Mini-grids are financed through grants and subsidies, equity and loans.
The choice of financial instrument and type of investor depends on the type of mini-grid (pilot or scalable model) and the stage of project development (early or late stage).
The more early stage and risky projects will probably be financed through grants, subsidies and equity, while the more advanced, less risky projects may also be financed by debt.
Grants and Subsidies
Most mini-grids rely on grants and subsidies for at least 30% of the investment costs.The grants are typically used for pilot projects, early stage development costs, capital investments and technical assistance. They come from a wide range of sources, including international development agencies, local government agencies, trusts and foundations, private individuals and others.
Most developers require capital from equity investors.There are many different types of equity investors:
- Angel investors and venture capitalists (early stage seed capital);
- Private equity and family offices (expansion capital);
- Impact investors (who look for a social and financial return and, depending on the investor, may invest very early or later stage); and
- Development financing institutions (DFIs) (which invest equity, either directly or through third party funds, and look for development impact and some evidence of potential commercial viability.
So far very few mini-grids have secured loans. The most likely loan providers in the short-term are the DFIs. They offer concessional loans which have significantly better terms than market-based loans. However, the high transaction costs of the DFIs are not well suited to small mini-grids.
Commercial banks are often risk averse and reluctant to lend to mini-grids until their business models are proven and the main project risks are mitigated.
Many African banks have limited experience in cash-flow lending and require significant collateral for lending. International lenders are often concerned about foreign exchange risks and may be put off by the small ticket size of mini-grid transactions.
The successful financing of a mini-grid may require guarantees which improve the debt or credit worthiness of the project. These guarantees help to reassure investors that mini-grids can meet their revenue expectations and honor their contractual obligations. There are two main types of financial guarantee:
- Loan guarantees, which cover full and timely repayment of a loan up to a pre-determined amount; and
- Risk guarantees, which cover all or part of a loan or investment and are paid out only if specific risks cause the default.
Foreign Exchange Risk
One of the big challenges for mini-grid developers in Sub Saharan Africa is foreign exchange risk. Most of the capital cost of mini-grids is in hard currency, while their revenues are in local currency. Mini-grids lose value in hard currency terms if the local currency loses value against the dollar. This currency mismatch creates significant problems for projects funded in dollars or euros, except for those in Francophone countries using the CFA Franc which is pegged to the euro.