Impact Investing - Win-win-win for Entrepreneurs, Investors & Society (Part 1)
There’s a new kid on the block. Impact Investing. This is the first of a two-part on this trending topic.
“The first question we ask ourselves when evaluating a new investment opportunity is: If this company becomes successful, will it make the world a better or more interesting place?”
This statement self-describes a pair of little-known investment funds which have invested in well-known mission-driven companies such as AltSchool, Reddit, and Kickstarter.
“We are Venture Capitalists and Impact Investors. We invest in companies that can deliver top-tier venture capital returns and enable social, environmental and economic benefits. In fact, we believe healthy financial performance and positive social change are inherently connected. That’s why we invest in and help nurture outstanding entrepreneurs and companies in Cleantech, Information Technology, Health Care, and Sustainable Products and Services.”
This statement self-describes a little-known investment fund in the heart of Silicon Valley that has invested in well-known mission-driven companies such as Tesla Motors, Brightsource Energy, Pandora, Space X, XDx, Solar City, just to name a few.
Everyone in finance is talking about “impact investing” and for good reason. Good companies expand, investor returns are exciting, and humanity benefits. This is a real trend that everyone in business and finance should understand.
If you are the visionary founder or executive of an innovative company, you above all should understand this trend. Chances are good, though not certain, that your vision intends to make a positive difference in the world, not just financial returns. If so, chances are you’re a candidate for some of the hundreds of funds that specialize in impact investing. Even more exciting, chances are you’re a candidate for some of the tens of thousands of wealthy individuals, family foundations and endowments who, flying under the radar, support companies that make a positive impact. This is a good reason to read on.
The primary purpose of this post is to motivate you as an innovative entrepreneur to make a positive impact an intentional part of your mission, then properly position your company in terms of its projected positive impact and then to learn how to find, motivate and close deals with impact investors.
As a second purpose, I want to remind investors of the advantages of investing in companies with measurable positive impact, if you don’t already know these advantages.
I’ll cover this material by asking and answering many questions that you may have on this topic:
What is the definition of “impact investing?”
This definition is provided by the Global Impact Investing Network (GIIN):
Impact investments -- im·pact in·vest·ments
“NOUN: Investments made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return.”
“Impact investments can be made in both emerging and developed markets, and target a range of returns from below market to market rate, depending upon the circumstances.”
“The growing impact investment market provides capital to address the world’s most pressing challenges in sectors such as sustainable agriculture, clean technology, microfinance, and affordable and accessible basic services including housing, healthcare, and education.”
Does everyone agree on this definition of “impact investing”
There is a wide range of definitions of “social and environmental impact.” As you can see from the funds described at the beginning of this post, “impact” may be narrowly defined or broadly defined, depending on the difference that the investor wants to make.
Impact investing overlaps with “socially responsible investing” or SRI. As Wikipedia states, SRI, “also known as sustainable, socially conscious, "green" or ethical investing, is any investment strategy which seeks to consider both financial return and social good.”
That sounds like the definition of impact investing, but SRI is primarily a strategy for investing in public stocks and bonds.
From Wikipedia, “In general, socially responsible investors encourage corporate practices that promote environmental stewardship, consumer protection, human rights, and diversity.” Some practitioners of SRI take an “avoidance” approach, avoiding businesses involved in what they consider to be socially destructive industries such as pornography, gambling, alcohol, tobacco, contraception, non-sustainable energy and weapons production. In this way, SRI differs from the newer movement toward impact investing.
In contrast to SRI, impact investing is pro-active, seeking well-defined and positive changes in the world. Impact investing is also frequently associated with investing in emerging growth companies which have one or few product lines and therefore can define their impact clearly.
The definition of impact investing becomes blurry in technical areas such as energy, health/bio-tech and automation, where social and economic justice is not the main issue. For example, is investing in a new treatment for Type 2 diabetes considered an “impact investment?” Is investing in a self-driving car an “impact investment.” Is investing in a new type of “social media” an impact investment?
The best answer to this is that the investor defines the desired impact. If an investor wants to see greater social engagement throughout the world, then it’s possible that social media may be an impact investment.
How do I define “impact investing” and “impact investment?”
I think that both investors and the community at large need more than just a promise of impact. They want to know that there is a measurable impact that is both quantifiable and rationally projected, based on facts and economic trends.
In order for a company or fund to be considered an “impact investment” I believe it must meet the following criteria:
- The impact must be positive according to a significant population of investors.
- The impact must be intentional – built into the mission of the company in addition to financial returns.
- The impact must be measurable; i.e. there have to be well-defined performance metrics for the desired impact.
- There has to be a way to rationally, quantifiably, project the impact performance metrics into the long-term future.
GIIN supports our views with the following statement:
“In general, components of impact measurement for impact investing include:
- Establishing and stating social and environmental objectives to relevant stakeholders;
- Setting performance metrics/targets related to these objectives using standardized metrics wherever possible;
- Monitoring and managing the performance of investees against these targets;
- Reporting on social and environmental performance to relevant stakeholders.”
I agree that investors will insist not only on measurable impact, but the on-going monitoring of the desired impact metrics and reporting on this performance periodically.
Why should investors seriously consider impact investing for a large portion of their assets?
This question is addressed to investors reading this blog who have not yet committed significantly to impact investing.
Impact investing challenges the commonly practiced paradigm that philanthropic donations and investing are separate operations with separate objectives.
A “paradigm” is defined by the questions asked. In the traditional paradigm, we ask non-profits what are the measurable positive impacts they intend and what will be the measurable impact of our donation. For the rest of our assets, we ask a different set of questions day-to-day: For example, we ask, what are the projected financial returns and what risks will be incurred? How long will we likely have to wait for a liquidity event? We also ask difference questions about the management teams, markets and business plans.
In the new impact investing paradigm, we ask all these questions about each investment opportunity. Though the due diligence is more complex for each investment opportunity, the total amount of analysis across an entire portfolio is not much larger. It’s worth doing.
This is because impact investing offers viable opportunities for investors to advance our desired changes in the world through investments that produce both financial returns and measurable positive impact.
What kind of financial returns can impact investing generate?
This question is asked by both impact entrepreneurs (“impactreneurs”) and by impact investors. Impactreneurs want to know if they can get away with predicting reduced financial returns if they can generate measurable positive impact. Investors want to know what they can expect from investing in impact-driven companies.
There’s no one answer for the entrepreneur. Impact investors report a range of financial return requirements. Some knowingly invest with reduced returns expected or with higher risk in order to take advantage of an opportunity to maximize a desired impact. Others openly pursue risk-adjusted market-level returns. Some are required to do so by their fiduciary duties. Most investors surveyed by J.P. Morgan pursue competitive, market-rate returns.
Given these survey results, it’s clear that a larger population of investors can be reached if a company seeks and projects market-rate returns. This is particularly important in the area of impact investing because impactreneurs will be more attractive to investors who share their mission and the impact they hope to make. Since the population of relevant investors is thereby reduced, it’s important not to further reduce your attractiveness by promising below-market rate returns. This makes sense.
As will become apparent later in this blog post and the ones that follow, there is really no good reason not to seek market-rate returns.
From the investor’s point of view, can impact investments really generate market-rate returns?
The data is overwhelmingly positive, that impact investments can and do generate market-rate returns. The following is from the JP Morgan survey cited earlier:
From a more recent and thorough study of private impact investment funds commissioned by GIIN and carried out by Cambridge Associates:
Except for a handful of very high-return funds, impact investing generates financial returns on par with or even higher than the general purpose (non-impact) funds of similar size. For example, 20% of surveyed impact investment funds achieved internal rates of return (IRR) from 0% to 5% vs 14% for general funds. 33% of surveyed impact investment funds achieved IRR of 5% to 15% vs 32% for the general funds. In other words, results are similar.
Only in the rarified air of IRR greater than 15% do non-impact funds out number impact funds. 12% of impact funds report greater than 15% IRR while 21% of general purpose funds report like results. This should not influence our decision, since the sample size is small and results like this are not repeatable.
On the downside, impact funds seem to be preferable as well. Only 10% of impact investment funds report a return of -5% to -15% IRR while 21% of general purpose funds report such negative results. Reporting losses greater than -15%, the two groups are about equal (6% for impact investing funds, and 5% for non-impact funds.) If you’re concerned about downside risk, impact investing has the advantage.
The entire report is available for download from the Intelliversity library, entitled “Introducing the Impact Investing Benchmark.pdf.” Click here to download article
Why do impact investments perform on par with or better than non-impact investments?
This is the subject of much debate and a research paper is warranted. My theory is that a passion for impact increases the motivation and staying power of the founders and executives of emerging growth companies. A passion for impact may also influence the selection of team members and the ability of the team to work together. Your shared passion may result in a cohesive collaborative corporate culture reducing the incidence of destructive corporate politics. The passion for impact may even result in greater support for and help from spouses and other family members. In sum, as most investors know, the composition and motivation of an executive team correlates highly with business success.
What do the above results mean for impact entrepreneurs?
Since impact investors have good reason to expect market-rate returns or near market-rate returns, as an impactreneur, you should find a way to project and actually generate market rate returns or near market-rate returns.
Of course, the returns that you can predict must be adjusted by risk. If you are operating an emerging growth company or a startup, the risk is large and growing as perceived by investors. The risk perceived by investors is largely the risk of your company never exiting and therefore never providing liquidity (the payoff desired by investors who buy equity.)
GIIN reports the following survey results of investors on the question of what kinds of risk do they perceive in impact investments:
As an impactreneur, if you can significantly reduce the perceived risk in the first three categories, your financial returns will be more highly valued by investors.
How to reduce risk as perceived by investors, using methods such as revenue royalties, will be covered in the following blog post.
Who is engaged in impact investing today?
The range of investors involved in impact investing has increased to cover the entire range of investor categories:
- Pension funds
- Private foundations (family foundations) – over 87,000 in the U.S.
- High-net worth individuals
- Single-family family offices (SFOs) with or without foundations
- Multi-family family offices (MFOs)
- Registered investment advisory companies (RIAs)
- Educational endowments
- Religious endowments
- Insurance companies
- Community development institutions
- Hedge funds
- Private equity funds
- Mutual funds
Is this trend (to impact investing) based on fact?
There’s no doubt that many investors and investment funds are interested in companies that promise measurable positive impact. Here are some data points worthy of your attention:
ImpactBase, a subscription database managed by the Global Impact Investing Network (to which I subscribe) has 2059 accredited investor subscribers and lists 355 investment products (funds) managing $25 Billion of committed capital, with significant diversity across asset classes and global regions.
The GIIN Leadership Council is a senior group of Impact Investors with $60 Billion under management intended for impact purposes.
The most recent JP Morgan 2015 survey of impact investors revealed the aggregate impact investment activities of a sample of 125 respondents who reported a total of $45 Billion intended for impact investment.
The JP Morgan survey cited above also shows a growth rate of more than 16% per year in assets intended for impact investing. I believe the impact investing community is growing much faster than this, because this statistic takes into consideration only professional firms that have declared themselves to be impact investors, leaving out the tens of thousands of individuals, families, foundations and endowments who are taking this approach to investing.
Summary and conclusion
To summarize the above, I’ve explained and defined impact investing, showing the range of possible meanings. The investor determines what is meaningful impact. However, all impact investors have common requirements – that impact must be positive, intentional, measurable into the future.
I’ve concluded that if there is an inherent higher-purpose benefit to your company’s product or service, you may be advised to elevate the long-term positive impact to an intentional part of your mission and develop ways to measure and predict the impact. This will give you access to impact investors. I’ll dive into how this access is achieved in the next blog post.
You’ve seen that the trend to impact investing is large and growing. I’ve demonstrated that all kinds of investors and investment organizations are turning to impact investing. You’ve seen that this trend is driven by returns that are on par and often better than returns in non-impact driven companies or funds. You are advised to find ways to maintain market-rate returns while also emphasizing impact.
Finally, I pointed out that various kinds of perceived risk are still an important element when impact investors decide where and how to invest their assets. You’ll need to find ways to mitigate risk with impact investors as with any kind of investor.
For investors, I’ve observed that market-rate returns can be obtained reliably and that your personal and family mission and legacy can be achieved through your investment strategy as well as through your giving. I’ve pointed out that this process involves more extensive due diligence since both impact and returns must be assessed. On the side of impact investing, I’ve observed that this extra analysis is worth the effort and that impact investing may actually reduce investment risks overall, and may be more enjoyable as well.
Take-away (most important point to remember and apply)
Make positive impact an intentional and documented part of your mission, and then to learn how to find, motivate and close deals with impact investors.
How do you achieve these desirable results?
The next blog post on this topic of impact investing will answer the remaining key questions:
- How do you as an entrepreneur gain access to the large and growing community of impact investors
- How do you demonstrate that your impact is positive, intentional and measurable? How do you demonstrate that this impact is large and growing over the long-term, making your venture compelling?
- How do you reduce perceive risk while maintaining market-rate returns?
In the next blog post, I’ll also address impact investors’ needs to minimize risk in all the important areas such as execution, liquidity, and exit strategy. Feel free to contact me with questions on the article. robk@intelliversity.info
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Author Robert Steven Kramarz - Specializing in funding for innovative companies, impact investing, royalty finance, and executive team building, Rob is passionate about empowering innovators with what they need most for success. To this end, he’s author of the recent book The Road Less Traveled - Raising Capital without Debt or Equity. He's currently Executive Director of Intelliversity and active team member of the Water Impact Alliance, Pacific Royalties, 22nd Century Ventures and Vantera Partners. He works tirelessly to increase the amount of private funding available for innovation and impact investments.