Financial Innovation for Good: Part 2

Follow the Money

Editor’s Note: Many non-profit organizations are pursuing financial innovation. Their goals are to raise additional, low-cost capital (beyond donations) and to engage new partners so that they can do more good work. We enthusiastically support these efforts and are actively discussing such opportunities with various organizations. This series summarizes key lessons. Catch up with Part 1: First Things First. 

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Financial engineering can look complicated at first glance. But it’s usually rather straightforward, as long as you know where to look. You just need to follow the money. 

Non-profits typically fund themselves through donations — money that can be spent and invested without any requirement to return capital. That's quite different from the world of financial engineering, which usually involves raising funds from investors or business partners with an expectation not only that the capital will be paid back but that there will also be a return on investment. Sometimes NGOs pay insufficient attention to the cash flow aspect of financial innovation.

Here are three examples from my time at TNC that illustrate how the cash component is often the driver in innovative NGO financing.

Example 1: Leveraged Buy-Outs (LBO) for Nature  

Backdrop: Back about ten years ago, TNC had the irresistible opportunity to purchase a large, spectacular, and biodiversity-rich parcel of land in the Western United States. But the purchase price was about $135 million — a big figure, all the more so because we had many other priority calls on the philanthropic capital we were raising. So we decided to borrow most of the money for the deal. 

We followed the private equity playbook and pursued an “LBO for Nature.” Not everyone liked that phrase, but I did — it was catchy, accurate, and helped donors understand our game plan. 

We wanted to raise 95% of the money with very low cost-debt (so-called “impact capital”). This would allow me to say to donors, “For every $5 dollars you donate to this project, we’ll lever your gift up with another $95 of almost zero-cost capital.” That would be powerful (and unusual) leverage for philanthropists and allow them to earn a high “philanthropic return on investment.”

Financial Challenge: How to raise so much debt?

In our case, the answer was straightforward. Once we completed the purchase, we’d own the land. We had a great track record of finding conservation-friendly buyers for land we purchased. Our debt capital providers were aligned with us on mission — that’s why they were willing to provide the capital on very favorable terms — and they were also confident we’d either sell enough land to pay down the debt or, if necessary, be able to refinance to do so.

Result: We raised 90% of the purchase price as senior debt with a zero coupon and another 5% of the capital as subordinated debt with a very low coupon. This was a superb outcome — great “financial engineering.” And, as you can see, it wasn’t all that complicated. 

Afterwards, other NGOs pitched us their own ideas for LBOs for Nature. The projects would have provided great biodiversity outcomes, but they didn’t have the ability to generate cash flow and so couldn’t be accomplished through debt. 

Example 2: Parametric Insurance for Coral Reefs 

Scenario: Many critical ecosystems are vulnerable to damage from storms — especially today in our climate-stressed time. Why not insure these ecosystems so they can be restored as quickly as possible whenever damaged? 

At TNC, we put together an insurance program like this where insurance proceeds would pay for reef restoration. 

Financial Challenge: Who pays the premiums on the insurance?

The project was an elegant way to ensure that reefs would be restored following damaging storms. Adequate funding would always be available through the insurance payout. But I didn’t anticipate the main challenge we would face (the very same one we always face when trying to raise funds to protect natural capital): How to persuade some segment of society (i.e., the government, the private sector, donors, you-name-it) to put up the money to pay for the protection — in this case, paying the insurance premiums.

Result: We did get our deal done, but it wasn’t easy. TNC has since replicated this strategy and other efforts are underway. I hope we see more deals like this. But note that financial engineering doesn’t obviate the need to raise capital. We’ll see whether funders/donors step up to do these deals at scale.

Example 3: Debt for Nature Swaps 

Backdrop: Debt conversions are having a renaissance, which is exciting to observe. TNC did the first of the recent vintage for the Seychelles when I was there, followed by Belize and Barbados.

The deals work like this: a country repurchases extant sovereign debt when it is trading at a discount, and it pays for this with the proceeds of a lower-cost new debt offering that benefits from credit enhancement. 

Financial Challenge: What will the sovereign do with its windfall? 

These deals are great because they create a pool of new capital that seems almost like “free money.” But that capital (obviously) belongs to the sovereign, not the NGO. So the main challenge for NGOs here is less financial engineering (yes, there are complexities that financial professionals need to address), and more persuading country officials (and potential credit enhancers) that the proposed project deserves to be a high national priority and that it can be successfully accomplished. 

Result: The four recently completed debt conversions all focused on ambitious marine conservation initiatives. It’s easy to understand why these initiatives would be viewed as high priorities by the country. Three of the projects were led by TNC, one by the Pew Charitable Trust— organizations well-positioned to design a program that would be viewed as likely to succeed. 

Going forward, it’s certainly reasonable to expect that debt conversions can be accomplished in areas beyond marine conservation and other nature-based initiatives. But NGOs should make sure they are proposing priority projects where they can deliver the desired outcomes. 

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The lessons noted above may seem obvious. Still, our experience is that NGOs don’t always pay enough attention to these fundamentals. We’ll have more to say about this matter and other opportunities for financial innovation in future posts. Meanwhile, we wish everyone pursuing these opportunities every success. 

Please let us know — comments are welcome below — if we can help in any way and if there are specific topics that you would like us to address.

Onward,