husk Power is tackling today.
The geographies in which the company operates are physically harsh and suffer
from severe skilled labor shortages. Their technology platform and business model
are new and require large teams to implement. Execution of the scale-up plan
requires high levels of capital expenditures and R&D spending. Sin embargo,
Husk Power is succeeding, step by step, in delivering on its business plan.

It’s important for us as funders to remind ourselves of this context, as it is an
example of how we are expecting entrepreneurs to tackle the world’s toughest chal-
lenges with new technologies in the toughest markets in the world, all while deliv-
ering a commercial return for investors in less than 10 años.

It’s an enormous task, and one that can only be achieved with a mix of fund-
ing instruments—from soft funding to angel investment to venture capital to com-
mercial debt—deployed in ways that are market-building, not market-distorting.
A glance at the current funding ecosystem in India reveals a mostly siloed
approach to funding: grant providers primarily fund NGOs, debt providers over-
whelmingly fund fully collateralized enterprises, and venture capitalists tend to
fund revenue-generating enterprises with at least a year-long track record,
although there are a few exceptions. The results are threefold: (1) a severe lack of
unsecured debt, forcing many enterprises to use expensive equity to fund their
working capital requirements, which in turn increases equity investment require-
ments and decreases the return on investment for investors; (2) limited deal flow
for venture capitalists and other social investors, as few enterprises are able to
attract sufficient seed-stage funding for proof of concept; y (3) provision of
grant funding is largely disbursed in unleveraged ways to organizations that are
not structured for scale, thus decreasing its long-term impact.

We need to innovate around how the providers of these different funding

instruments can work together more effectively.

Simon Desjardins manages Shell Foundation’s Access to Energy Program.

© 2011 Simon Desjardins
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Simon Desjardins

THE SHELL FOUNDATION APPROACH

Our approach at Shell Foundation has been to support small and growing enter-
prises that provide modern energy services to the poor in ways that are financial-
ly viable and scaleable. We support these enterprises by providing smart subsidy in
the form of grants, typically at the post-R&D, pre-revenue stage, when commercial
funding is not yet available. We also subsidize the creation of new financial inter-
mediaries that are structured to provide appropriate finance and skills support to
sections of the market that are currently underserved by existing financial institu-
ciones.

From Traditional Grant Funding to Smart Subsidy

Our grants are never used to subsidize the price of the end product or service to
the consumer. That is a market-distorting practice traditionally associated with
grant funding, and is more likely to frustrate the long-term growth plans of an
enterprise than to help them. Our funding is instead used to create the core com-
ponents required for scale: seed funding for proof-of-concept, business plan and
strategy development, initial partial subsidy support for senior managers who are
needed but often too expensive to hire at the pilot stage, creating relationships with
new channel partners, R&D, and technical assistance from relevant experts, incluir-
ing Shell engineers and safety managers. This market-building approach is what
differentiates smart subsidy from traditional grant funding.

It’s critical to note that smart subsidy should not necessarily be delivered inde-
pendently of commercial funding. A popular misconception is that once an enter-
prise has attracted commercial risk capital, grant funding ceases to play a role. En
hecho, grant funding delivered in parallel with commercial investment can be partic-
ularly catalytic and lead to higher impact per grant dollar spent, as both types of
funder are able to leverage their investments while remaining true to their invest-
ment strategies. What changes is the role of grant funding post-commercial invest-
mento. Por ejemplo, we made our third grant to Husk Power (US$550,000) contin- gent on the company raising at least US$1 million from commercial investors. Nosotros
then altered the role of our grant from mainly providing capital expenditures to
build new power plants, which was necessary when no other capital was available,
to a focus on providing operating expenditures to support key long-term initia-
tives (R&D, HSSE, human resources, y entrenamiento). We have employed a similar
strategy with our fourth grant (US$1.1 million). Disbursement of a portion is tied to the company raising a Series A round of funding, expected to be more than $5
millón. At that stage we expect to disburse the final portion of our grant to Husk
Fuerza.

The Risks of Non-Dilutive Funding

Manoj outlined the funding considerations for Husk Power, and the relative
advantages and appropriate timing of different instruments. Despite the merits of

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The Need for a Smarter Funding Ecosystem

smart subsidy, we also need to be cognizant of two major risks that are a direct
result of our funding.

Risk of over-subsidizing a business
While the components of a business that we fund are vital to long-term growth,
they are also at risk of excessive subsidy, which has the potential to remove the
incentive to innovate and ensure a low-cost structure. Por ejemplo, it would be
tempting to provide sufficient funding to Husk Power to equip its existing opera-
tional sites with safety standards that Shell would employ at its refineries. Este
might reduce some safety risks in the short term, but it would also increase the
capital expenditures per plant to the point where the business would become unat-
tractive to next-stage investors. We need to be smart about deploying the key HSSE
lessons learned from Shell experts in selective and more cost-effective ways. El
same holds true for human resources. We are using a grant to partially subsidize
the cost of some of the senior management at Husk Power, although these are costs
that the business will be able to absorb without subsidy in the next two years.

We mitigate this risk partly by asking for shared risk, including co-investment,
from our grantees, and mutually agreeing with management on an exit strategy for
subsidy provision. We are also starting to involve commercial investors early in the
process to help ensure that they understand the use of the grant and the costs that
will eventually need to be borne entirely by the business.

Risk of becoming perceived as a noncommercial organization
As an early stage company like Husk Power grows, it’s important that it be per-
ceived as a commercial entity on its way to financial viability. By being a visible
partner with Husk Power, Por ejemplo, we put the company at risk of being per-
ceived by potential future investors and government as a noncommercial opera-
ción. At a higher level, we run the risk of helping create the perception that serving
rural customers with reliable and affordable electricity requires grant funding, y
therefore doesn’t represent a commercial investment opportunity for mainstream
investors. Messaging plays an important role in mitigating this risk, and we and
our grantee jointly emphasize the role that grant funding is playing in the organi-
zation and make it clear that there is an enterprise-based approach at the core.

Helping Next-Stage Investors Generate a Financial Return

Curiosamente, the risk often heard from other grant providers relates to the fear of
helping to provide a financial return to next-stage commercial investors. Our view
is that the idea of allocating grant funding only to NGOs is archaic and needs to
be weighed against the real, lasting, and scalable social benefits associated with
providing grants to social enterprises, like Husk Power. The reality is that if an
investor is eventually able to harvest a financial return from a company we subsi-
dized several years ago, it actually means that we’ve done our job effectively. It also
necessarily means that company has proven its potential to achieve scale and hence
delivered on our charitable objectives. We specifically use grant funding to create

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Simon Desjardins

the elements of a business that will create value for existing and future investors,
because if those value drivers do not exist, the company will never be able to attract
sufficient risk capital to achieve financial sustainability.

TWO COMPONENTS OF HUSK POWER
REQUIRING INNOVATION IN FINANCING

Husk Power University

To accommodate the hundreds (and soon, thousands) of new operators and man-
agers entering the company, Husk Power is creating a centralized training facility,
dubbed Husk Power University (HPU), which will deliver capacity-building con-
tent through video, e-learning, and lectures by technical experts. HPU will be
unique in the world in providing this kind of specialized training, which will guar-
antee graduates a job at HPS, along with long-term career prospects.

Rama Siva, who heads this initiative out of Patna, Bihar, has plans for the uni-
versity that extend far beyond Husk Power. Given the general skills gap that cur-
rently exists in Bihar, a state with a population over 90 millón, HPU has the poten-
tial to become an accredited provider of technical diplomas and certificates for the
wider population. The willingness of locals to pay for an education at HPU will
partly be a derivative of the scale and credibility that Husk Power achieves, pero
will largely be a function the company becoming a government-certified educa-
tional institution.

The complexities of managing additional students who are not just Husk
Power trainees could be offset by the benefits of increased revenue from a higher
throughput paying to receive training. What began as a necessary division of Husk
Power that was initially funded mostly by grants will soon become integrated into
the wider business as a cost center paid for internally with equity funding, y eso
could well become a profit center in the years to come.

While Husk Power intends to invest over $1 million of its equity funding (alongside a Shell Foundation grant provision) over the next two years to establish HPU, there is a unique opportunity for education-focused donor funders and local government bodies to play a role in its financing. If developed as planned, HPU will likely be much more effective than most local educational institutions in turn- ing unskilled seasonal laborers into a permanently employed workforce. Given the high level of social impact this specialized education will generate, we stand ready to work with scale-driven donor funders and government bodies alike to assist us in creating this institution. Funding Husk Power’s Scale-Up Partners Husk Power’s model—to “build, own, operate, and maintain” each plant—requires a large volume of workers at the ground level, including mechanics, plant opera- tores, village collectors, trainers, cluster managers, y otros. Given these resource requirements, scaling-up to hundreds of power plants will be difficult. A more viable approach to growth (and the one Husk Power has chosen) will be to adopt 88 innovaciones / Impact Investing Downloaded from http://direct.mit.edu/itgg/article-pdf/6/3/85/704690/inov_a_00084.pdf by guest on 08 Septiembre 2023 The Need for a Smarter Funding Ecosystem a “build and maintain” (BM) modelo, where Husk Power only installs the technol- ogy and provides maintenance, and partner organizations own and operate the plants. These partner organizations, or “BM partners,” will share some character- istics of a franchisee, as they will be purchasing an established business model and technology and will benefit from Husk Power’s centralized training facility, HPU, as well as ongoing maintenance and technical support. Sin embargo, it’s unlikely in the short term that the BM partners will benefit at the ground level from the Husk Power brand, as it may not be recognized in the areas where BM partners will oper- ate. BM partners could be a range of organizations, from larger energy companies looking to increase their rural penetration with appropriate technology, to individ- ual entrepreneurs, to government-backed organizations. El reto, entonces, will be to develop a financing mechanism to attract a mul- titude of BM partners. It’s likely that many potentially strong BM partners will only be able to provide portion of the capital requirement. A McDonalds fran- chisor, Por ejemplo, would have little trouble securing a top-up loan in most parts of the world, as that revenue model is proven and understood by banks. Buyers of the Husk Power model, aunque, would be unlikely to enjoy this luxury, especially in India, where small and midsize enterprises (SME) debt is scarce and expensive, and the process to secure it is often fraught with bureaucracy. Our ability to inno- vate around a new financing mechanism for the remaining debt requirement of Husk Power’s BM partners will play a deciding role in determining the success of the company’s scale-up plan. We can assume several things about this debt requirement: • Loans would be considered uncollateralized by a local bank, as the power plants would likely be deemed to have minimal resale value • The BM partner would be a for-profit organization (or at least able to take on debt) • The loan amount would typically range from US$75,000 to $400,000 per BM partner • A single standardized mechanism is required to avoid the scenario where a fresh financing mechanism needs to be developed for every BM partner, as this would cause significant delays and reduce the attractiveness of the package to potential BM partners • The annual debt requirement would be US$2-$4 million, spread over multiple BM partners Given these assumptions, there are a number of potential vehicles for address- ing this debt requirement. Guarantee facility with a local bank In this option, a local Indian bank with national presence would pre-authorize loans to Husk Power’s BM partners, enabled by a loan guarantee from a third- party organization (potentially a DFI, foundation, or government guarantee scheme such as the Credit Guarantee Fund Trust for Micro and Small Enterprises). The advantages of this option are that no new entity would need to innovations / volumen 6, number 3 89 Descargado de http://direct.mit.edu/itgg/article-pdf/6/3/85/704690/inov_a_00084.pdf by guest on 08 Septiembre 2023 Simon Desjardins be established, capital availability would not be a constraint, and the local financial institution would assist in building track record for the model. The cost of debt and the guarantee fees combined may prove unattractive to the partner, sin embargo. It also may be difficult to translate a high-level agreement between the guarantor, the bank, and Husk Power with swift action on the ground, as lending decisions on the ground tend to be made independently by branch managers operating under an independent set of performance incentives. Establish a financing division of Husk Power Systems Similar to GE Capital or Tata Capital, Husk Power could establish its own financ- ing arm, dedicated in this case to covering the finance requirements of its own BM partners. This may be necessary if alternatives don’t materialize, but it is an unap- pealing option, as it would require establishing a separate legal entity (a nonbank- ing finance company)—a complex process that would require significant time and financial resource commitments. Además, it would force Husk Power to take on the credit risk of its BM partners. Social impact bond A further option could be to create a social impact bond dedicated to meeting the financing requirements of BM partners. Bondholders would receive a small annu- al yield (1-2 por ciento) not commensurate with the risk they would take on, though their overall return would be bolstered by the significant social impact generated. This would allow participation by multiple organizations, potentially boosting the chances of meeting the funding requirements. Fundamentalmente, it would improve the eco- nomics for Husk Power and its BM partners through decreased capital cost, and it would transfer the financing risk from the company onto organizations better structured to absorb it. Sin embargo, tiempo, costo, and Indian regulatory constraints may frustrate our ability to execute on this option. Partnership with a local SME lender Husk Power could also refer its partners to a local financial institution structured to lend uncollateralized to SMEs. This option would bypass the need for a guaran- tee and in principle could be the most sustainable option, as the loan risk would be matched with the capital provider’s normal risk tolerance. In India today, such institutions are extremely scarce (IntelleCash and SIDBI are exceptions), sin embargo, and without clear guidance on the timing of the loans provided to individual BM partners, every new partner’s merits would likely need to be considered independ- ently. This option would also involve a high capital cost of at least 17-20 por ciento. Grant-funded revolving working capital pool This option would involve providing a ring-fenced grant to Husk Power, which would allow the company to offer extended credit terms to BM partners. The grant would be revolved indefinitely as BM partners covered their obligations. This would channel soft funding in a way that would directly support the development 90 innovaciones / Impact Investing Downloaded from http://direct.mit.edu/itgg/article-pdf/6/3/85/704690/inov_a_00084.pdf by guest on 08 Septiembre 2023 The Need for a Smarter Funding Ecosystem of the energy sector, and it would clearly represent the lowest cost option for Husk Power. Negatives would include the added complexity involved in managing the pool, and the limited capital provision would restrict the scalability of this option. IMPROVED COORDINATION BETWEEN FUNDERS The above two examples illustrate the need to deploy a range of different funding instruments to catalyze Husk Power’s scale-up efforts, and therefore the need for increased coordination between different types of funders. For grant providers, increased coordination could mean providing a grant to an enterprise with a pre-identified, short-listed set of next-stage commercial investors. Having a commercial investor involved at the grant stage (as part of a steering committee, Por ejemplo) would help ensure that the grant is used to prove the concept sufficient to attract that later stage investment, not to subsidize the product itself. The entrepreneur would benefit from greater clarity on the mile- stones needing to be met before pitching to commercial investors, and the investor would benefit from an enhanced pipeline. For development finance institutions with larger minimum ticket sizes, increased coordination could mean providing loan guarantees to local finance institutions alongside grant providers and commercial investors. For impact investors, increased coordination could mean sharing opportuni- ties that are too early stage for them to invest, or that require assistance in build- ing new markets in new geographies. Por ejemplo, in partnership with the OPEC Fund for International Development, we are establishing a revolving working cap- ital pool in select African countries that will unlock high-potential distribution partnerships for d.light, another Shell Foundation energy partner. The goal will be for this working capital pool to be financed in the future by d.light’s existing com- mercial investors. TWO NEW FINANCIAL INTERMEDIARIES FOR INDIA In India, we have recently launched two financial intermediaries that are designed to address financial gaps in the market and to operate at the intersection between donor and commercial funding. Accelerator for Seed-Stage Enterprises Shell Foundation and First Light Ventures, a U.S.-based venture capital fund, have together launched the First Light India Accelerator, which will provide risk capital (up to US$400,000 per enterprise) and business development assistance to seed-
stage enterprises that target low-income consumers in India. A dedicated local
team with strong commercial experience will provide skills support to selected
enterprises to prove their concept and seek the capital necessary to achieve scale.
The Accelerator will act as a feeder to later stage commercial investors, thereby
helping to address the “valley of death” between the concept “pre-investable” stage
and commercial funding that plagues the social enterprise sector globally. Lo haremos

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initially seek to do four deals this year of between $150,000 y $400,000, con
approximate 18-month funding periods.

Commercial Debt

To help address the lack of commercial debt financing to SMEs in India, in late
2010 we launched a credit facility in partnership with IntelleCash, an Indian non-
banking finance company. The facility is providing debt (less than $250,000/loan)
tied to specific anticipated cash inflows. The facility was launched in 2010 and cur-
rently has a test portfolio of five companies, including Husk Power. The facility
specifically targets small businesses that do not have three years-plus profitability
or full collateral (eso es, are not able to be served by banks), comprising the “miss-
ing middle” asset class. Employing lessons learned from our partner GroFin in
África, we are aiming to create an independent business capable of attracting com-
mercial funding for scale.

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