Journal of Business Research 62 (2009) 906–912
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Journal of Business Research
Ago\ra Partnerships Nicaragua: A micro venture capital fund☆ Luis J. Sanz a,⁎, Mario Lazzaroni b a b
INCAE Business School, Apartado 2865, Managua, Nicaragua McKinsey & Company, 600 Campus drive 07932, New Jersey, United States
a r t i c l e
i n f o
Keywords: Agora Partnerships Micro venture capital fund Venture capital model
a b s t r a c t Agora Partnerships is a micro venture capital fund founded by Benjamin Powell in the US and Ricardo T. Teran in Nicaragua. Agora started operations in 2005 with the goal of identifying and supporting entrepreneurs and business plans with high potential for success. The fund faces some unique challenges. First, the size of the businesses that is investing in does not allow for a traditional “management fee” structure. Secondly, traditional investment exits are nearly impossible in Nicaragua. This teaching case includes analysis on sources of investment capital, deal structures, and expected returns. The unresolved dilemma remains how to structure an investment proposal attractive to both investors and entrepreneurs. The case also allows discussing how to adapt the venture capital model to an emerging country like Nicaragua. © 2008 Elsevier Inc. All rights reserved.
Agora Partnerships is a private, not-for-proﬁt organization with the mission to launch and grow socially-responsible companies in poor countries. Agora's founders, Ben Powell and Ricardo T. Teran, believe the time is right to apply the insight of microﬁnance – that the poor are bankable – to entrepreneurs trying to start businesses in the formal economy. According to Ben “Most aspiring entrepreneurs in poor countries are caught in a development blind spot. Too big for microﬁnance, too small for traditional lending, they represent perhaps the greatest under-utilized asset of poor countries. These entrepreneurs hold the key to job creation. Countries need to ﬁnd new ways to unleash them.” Agora's model provides promising entrepreneurs with a comprehensive program that attacks the key barriers to small business development, which Agora management identiﬁes as the lack of: business and social networks, education, ﬁnancing, and management expertise. They ofﬁcially piloted ofﬁcially the model in Nicaragua in 2005. By early 2006, Agora had provided consulting to nine entrepreneurs and six others were identiﬁed. Now the volunteer Investment Committee is in the process of deciding which ventures to fund, and on what terms. Agora management knows that investing in the asset class of early stage, and even pre-incorporation businesses in Nicaragua, is incredibly risky and poses signiﬁcant challenges. The organization needs to lower transactions costs necessary to ﬁnd and analyze deals and prepare and educate entrepreneurs for possible investment. Aside
☆ Both authors acknowledge ﬁnancial support for this teaching case from the Microﬁnance Management Institute. The authors thank Connie Jones for her editorial assistance. The authors are responsible for all remaining errors. ⁎ Corresponding author. E-mail addresses: [email protected]
(L.J. Sanz), [email protected]
(M. Lazzaroni). 0148-2963/$ – see front matter © 2008 Elsevier Inc. All rights reserved. doi:10.1016/j.jbusres.2008.10.014
from ﬁnding great entrepreneurs and great business ideas, Agora needs to ﬁnd a way to adapt the principles of venture capital (VC) to the context of Nicaragua, the second poorest country in the western hemisphere. What works in the United States or the European Union can provide a guide but certainly not a map to what might work in Nicaragua. For starters, traditional exit opportunities are virtually absent in Nicaragua. Figuring out the most effective way to provide support and investment is a major challenge. In the end, Ricardo and Ben believe that their organization's fate relies on the success of the ﬁrms in which they invest. This conviction is similar to how VC ﬁrms in the United States operate and will indicate to Agora's donors whether the organization is succeeding in making an impact on new, Nicaraguan businesses. Adapting the VC model to Nicaragua poses a myriad of challenges due to the many barriers to entrepreneurship in the country. Chief among the challenges for the Agora team is deciding what kind of ﬁnancial deal Agora should offer to entrepreneurs that show potential for investment: What would the deal look like? Ricardo Teran Teran, Co-founder and managing partner of Agora Nicaragua, commented: “Finding the right structure for the deals Agora is going to offer to the entrepreneurs is of paramount importance. The investment committee needs to make sure that the entrepreneur will feel in total control of his company, and that he can extract as much value out of the venture as possible. At the same time, the committee needs to make sure Agora can capture at least a share of the upside of the successful companies, since these will have to balance out the negative experiences. Balancing all these competing needs into a single ﬁnancial structure which is also easily understandable for the entrepreneurs is an enormous challenge.” At the wake of their ﬁrst Investment Committee meeting, the management team is outlining the numerous questions requiring an
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answer before offering a deal to an entrepreneur. The questions include: How should Agora achieve an exit in the absence of a possible management buyout or sale to a strategic competitor? To what extent should third-party participation from commercial investors be allowed? How will Agora create a deal structure that would give the entrepreneur a fair and transparent deal while also achieving the investment goals? What portfolio Internal Rate of Return (IRR), if any, should Agora commit to the donors or social investors for the fund? What Return on Equity (ROE) should Agora seek from each investment? As Agora's Investment Committee will meet concurrently in Managua and in New York to discuss these issues, they know the stakes are high. If they can be successful in bringing the VC approach to early stage ventures in the developing word, they can help create a new development model that will open the door to thousands of new jobs and new companies and inspire entrepreneurs from all socioeconomic levels to try to start their own businesses. In order to be successful, however, the ﬁrst few deals need to work – and that requires coming up with a successful deal structure for both Agora and the entrepreneurs. 1. Entrepreneurship in Nicaragua Nicaragua lies at the heart of Central America, between Honduras and Costa Rica. The country has an area of 129,494 km2, and a population of 5.3 million. In 2005 the country had a labor force of 1.91 million with 22% unemployment and underemployment estimated at over 40%. Annual per capita income was US$730, and 50% of the population lived in poverty. The minimum wage was $0.42/h, and the market average was $0.67/h. The Agora Partnerships team invested months determining the key barriers to new enterprise growth in emerging markets, speciﬁcally in Nicaragua. They found that start-up costs and timing are prohibitively expensive for the vast majority of Nicaragua's potential entrepreneurs. Start-up costs average about US$1200 or 170% of the country's per capita Gross National Income (GNI), compared to a regional average of 60% and an OECD (Organization for Economic Cooperation and
Development) average of 6%. Entrepreneurs taking the least amount of time can legally start a business in Nicaragua in about 45 days (compared to ﬁve days in the US). In addition, potential entrepreneurs have fewer than half of the property right protections offered in wealthy countries (IFC, 2005). According to the Inter-American Development Bank (IADB, 2001) the single largest barrier entrepreneurs face in Nicaragua is access to ﬁnancing. The formal banking system does not lend to start-ups, and angel investment opportunities are in short supply outside of family networks. Hundreds of microﬁnance institutions exist to serve the “poorest of the poor,” but a gap is clear for the ﬁnancing of small- and medium-sized enterprises and particularly for young entrepreneurs with great ideas but no collateral assets. Besides ﬁnancing, a host of additional barriers make extremely difﬁcult for talented Nicaraguan entrepreneurs to achieve their potential. The key barriers Agora management identiﬁed are: Closed social networks: closed family networks and socio-economic discrimination difﬁcult for even middle-class entrepreneurs to access needed business networks. In turn, this lack of access hinders conﬁdence and imagination, with many talented entrepreneurs not believing they can become successful and, if they do, they usually aspire to own a small family business. They rarely dream of creating a truly new, successful company. Education: few entrepreneurs have experience with the private equity model and very few have the opportunity to study venture creation. They also lack critical information about market opportunities. Management expertise: the lack of training and experience means that those few ventures that receive enough capital often stumble at the operational level or fail to manage growth properly. Management also points that an additional obstacle to new enterprise creation is that institutions linking economic development and VC professionals are scarce. Thus, agents and policy makers usually ignore the possible interdependence between development
Fig. 1. Organizational structure.
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Fig. 2. Agora's model.
and venture creation. This break creates a structural expertise gap that, even further, magniﬁes the ﬁnancial gap. 2. Agora Partnerships Agora Partnerships started as the product of a lunch meeting between Ben Powell and Ricardo Teran Teran that took place in Miami in July 2004. At that time, Ben was a full-time student at the Columbia Business School, and he was looking for a partner in Central or Latin America to help develop and implement a new kind of business incubator for start-up ventures in emerging markets. Ben believes on the enormous untapped entrepreneurial potential in emerging markets. Ricardo thinks that Nicaragua needs to move beyond a mentality of alleviating poverty and focus instead on creating wealth, exporting, and competing in the global market. He met enough people as the President of the Association of Young Entrepreneurs (AJE) in Nicaragua to realize the level of untapped talent. Ben and Ricardo quickly realized their perspectives on social and economic development were perfectly aligned, and they believed they had very complementary skills and networks. They agreed to launch the initiative, which came to be known as Agora Partnerships, as quickly as possible. Ben spent the ﬁrst six months of cooperation working with classmates at Columbia to design a model to identify, consult, ﬁnance and support outstanding entrepreneurs interested in starting new businesses. At the same time, Ricardo worked with his network to identify entrepreneurs to work with and engaged the Columbia team in discussions about the best ways to tackle the many barriers to entrepreneurship in Nicaragua. 2.1. Organizational structure Agora Partnerships is a non-proﬁt organization with a parent institution in Washington, DC, and an afﬁliate in Managua, Nicaragua. This structure aims to maximize local participation in Nicaragua, while facilitating a more-global reach and future replication in other countries.
The Washington ofﬁce's core responsibilities include: establishing global partnerships, matching MBA student groups with entrepreneurs, fundraising, advocacy, and improving and replicating the model. Agora Partnerships Nicaragua is responsible for selecting the Agora entrepreneurs who will receive consulting, managing that process, providing local education and advocacy, and managing Agora's incubator services to support the portfolio ﬁrms that received investment from the Agora Fund (Fig. 1). Agora Partnerships seeks to raise private capital to create a seed fund (called “Agora Fund”) to invest in the most promising Agoraselected entrepreneurs. The Investment Committee comprised of professional investor volunteers in the US and Nicaragua, will meet periodically to design and sign-off on all deals, approve all investments, and help guide exits and ensure overall transparency during the process. The managing partners hope to raise $500,000 for the ﬁrst fund, an afﬁliated but legally separate entity, which will support 5–7 new businesses. After demonstrating a track record, they hope to raise more funds and to expand to other countries. Agora targets their fundraising effort mostly towards foundations, private donors, and the Inter-American Development Bank (IADB), which has been very supportive at the staff level. These institutions hold signiﬁcant capital, but they also take considerable time to process applications. After extensive discussion with the Investment Committee in New York and Managua, Agora management decided to seek private investors for the ﬁrm's ﬁrst fund. 2.2. The model—how does Agora work? Agora describes the model as a value chain that addresses the core barriers to entrepreneurship: entry, education, ﬁnancing and management. The value chain begins with entrepreneurial selection in Nicaragua and ends with empowerment of entrepreneurs through the launch and growth of new start-ups. The model identiﬁes the most talented young entrepreneurs and allows them to develop their business ideas to the point of turning them into actual enterprises. Agora's key innovative
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Fig. 3. Criteria for selecting entrepreneurs.
element is that the organization's investing arm provides the ﬁnancing (Fig. 2). Agora's selection process begins with a standard application submitted to the Managua afﬁliate twice a year, to coincide with the partner universities' semester schedules. The purpose of the selection process is to ﬁnd the most ethical, hard-working, committed and purpose-driven entrepreneurs with viable, socially-responsible business ideas. These promising candidates, “Agora Entrepreneurs”, are both individuals and groups of individuals working together. Agora chooses between ﬁve and ten ventures every time for a total of 10–20 ventures per year, according to the following criteria (Fig. 3). Ventures approved by the Investment Committee will then receive investment from the Agora Fund. The fund plans on investing US $25,000 to US$125,000 per venture. The actual amount depends entirely on the quality of the management team, the business idea, and the prospects for success. Agora Partnerships also hopes to create a global support community among Agora Entrepreneurs and provides local networking opportunities through strategic alliances with local development organizations. The organization wants to be a strong voice for the entrepreneurs while demonstrating, through the success of the portfolio, that ﬁrms receiving new-venture investment could generate positive social and economic beneﬁts. Agora also cooperates with other leading development, education, VC, and entrepreneurshipdriven organizations to help educate young business people about the venture capital and incubator models. Agora Partnerships began the ﬁrst pilot selection in the fall of 2004 by identifying one entrepreneur. In the spring of 2005 an additional three entrepreneurs were hand-selected. Each entrepreneur worked with volunteer consultants from the Columbia Business School. At the end of this process the consultants presented their analyses to Agora's managing partners and a room of over 50 Columbia students. While Agora believed that many of the ideas and the entrepreneurs had potential, the Partners did not feel that any were ready to receive investment funding at that time. After the pilot phase, the ﬁrst ofﬁcial selection-by-application process took place in the summer of 2005. Ben spent most of the summer in Nicaragua, where two full-time interns from Columbia helped to set up the Nicaraguan afﬁliate's administrative structure. Agora received over 60 applications and selected ﬁve to participate in the fall 2005 consulting period.
3. Competition Organizations working to help Latin American entrepreneurs run the gamut from foundations to non-governmental organizations (NGOs) to governmental and quasi-governmental organizations. Services offered include: technical assistance, business plan development, small-scale grants, and low interest loans. They also include: “brokerage” services with investors, entrepreneurial branding, consulting, and curriculum development. Finally, some also offer teacher training and networking facilitation. Endeavor, an organization operating across Latin America, has a very similar mission to Agora – ﬁnding and empowering emerging market entrepreneurs – but does not target the seed level, small-scale entrepreneur seeking approximately US$25,000–$150,000, nor does Endeavor provide ﬁnancing. Some new, innovative models seek to connect economically-viable social ventures with investors (World Resources Institute, NEsST), but these do not provide direct investment. Technical assistance groups (Fundes, Technoserve) provide assistance, but do not make equity investments. Even though some VC groups with strong social missions exist (like, EcoEnterprises, Small Enterprise Assistance Fund, etc.), these organizations tend to be very sector-speciﬁc and do not focus on seed stage companies. Some organizations like the Ford Foundation-funded Fate Foundation in Nigeria provide a comprehensive suite of services for young entrepreneurs, including debt ﬁnancing (but not equity). Aureos Capital provides equity ﬁnancing for SMEs globally, and in fact, Aureos' Central America Fund, (US$36 million) is already active in Central America, including Nicaragua. However, Aureos targets larger, later stage, sector-speciﬁc projects and will not consider supporting technically seed level entrepreneurship. The major organizations that work with young entrepreneurs in Nicaragua include: Technoserve, Junior Achievement Nicaragua, the Young Americas Business Trust and AJE Nicaragua. Agora developed strong relations with all of these organizations. Nicaraguan universities that support entrepreneurship include the Universidad Americana (UAM) which works with Instituto Tecnologico de Estudios Superiores de Monterrey, and the Universidad Nacional de Ingeniería (UNI), which is a local leader in entrepreneurship. Hundreds of formal microcredit organizations (Accion, FINCA, and Prisma, to name a few) are also involved in Nicaragua. Many of these organizations are legally ﬁnancial institutions, and this status allows
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them to receive deposits. ProCredit and Findesa receive of dollars in funds from the World Bank and IADB to promote the development of micro businesses in the informal sector through loans and training services. Other organizations include: rural lending circles, cooperatives, and village banks. 4. Problems and future outlook In preparation for the ﬁrst formal Investment Committee meeting, the Agora managing partners want to review their initial ideas about what investment vehicles Agora could consider. These are relevant to the part of the Fund that does not come from the IADB (which states that Agora should invest funds from this source as debt). This structure is a key element in the design of the fund and in guaranteeing the long-term sustainability of the initiative. Agora's mission is to help launch new businesses, and with this in mind, the management wants to provide the most favorable conditions possible to the entrepreneurs. On the other hand, Agora wants to guarantee that the enterprises will develop within a market-based environment and that the returns on the investments are comparable to those of commercial investments. In this respect, they need to structure the deal in a way that the investments can be proﬁtable, but will still have a set of check-and-balance controls in place. In summary, the management has four main goals in mind, which are in line with the overall mission of the organization: a. The deal has to be fair and give the entrepreneur the best possible chance to succeed without constraining him by the investmentrelated cash ﬂows. b. The entrepreneur has to feel he has as much ownership over the company as possible and has to stay motivated for the long run (including once Agora exits the investment). c. The fund has to have a reasonable chance to exit the investments and realize a positive IRR that will satisfy the donors and investors. This condition is necessary to prove the fund's sustainability and to think about expanding the concept to a new country or region. d. Last but not least, the deal has to be simple. Most of the entrepreneurs have a very limited understanding of ﬁnance, and the deal has to be easy to explain and understand. The deal structuring discussion starts amidst the most generic terms possible, comparing the pros and cons of debt and equity in the context of small enterprises in Nicaragua. The fact that the IADB is providing limitations as to how to use the available funds forces Agora to invest in enterprises partly through debt. The issue then is whether to make the remaining part of the investment in the form of debt, equity, or something in between. Agora's management leans toward an equity option because of a simple market-based consideration: If the local banks are not able yet to avoid charging prohibitive interests of up to 45% for their loans in order to be proﬁtable, Agora cannot imagine a reason to do any better. Only by capturing the upside of an equity-like investment, while providing the entrepreneurs with the capital they require to start their ventures, Agora has a chance to succeed. Also, the Agora management believes that they can add more value to the new ventures as strategic investors than as bankers. Even if the managing partners agree to invest in equity the unconstrained part of the fund, some other parameters require further analysis. Ben and Ricardo want to further examine three drivers: 1. What type of position to take in the new company (majority versus minority stakes) and which mechanisms to put in place to keep enough control over the management of the enterprise while giving the entrepreneur total operational control. 2. How to guarantee an exit in case the traditional routes are not available.
3. To what extent to allow individual investors to partake in the investment on a purely commercial basis. 4.1. Majority versus minority positions Even though the average investment required rarely exceeds US $100,000, the management believes that very few entrepreneurs can come up with even 20% of the needed equity. Even assuming a 25% sweat equity stake (stock rewarded to the entrepreneur), the entrepreneur is unlikely to reach majority (51%) ownership. A clear opportunity presents itself to enter the investments with a majority stake, which could guarantee reasonable returns to Agora, as well as complete control over the operation. For at least an initial period of time, the entrepreneur will follow the directives set by Agora, assuring implementation of the agreed-upon business strategies. However, the Agora management is afraid that, given the scarce entrepreneurial culture in Nicaragua, many entrepreneurs can feel threatened by the idea of giving away a majority of their company, no matter how quickly the deal is planning to give back the ownership. Another fear is that those who accept the deal will feel like Agora employees rather than business owners. A risk exists that the entrepreneurs will lose incentive to maximize their effort in the start-up phase and that some of them will eventually end up quitting in favor of a salaried job that will provide them with an easier lifestyle and fewer responsibilities. Ultimately, the Agora team supports having a minority position, albeit protection by a series of rights provided by clauses attached to preferred shares. In case the entrepreneur cannot come up with enough capital to reach a majority position, Agora will take a majority stake, always making sure through incentives and shareholders' agreements that the entrepreneur feels completely in charge of his operation. 4.2. Dividends-based exit How to exit investments is a major issue in the worldwide venture capital market. In the case of the Agora investments, this issue is potentially even more severe. Given the development level of Nicaragua's equity capital markets, the Initial Public Offering (IPO) option is not a feasible exit strategy. Management leveraged buyout could be an option for those companies that achieve a certain size, enabling the possibility of taking commercial or assisted debt on the balance sheet to buyout Agora. In this respect, if Agora proves to be a successful concept, the IADB or another multilateral bank could consider providing the single enterprise with leverage in favorable conditions. Finally, is possible that a strategic buyer may want to acquire one of the businesses in Agora's portfolio at some point. With CAFTA in place, some of the large, Central American wholesalers and distributors could look at vertically integrating some of their businesses. At the same time, for service-oriented businesses, acquisition by a foreign investor hoping to expand revenues might be an option. But after deeper consideration, the Agora team believes traditional exits are a possibility but are not a true option on which to rely. For such a reason, they are looking into a dividend-based exit. The main idea is that when the cash situation and the forecast for cash requirements in the coming years is good enough, the company will pay dividends. The actual amount of dividends disbursed must be a proportion of the cash requirement for the following year, so as to not cash-starve the business in the ﬁrst years of development. The entrepreneur will receive his share of dividends and use the money to buy back Agora shares until the entire stake is bought. In other words Agora will hold a put option on each of the fund's shares that Agora can exercise every year in an amount equal to the dividends that the entrepreneur receives for that year. Several possibilities about how to structure the deal in this case are available; however, they differ in terms of how much downside
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protection and how much possibility to capture the upside, in case of major success, they offer. Agora management is focusing on three of them. For the purpose of illustrating the dynamics of the different structures consider a company requiring a total capitalization of US $130,000, of which $100,000 is in equity and $30,000 in debt. Also, consider in all three situations that the entrepreneur contributes to the capitalization with US$10,000. 4.2.1. Preferred shares with ﬂoating appreciation, ﬁxed sweat equity In this case, the capitalization of the company is US$10,000 from the entrepreneur and US$90,000 from Agora. The entrepreneur receives 15% sweat equity upon disbursement of funds, increasing his company stake to 25%. The entrepreneur uses this amount to purchase back Agora shares at book value, provided that Agora is willing to sell. This option clearly exhibits beneﬁts for the entrepreneur. Also, in case the company growth rate suggests a signiﬁcant increase in value, Agora can choose to maintain the investment until the opportunity for a proﬁtable exit through sale materializes. But this option provides limited downside protection. For example, should the book value of the equity remain contained; the entrepreneur will buyout Agora at a relatively cheap price. Regardless of these considerations, the level of sweat equity must be set such that, on one hand, provides a beneﬁcial deal to the entrepreneur and on the other, would not overly dilute Agora's ownership. 4.2.2. Preferred shares with minimum appreciation The capitalization structure for this case is similar to the ﬁrst. However, a minimum appreciation rate is set for the Agora shares' value. The entrepreneur receives sweat equity equivalent to 10% upon disbursement of the funds; and an additional 10% as a performancerelated bonus for years 2 to 5 of the investment, in four trenches of 2.5% each. The set dividend amount is split between Agora and the entrepreneur, who again uses his share to buy back the appreciated preferred shares. To calculate the share price they use either the yearly book value appreciation rate or the minimum pre-deﬁned appreciation rate, whichever is higher. This option offers a downside protection for Agora in case the book value of the equity grows slowly. However, the question of what is a fair minimum appreciation rate, given the lower protection from the downside compared to a pure debt instrument, needs an answer. At the same time, Agora needs to incorporate the lower risk compared to an equity situation. One possibility is to set this level at 20%, which will make the equity cost only slightly more than the debt instrument cost for this class of investments. Similarly to the previous option, Agora needs to deﬁne an optimum value for the sweat equity. (Actually, in this case Agora needs to deﬁne two different values: one for the initial sweat equity and one for the performance-related stake.) 4.2.3. Mix of preferred shares with ﬁxed appreciation rate and common shares In this case, the capitalization structure is more complex, since Agora invests US$62,500 in preferred shares at a ﬁxed appreciation rate and US$27,500 in common shares. The entrepreneur receives 15% sweat equity in common shares, thus owning 2/3 of the total common stock, which would total 25% of the company value. In order to allow the entrepreneur a faster buyout, each preferred share only receives half of the dividends that their value ownership will permit. As with the previous cases, the entrepreneur must use his share of dividends to buy back the preferred shares. Once this operation had taken place entirely, Agora also owns a put option on common shares, with a strike price equal to the book value. This structure captures some of the upside in case the company is very successful; while providing enough protection on the downside through the ﬁxed appreciating element. With participation in both classes of shares, a more sophisticated control structure can be set, which
gives the entrepreneur more control over certain decisions and leaves Agora with more control over others (through the preferred element). But this structure forces Agora to deﬁne upfront how much to invest in preferred shares with ﬁxed appreciation and how much to keep in common shares with book appreciation. This could limit the amount of upside that Agora could capture. Another disadvantage is that the structure's complexity may intimidate some entrepreneurs. As per the other options, Agora must set the appropriate level of sweat equity for the entrepreneur upon establishment of the company by-laws. 4.3. Third party investments While talking to donors and investors involved in the fundraising efforts, the Agora management has come across a number of private investors showing a particular interest in one individual venture, believing that this speciﬁc opportunity offers signiﬁcantly more potential than the others. Some of Agora's advisors think, though, that a conﬂict of interest can arise from allowing these third-party investors into the game, because both the donors and Agora are targeting a double-bottom line while the third-party investors are seeking pure ﬁnancial gain. The Agora team is considering three possibilities: 4.3.1. Unlimited participation In this case, no limit is set to third party investments at any time. Beneﬁts of this option are that Agora limits the exposure on a given investment and receives wider exposure to the commercial investors' arenas. Concerns about this option have to do with the donors' community that is backing Agora. The considerable overhead that Agora will have to staff in order to provide all of the necessary support to the entrepreneurs signiﬁcantly affects the returns for these organizations; the third-party investors will “free-ride” these investments and potentially make returns as in a standard VC situation. Agora management also must consider the US Internal Revenue Service (IRS) in order to protect Agora's charitable status. Additionally, in this case decisions will not depend only on Agora and the entrepreneur, but also on the third party investor. 4.3.2. No participation To avoid any potential conﬂict of interest, the clean-cut solution is not to allow any third-party investment in the enterprise until Agora completely exits the business. While this is perfectly in line with the not-for-proﬁt mission, not allowing third party investments also limits the enterprise's capitalization and potentially cuts off eventual exit opportunities (in the case that the third-party investor decides to buyout Agora). 4.3.3. Limited participation An intermediate solution, consisting of capping the allowed thirdparty investor participation to 20 or 30% in the equity structure seems like a reasonable compromise, even though this middle ground still presents all the issues inherent in the unlimited participation method. 4.4. The portfolio approach When evaluating each investment, Agora only seriously considers those that can deliver 25% IRR. The standard VC experience suggests, however, that a number of external factors (i.e. economic cycle and the incumbency of a competitor that monopolizes the market) as well as internal factors (i.e. over-optimism in the development of the revenues forecast and technical or ﬁnancial mismanagement of the company) can lead to unexpected results. In the case where Agora invests part of the fund as debt, the question of what IRR to commit to is less of an issue than in other cases. Agora needs to deliver the borrowed funds with an appreciation equal to the interest rate at which they received the loan (5.0–6.0%). The key issue in this scenario is how to determine the interest rate
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Agora needs to set for the entrepreneur to make sure that, once the default situations are taken into account, the overall return on the portfolio is in the range of 5.0–6.0%. However, Agora does not want to lose money on a debt that they are simply “transferring” from the IADB to the entrepreneurs. Additionally, Agora does not want to overcharge the entrepreneurs. Especially in the case of leverage, each additional percentage point Agora charges translate into cash coming out of the business, and consequently reducing the growth opportunities. This cannot only hinder the potential for the enterprise to be cash-positive every year; but less cash also can lead to a signiﬁcant reduction in the equity value, which Agora is undoubtedly trying to develop. For equity investments, both foundations and private donors usually provide not-for-proﬁt organizations with grants and do not expect to monitor anything but the social impact that their disbursements generates. However, Agora is pushing for a market-based dynamic to demonstrate the model's ﬁnancial sustainability and the aspiration to later harness the angel investor community. Committing to a low IRR (in the low single-digit range) means increasing the likelihood for success. At the same time, a low IRR also means delivering a strong signal with respect to the model's limited capability to deliver commercial returns, which limits future access to the desired investors. Conversely, committing to a higher IRR might give Agora faster access to the angel investor arena, but a higher IRR also increases the likelihood of failure in delivering the target. Whatever deal structure is set in place, the issue is to try and predict the actual performance of each investment and associated cash ﬂows, which can provide an estimated portfolio return. Agora's team is acutely aware how difﬁcult this is.
5. Conclusion Agora's managing partners know that the upcoming Investment Committee meeting is particularly important for the organization's future development. They have to provide arguments to the Committee members that can convince them that the fund will create successful ventures, but also that Agora have an exit plan. Aside from being able to ﬁnd outstanding entrepreneurs with promising business ideas, they have to answer the following two ﬁnance-related questions: Which dividends-based structure to put in place to guarantee a fair deal to the entrepreneur but also a good return on each investment, given the extreme volatility of each portfolio company's performance? And, to what extent should they accept third-party investors? After that they will have to discuss the performance of the fund, where the following issues remain unanswered. What IRR should the donors/investors expect to receive for the equity portfolio? And, what returns on the debt and equity should Agora seek from each investment to achieve the committed IRR on the debt and equity portfolios? Should they even set a target IRR for the fund? Answering these questions also involves understanding the nature of the capital sources that are investing in the Agora Fund. References International Finance Corporation. Doing business in 2005: removing obstacles to growth. International Finance Corporation; 2005. 2006. Inter American Development Bank. The business of growth, economic and social progress in Latin America. Johns Hopkins University Press; 2001. 2001.