This dialogue was originally published on ImpactAlpha.
Circulate Capital, spun off from recycling investment fund Closed Loop Partners, is leveraging growing corporate interest in securing their supply chains and public interest in protecting the oceans to raise capital for investments in solutions to plastic waste in South and Southeast Asia.
Circulate secured a $35 million guarantee from USAID’s Development Credit Authority earlier this month. The DCA, which is slated to move into the new U.S. International Development Finance Corp. later this year, has made more than 600 such risk-sharing agreements to help unlock $5.5 billion in private financing. At least half of the loans covered by USAID’s 50% guarantee will be deployed in Indonesia, The Philippines, Vietnam and Sri Lanka.
USAID’s John Patrick (JP) Gibbons and Circulate Capital’s Rob Kaplan sat down to talk about the partnership, and the role of guarantees and blending capital in solving sustainability challenges at scale. “As a donor, USAID wants to work ourselves out of a job as quickly as possible,” says Gibbons. “Eventually we want the market to say, ‘We no longer need a guarantor in this structure.’”
For Circulate, the guarantee comes on top up of up to $100 million in equity commitments from PepsiCo, Procter & Gamble, Dow, Danone, Unilever, Coca-Cola and other corporations. “For many of our investors, too much of their packaging is polluting the environment,” Kaplan says. “They lack access to the recycled content to put back into their products. They are constantly getting accused of being bad actors and face a huge ‘license to operate’ risk.”
Rob Kaplan (Circulate Capital): Where does Circulate Capital fit in the context of the other kinds of deals USAID is asked to fund?
JP Gibbons (USAID): USAID interacts with a good number of prospective fund managers through the Development Credit Authority office. Each week, we probably hear at least one pitch from someone trying to create an impact investing opportunity with a particular angle, and they tell us that they’re going to try to raise a certain amount of money in six or nine months. And they want to know if USAID would be able to guarantee it.
They almost always want the guarantee up front because it helps them raise capital. This way they can say to prospective investors: “We have this investment idea. Yes, it is the first time someone has done this. Yes, it is in developing countries, but we have a 50% credit guarantee.”
When speaking with potential fund managers, I almost always tell them they’ll need to cut in half the amount of money they think they’re going to be able to raise and double the time it’s going to take to close. Or triple it. That’s because I understand how difficult it is to raise capital for investments in these innovative and market leading concepts. A sustainable fisheries fund recently had a first close two years after we signed a guarantee partnership – which is typical for an impact investment in the developing world.
Prospective fund managers almost always follow the same, well-traversed path. They will create their pitch deck for a concept that they believe in and think they can make a living from. Then, it is typical to call up the Development Credit Authority office or similar support provider to see what risk mitigation they can get. After USAID, they will reach out to the development finance institutions, who often take much longer to make a decision – often about a year. They will also reach out to the foundations, such as Rockefeller, MacArthur and Packard, to inquire about mission alignment and see if they can help smooth the way to attract private investors to the fund.
This process continues to add time to the fund’s close. After exhausting those resources, a prospective fund manager might call on some of the impact-oriented family offices. And at the end of this lengthy process, the successful fund managers have typically cobbled together about $30 million for a first close.
Circulate Capital went about it in a completely different way. You first looked at the corporate need in the ocean plastics pollution space, and through your great relationships with the corporate partners, solved a problem for them rather than creating a strategy independently and then trying to sell it. Having a fundamental understanding of the corporate’s need at the outset allowed you to be in a position six months later to succeed and make a big announcement. This made the entire process much more efficient from a financial partner’s perspective.
Kaplan (Circulate Capital): How did Circulate’s backing by larger corporate investors factor into USAID’s decision to provide guarantee capital?
Gibbons (USAID): First of all, you had worked in sustainability at Walmart and I met you while you were still at Closed Loop Partners, [Note to the reader: Circulate Capital is a spin-off of Closed Loop Partners], so you came with a significant amount of experience in impacting investing when you approached us.
From a guarantor perspective, the worst thing we can do is to provide a guarantee or other support and then watch as the investment concept never gets off the ground, particularly because the fund never raises capital. It is a waste of time, effort and resources. The fact that you were able to provide an incredible list of investors right up front was totally unique and gave us the confidence that we would be able to succeed and get this transaction out the door much faster.
What’s more, USAID would love to have more public-private partnerships with larger organizations like Circulate Capital’s corporate investors. Many of our guarantees of impact funds provide partnerships for USAID with investors that are already active in the space – DFIs, foundations, etc.
With Circulate Capital, we can back a blended finance vehicle that partners us with large corporations, plus we get Circulate Capital’s implementation expertise. This can be a starting point for USAID to continue conversations with the investors on partnering in the sector of solving the ocean plastics issue. In fact, the team within USAID that sponsored this deal is eager to establish better relationships with corporate investors so they can reach out to the corporates in the future, whether that be for a guarantee concept or another type of activity. This way we will already have developed a relationship with them.
Gibbons (USAID): Rob, why do you think your corporate partners responded to your vision for Circulate Capital? What resonated with them?
Kaplan (Circulate Capital): Well, one of our investors gave us direct feedback on this point. They said that they get pitched by funds all of the time saying that they can solve the company’s sustainability problems. But the typical fund solution only solves a small fraction of the corporation’s problems. Circulate Capital deliberately developed a strategy that hits on a number of levels for them so that we were more than just a Venn diagram with a small overlap of concentric circles.
For many of our investors, too much of their packaging is polluting the environment. They lack access to the recycled content to put back into their products. They are constantly getting accused of being bad actors and face a huge ‘license to operate’ risk.
At Circulate Capital, we designed a strategy to target hotspot regions. It will prevent plastic pollution and create access to recycled material. There’s something in it for the supply chain team; the government affairs team; and the sustainability team. We are then tackling the problem on multiple fronts. In much the same way, our strategy addresses a specific development goal of USAID – improving municipal solid waste management – so it aligns with what their program was trying to do.
Gibbons (USAID): Why don’t more funds behave this way?
Kaplan (Circulate Capital): For sure it’s in part being in the right place at the right time. The plastics issue is very hot right now and there are a number of unique drivers creating a sense of urgency. But we also know how to talk to the corporates. We know their goals and how they make decisions. Most investment managers really only know how to manage capital, not solve for a corporate investor’s sustainability goals. By engaging with you over two years ago, we were also able to design a strategy that solves for USAID’s problems as well.
Did this work for USAID? What was it about Circulate Capital’s approach that stood out?
Gibbons (USAID): Circulate Capital’s strategy aligned well with one of USAID’S investment priorities – supporting investment to deal with municipal waste and recycling as a strategy to reduce ocean plastic pollution. You had done your homework. Usually funds that approach us don’t have this long a time horizon. They often have a limited amount of operating capital so they either have to figure it out or switch directions. We knew you when you started researching this opportunity a couple years ago and when you were just starting to think about creating Circulate Capital, so it was just a much longer dialogue. This was helpful because we could see how thorough and deliberate you were in thinking through the strategy.
Kaplan (Circulate Capital): What about the Circulate Capital’s fund structure or track record helped move them over the goal line at USAID?
Gibbons (USAID): For USAID to get involved, the opportunity has to be fairly unique. If the solution is already investible, we don’t need to become involved. We strive to be the additionality that makes something investible. The concept also has to have a development angle that is important to USAID. We strive to reach the parts of the economy that are often considered too risky for investment such as a new sector like the recycling value chain in the developing world. It’s also important to ensure that USAID’s investments and public-private partnerships are best-supporting of a country’s journey to self-reliance.
All that said, USAID completes a thorough due diligence process including taking all guarantee partners before a credit review board, so it has to pass muster. In Circulate Capital’s case, the concept was very well thought out. You came to us having already secured grant funding for a market analysis, so we knew you were going about the process the right way right from the start.
Kaplan (Circulate Capital): What did your research uncover about entities that work in this sector?
Gibbons (USAID): As mentioned earlier, we had a team within USAID already focused on municipal waste and recycling activities in South and Southeast Asia, which is a hotspot for mismanaged waste due to rapid urbanization and population growth. We wanted to identify a private sector investment vehicle that could complement the more traditional USAID support for the sector through grants and technical assistance to local actors. I researched existing opportunities and looked at investment ideas in a number of countries.
At the time the Closed Loop Fund was really the one that kept coming up as having the reputation of a fund that could probably raise the necessary capital in what would be a first-time investment concept focused on recycling in the developing world. We started talking to you and your colleagues probably two years before we signed the guarantee and told you that when you were ready to move to investments in the developing world, please come back and talk to us.
Kaplan (Circulate Capital): What sorts of factors do you look at when considering a guarantee?
Gibbons (USAID): As an office, Development Credit Authority is here to serve the rest of USAID through the development of guarantee partnerships. Once we have buy-in internally to identify private sector financial partners, there are two main factors we tend to consider: (1) Does the potential partner have a viable investment strategy?, and (2) Is the partner reputable? If it doesn’t hit each of these two things, then it won’t create the sustainability for second, third and fourth investment opportunities for a fund.
As a donor, USAID wants to work ourselves out of a job as quickly as possible. We simply want to provide the additionality early-on for blended finance. Eventually we want the market to say, “We no longer need a guarantor in this structure. Why should we provide additional fees for risk mitigation that we’re not going to utilize for funds two or three, so let’s proceed without a guarantor.” And we’re happy for a fund like Circulate to succeed in achieving its strategic objectives and to provide great returns.
Kaplan (Circulate Capital): What are some of the barriers to achieving development goals and how can blended finance help?
Gibbons (USAID): The goal of blended finance, as we see it, is to utilize public resources to help unlock more private capital to achieve development goals. There are a number of factors that are keeping capital on the sidelines from being allocated at scale to address large social and environmental issues. Perceived risk and expected return have a lot to do with it but they aren’t the only issues. USAID continues to work to solve the problem by removing some of those barriers.
What barriers do you see?
Kaplan (Circulate Capital): You might call it the trail of death – the capital raise takes too long, the proof of concept takes too long, the amounts raised are too small to scale solutions and the ideas essentially die on the vine. And we’re back to where we started. Most funds are raising only $20 to $30 million dollars. Circulate Capital tripled these amounts through our strategy, putting us in a position to accelerate solutions at scale.
How do we accelerate this process to bring in institutional and public sector dollars faster to solve sustainable development goals?
Gibbons (USAID): I see a lot of finance vehicles with philanthropic or government dollars blending with other philanthropic and government dollars. That’s great, but ultimately it’s not going to provide the necessary capital at scale to solve these complex problems. Additionally, that public/philanthropic funding could often be more catalytic if it was willing to come in below market rate. That will stimulate the private money and this is the barrier that Circulate Capital was able to crack. A great example of how you can accelerate innovation and the flow of capital is to aim to solve problems at scale. Right?
Kaplan (Circulate Capital): That’s right. This is catalytic capital which ends up bringing in institutional dollars faster than public funds.
Gibbons (USAID): Why do you think an institutional investor or family office should care about blended finance?
Kaplan (Circulate Capital): Well, the first reason is that blended finance provides a clearer path to impact. If you’re bringing private and public sector dollars to bear on an investment, there is a much better chance that you’re going to be able to make a difference. But the second is that it’s also more catalytic – blended finance unlocks more capital by bringing different players to the party, all of whom have aligned interests and have skin in the game. What do you think?
Gibbons (USAID): When you look at the amount of money going into the developing world, there is so much more capital available in the private markets than with philanthropic or government dollars, and therefore there is so much more potential with the larger pool of dollars.