Harvest Contract Vehicle for Smallholder Tree Financing

About

Agriculture, land use, and forestry are responsible for 75% of Kenya’s GHG emissions, and forestry has been identified as the largest source of abatement potential. In addition, Kenya has high vulnerability to drought and flooding, especially for the poorest who are reliant on natural resources for their livelihoods. Finally, Kenya is experiencing a wood supply shortage, currently met through imports and illegal deforestation and reflected in increasing prices. This shortage is expected to continue as the economy grows and the government increases enforcement of deforestation. Moreover, these trends are not confined to Kenya, with demand for wood across the African continent increasing 5-7% per annum as a result of increasing urbanization and population growth, with only 10,000 new hectares planted annually, compared with a need for 300,000 hectares (Criterion Africa Partners, 2017).

While agroforestry, increasing tree cover, and sustainable land use have all been identified as key elements of Kenya’s climate change goals, there are three critical barriers preventing investment. The first key barrier is a lack of available land to expand forestry, especially plantation forestry. Second, while restoring degraded land in partnership with smallholders is a critical pathway for addressing this shortage, smallholders typically lack access to inputs, skills, and market linkages to sell timber products. Finally, investor risks specific to forestry are compounded in developing countries, especially the long time horizon of growing trees and lack of access to long term, low cost capital.

The Harvest Contract Vehicle seeks to scale up smallholder forestry in Africa to address climate change, wood supply shortages, and poverty, through an innovative mechanism that allows investors to buy portfolios of trees.

The Harvest Contract Vehicle addresses barriers to smallholder forestry through several key components. First, the Harvest Contract Vehicle partners with a smallholder forestry company to provide critical inputs and training to farmers to plant trees on unused, typically degraded land. The Vehicle then packages a portfolio of tree contracts, creating an investment vehicle suitable to long term investors. The forestry company partner harvests the trees and provides the necessary market linkages. Smallholder farmers build wealth and climate resilience by maintaining the tree assets and receiving payments at for thinning and harvest.

The expected smallholder forestry partner company for the pilot Vehicle, Komaza, has a 10-year track record building its business and working with smallholder farmers in Eastern Kenya. Komaza has collected data on its tree performance to date in order to develop the necessary baseline for establishing the Vehicle. The implementation of the Vehicle is expected to create wealth for farmers, restore degraded land, increase soil quality and water retention, and sequester carbon. Other potential nearby markets that could benefit from the Vehicle in the future include Tanzania, Mozambique, Rwanda, Ethiopia, and Uganda, in addition to possible expansion within other regions of Kenya.

DESIGN

The Harvest Contract Vehicle is a Special Purpose Vehicle (SPV) that will raise debt, mezzanine, and equity capital from long-term investors to purchase portfolios of trees planted on smallholder farms.

Each portfolio will consist of 1-3 vintage years of tree contracts. The tree contracts will be sold to the SPV by a smallholder forestry company (the “Company”), in exchange for an upfront payment. The Company is responsible for growing seedlings, working with farmers to plant the seedlings, maintaining the trees over time, and finally the harvest, processing, and sales of the trees. The Company sells the tree contracts to the SPV after approximately one year of growth, the highest mortality period. The SPV contracts with the Company for the continued maintenance of the trees. The SPV-financed activities associated with tree maintenance are accounted for separately from the Company’s other activities, separating the risks. The Company manages the sale of the trees after harvest, with proceeds going directly to the SPV, which then disburses to investors according to a pre-agreed waterfall.

Revenues between planting and final harvest would include thinning around years 4-6, and possibly other impact-related incomes such as carbon credits.

The first proof of concept fund will raise in the range of USD 10-30 million. To launch this proof of concept, the Vehicle will target investors for two to three tranches – a senior position that accepts fixed returns in exchange for lower risk, and a likely guarantee from a development agency, with private investors and Development Finance Institutions; a mezzanine position with higher returns and similar investor classes, and a junior equity or first loss tranche, which the Company will also participate in, alongside other concessional investors.

Once proven, the Company would seek to launch follow-on vehicles every 3-5 years, each around USD 30-50 million fund size and covering 10,000 hectares of planting at a time.