Development Finance Institutions and Their Role in Private Equity Funds

3 min

Development finance institutions (DFIs) are entities that, among other things, provide capital for economic development projects. Historically, DFIs, which are founded by governments and charitable institutions, fund projects that would generally not be able to get funds from commercial lenders or invest in the private sector. DFIs are typically backed by countries with developed economies; have provided finance to private sector investments that promote development in certain countries; play a fundamental role in emerging markets (there has been a rapid expansion over the past few years in DFI investment in private equity funds); and are important to certain private equity funds, as they often act as cornerstone investors and can provide the momentum for a successful first close.

Historically, DFIs aim to invest in sustainable and profitable businesses in emerging markets and developing countries, either directly or through financial intermediaries, such as private equity funds. The purpose of the DFI model is to provide finance or capital in areas and countries where the private sector would otherwise not have access to them, and to ensure a high and sustainable impact. In this regard, DFIs can play a crucial role in moving social considerations up on the private equity industry's agenda. DFI is an umbrella term for organizations that include, among other entities, the International Finance Corporation, European Bank for Reconstruction and Development, and the Overseas Private Investment Corporation. These DFIs are known to share financial risk, provide loans, take minority equity investments, support emerging market equity funds, and provide advice to both companies and government in the developing world.

Examples of possible positive social benefits include creating employment, increasing exports, or producing a product or service that is otherwise not available. Generally, an investment in a private equity fund by a DFI has the potential to attract additional commercial capital by providing a positive signal to the market, encouraging other investors to consider investing in such a fund. One reason for this is that DFIs conduct thorough due diligence on clients that otherwise might not have been considered by private investors. Moreover, DFIs are seen to play a key role in developing private sector environmental, social, and governance (ESG) standards. And DFIs play a major role in emerging markets because they have the capacity to make long-term investments at attractive rates in markets that the private sector finds too risky to commit to. Many DFIs have increased their financial support to emerging market private equity funds and have improved the standards of local industries.

Overall, DFIs can play an important role in promoting innovation for increased competitiveness and sustained development in their client countries. Private equity funds are key players in the creation of high-growth businesses and the dissemination of their innovations. Private equity funds that focus on impact investing are able to source deals that bring about not only financial returns, but also social and/or economic benefits. DFI support of private equity funds could continue to mobilize innovation in emerging markets and foster change in various industries.