Impact Investing for Green and Inclusive Business
Green and inclusive businesses need finance - impact investing can provide this. Discuss with us along seven hot topics why impact investors and green and inclusive businesses are a perfect fit and how they could be better matched - from new kids on the block to the super-heroes in the field.
Green and inclusive businesses, like all businesses, need finance. They can go to normal banks – or tap the growing pool of impact investments – “investments made into companies, organizations, and funds with the intention to generate measurable social and environmental impact alongside a financial return” (as the Global Impact Investing Network defines it).
With an estimated stock of USD 36 billion and USD 9 billion in planned investments in 2013, the market for impact investing is still relatively small, but growing steadily. Demand for capital for the greater good was increased by the global financial crises in 2007-2008 and related pressure on government budgets as well as other drivers of the impact economy: the need for increased resource efficiency and green growth, the pent-up demand at the “Bottom of the Pyramid” as well as the rise of “lifestyles of health and sustainability” consumers.
Hot topic 1: Why is there a need for impact investing?
Impact investors have started to go where no one else wanted to: To businesses aiming for a social and/or environmental impact, that often face difficulties attracting investors and long-term debt. First, (venture) capital markets and products in many developing and emerging countries are not yet well developed. This results in insufficient supply of capital and lack of market infrastructure to ensure a smooth flow of capital and information between potential investors and investees. Second, green and inclusive businesses typically apply new technologies or pioneer business models with short track records. Margins are lower and more volatile and investment size is often comparatively small. Projects with a social mission rely on diverse stakeholders and often take longer to scale. Some of the social and environmental benefits generated cannot easily be monetized since customers will not pay for the social or environment services provided. Last, value gaps between investors and impact driven organisations can make or break deals – as a green entrepreneur in Turkey told me recently: ‘they have no clue about the impact we are trying to achieve, and they don’t care about it at all’).
Hot topic 2: The new kids on the block: different motivations, same objectives
Investing for social impact has once been the domain of Development Financing Institutions (DFI) and investment funds funded by multi- and bilateral DFIs. Not any more. The growing market increasingly attracts new investors targeting the ‘missing middle’: Investment funds, social business angels, philanthropists or foundations, large companies or civil society actors alongside professional and institutional investors and governments. They have similar objectives but different motivations to get involved. Asset owners demand that their investments not only minimize risk, but actively create social and environmental value. Philanthropic or civil society organisations see impact investments as a way to increase the impact of their philanthropic contributions. Angel investors consider early stage investment in social or green ventures in order to align personal values with business interests. The corporate world increasingly realises the huge potential of partnering or investing in social ventures to access new market segments and diversify their income stream. And governments facing budget pressure and criticism on their effectiveness in tackling long term challenges have an interest to make social innovation work.
Hot topic 3: Attract more (diverse) sources of capital for impact
Some old school investors may be concerned by the growing ‘competition’. But visionaries see the emergence of new players as an opportunity: Many entrepreneurs look for financing that reflects their ‘hybrid’ character. Governments and development organisations recognize that ‘nobody can do it alone’. Layered financing structures, leveraging on philanthropic or public financing using catalytic first loss capital will bring together investors with different risk/return profiles and increasingly attract private capital for social impact in emerging and developing countries. Co-investments, pooled financing, or hybrid financing structures will be more and more common, and more collaboration across traditional boundaries will be needed. I expect that one interesting source of finance (and support) for impact in the future will be diaspora investing, i.e. investing by diaspora communities around the globe who want to engage in the development in their home countries in a more meaningful way.Furthermore, in addition to international funds, businesses and organisations, local leaders in business, finance and civil society will engage in impact investing and inclusive business activities such as Aavishkaar Venture Management Services and Intellecap in India - both represented at the IBF - as well as the Tony Elumelu Foundation in Nigeria or Vox Capital in Brazil. And - possibly related to the two above trends, the emergence of diaspora investing and local investment champions - I hope to see more and more debt and equity crowd-funding mechanism outside the microfinance sector that aggregate and channel investment to green, inclusive businesses and social ventures.
Hot topic 4: We can’t have it all. Or can we?
To many (including in Turkey) investing in an organisation driven by a social mission and expecting a financial return is a contradiction with a strong moral dimension. In a ‘Muhammad Yunus type’ social business investment, the investor gradually recoups the principal but should not earn dividends. To many others, investment in the environment or a business models that seek change in society automatically imply increased costs and thus a considerable trade-off between profits and impact. The big promise of impact investing is that a mandatory trade-off does not exist: Both impact AND financial returns would be possible. Nikolaus Hutter, MD of Toniic network argues, for example, that “creating environmental and social impact is a deep source of long-term value, competitive advantage, and growth opportunity for a business, rather than a drag on your financial returns.’
Hot topic 5: Doing good – and proving it well
Investors increasingly ask for their fund managers and investees for accountability and measurable impact. We thus may see more fund managers’ remuneration linked to their performance on impact – in addition to financial returns. Internationally agreed and consistent standards as well as harmonised impact measurement and reporting will continue to remain a challenge (e.g international Impact Investing Reporting Standards IRIS) as will be attempts to fit to the specific local circumstances at the national level. Impact measurement, reporting and story- telling will also create the data that is required to attract institutional investors and other more risk-adverse investors.
Hot topic 6: Waiting for super-heroes is not enough
Many impact investors have capital to deploy but suffer from a lack of investable mature business opportunities. At the same time, social innovators, in particular early stage ventures often struggle to get business ideas off the ground or reach scale due to lack of capital, access to networks and capacity. To many impact investors it has become clear that waiting for a deal pipeline of investable ‘superheroes’ is not enough. I agree with Matt Barnick and Paula Goldman of Omidyar Network that we need to “prime the pump” to see impact at scale. This requires effective and sustainable accelerators and other market infrastructure providers such as basic research, training, rating or investment advisory services. Both topics will be discussed in the Finance Session on Day 1 of the IBF workshop.
Hot topic 7: Government as direct market participant?
Last, more attention will be paid to government’s role in impact investing.
This includes the difference a visionary government can make in influencing social impact markets and attracting impact investors as well as innovative interventions to promote social innovation. The Ghana Venture Capital Trust Fund, for example, established by the Ghanaian government in 2004 as a fund-of fund to help promising SMEs increase access to private equity, is one of many speakers to share their story at the IBF. We will also hear about the DFID Impact Programme which includes a £ 75 million fund of fund for impact investments in Sub-Saharan Africa and South Asia. Check out the Impact Investing Policy Collaborative for more interesting case studies