Long-term risk-tolerant finance is widely recognised as essential for the achievement of the UN SDGs.[1] The economist Mariana Mazzucato argues that mission-oriented development banks play a crucial role here. BII’s mission is clear.[2]
We pursue our mission by investing patient public capital – that means we are willing to support business plans that take a long time to generate the earnings needed to repay the initial investment. When we agree a loan, we are prepared to schedule repayment over decades. When we invest equity, we will support management to execute more impactful long-term business plans and do not push them to engineer short-term earnings to help us sell quickly.[3]
At the same time, we do not want to hold assets for longer than is useful. If we can recycle our capital without loss of impact, we will. But we must also realise a fair value for our investments. Because we recycle our returns into new investments, the money we realise enables future impact. Getting back as much money as possible, without doing harm to impact, is therefore not only responsible stewardship of public funds, but integral to maximising our impact over time.
How we take exit decisions
Our ability to choose the timing of exit depends on the nature of the investment. For instance, we cannot simply renege on our legal agreement with a borrower and demand early repayment because we no longer want the loan in our portfolio. Likewise, many of our investments are made through partnerships with other financial institutions. We do this for two reasons: we want to reach more and smaller firms than we could do by ourselves alone and we want to build local institutions that can invest domestic savings in the real economy. These partners aim to return our money within an agreed period, but within that they are empowered to decide when to exit from the investments they have made.
For investments we hold directly and where we can decide when to sell, each sector team conducts annual assessments of the impact and commercial rationales for an exit. From an impact point of view, we think about whether our continued presence as an investor will make a positive contribution to the future impact of the business. We do not sell because impact has been ‘achieved’ in the sense that a predetermined impact target has been met – we might sell before, if we thought that impact would be achieved without us, and we might hold afterwards, if we thought our presence was important for further impact. From a financial point of view, we consider whether we would be likely to recover more money if we wait. Our Responsible Exit Guidance, which addresses how impact will be sustained after our exit, is outlined on page 28 of this document.
Comparison with grant-funded developed projects
For some observers, it is hard to understand why a DFI would have an investment in its portfolio that it would not make today.[4] That may be because they are thinking of an investment as they would a grant-funded development project. For grant-funded projects, as a rule, once the money stops, the project stops. When a project is performing badly or is no longer “on strategy” the funder can shut it down. Investments are quite different. Investment involves an initial disbursement of capital, which the company (hopefully) uses to create a commercially sustainable enterprise. Exiting from an investment is not about stopping something, it is about getting money back to invest again. That introduces considerations that simply don’t apply to grant-funded projects.
As mentioned above, the repayment schedule for loans is agreed in advance. But for equity investments, getting our money back usually requires negotiating a sale. DFIs are generally not trading assets in liquid markets. Finding a buyer is not always easy and on occasions when only one suitable candidate can be found, a DFI’s only bargaining chip is to decline their offer and hold out for a better price. That means we must avoid being perceived as a “forced seller” once an investment is no longer one we would make today. Having to exit historical investments as soon as they move “off strategy” would put BII in a bad bargaining position and risk giving away millions of pounds that could have been recycled into future investments.
Evolving additionality
The concept of additionality is at the heart of development finance. We call it our “contribution” – it’s about more than providing something that the private sector would not, it’s about how those inputs contribute to impact. We do not make an investment unless we have reason to believe – at the point of investment- our capital, or influence, is contributing to development – for more on how we do that, see here.
What additionality means in the context of exit decisions, however, is rather different to what it means at the point of investment. The recent International Development Committee report on the UK’s strategy towards Development Finance Institutions recommended that “BII must annually assess the value it adds to investee companies. Where BII has not proven its additionality to an investment or its case for additionality is no longer valid, BII should exit that investment.”[5]
Naturally, after we have invested, the case for additionality – what we are bringing that others would not – is something that evolves over time. As explained above, we will consider an exit once we think our presence as investor is no longer contributing to the impact of the business. It is not about asking whether the business would still need our support if raising money today. Exit decisions are not about the additionality of a hypothetical new investment in the business.
Even if a business can now raise money from private investors, our presence as an investor could still be contributing to impact. We might be actively engaging with the business through our ESG, climate or gender and diversity teams. Our presence as a patient and impact-oriented shareholder might be enabling management to pursue a business plan that purely commercial shareholders present in the business would oppose. Sometimes we remain as shareholders for a while, to help a business raise new funds from private investors.
A lot at stake
Whether a historical investment would be made today, or whether that business would still need to raise money from DFIs today, our approach to taking exit decisions is the same: it is about whether we are still enabling impact and can protect impact after exit, and then it is about whether we can secure a fair price.
Sometimes we wait a long time for valuations to improve. We do not always get that right – nobody knows how to time markets perfectly – but our investment professionals have that responsibility. There can be a lot at stake – our investments in the Indian financial sector, for example, saw valuations tumble after a crisis in 2020. Since April 2023 the Indian stock market has surged.[6] If we had sold investments while valuations were depressed, we would have forgone tens of millions of taxpayer dollars that could have been recycled into new impactful investments.
BII fulfils its mission by providing patient public capital. Finding the right time to exit needs patience too.
[1] Here is an example op-ed on short termism and a report.
[2] BII is not a bank, which connotes an institution that borrows to finance its assets. BII is a public limited company with the UK Government as sole shareholder.
[3] BII is active in many different market segments and is responsive to the needs of our clients. Not everything we do is long-term, some instruments are intrinsically short-tenor but can be rolled-over, such as trade finance facilities, and at other times businesses may require bridge finance or other short-term instruments.
[4] Recommendation 12 in the IDC report includes the words “BII must divest from those investments that … do not align with the International Development Strategy”
[5] The FCDO response to these recommendation can be read here.
[6] The valuations of privately held investments are tied to the valuations of comparable publicly traded stocks.
