NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

In the original version of this post, the authors referred incorrectly to LGT Venture Philanthropy as “The government of Lichtenstein’s venture philanthropy arm.” LGT Venture Philanthropy is not part of the government of Lichtenstein.

Earlier this month, 35 men and women gathered in Santa Barbara to discuss how to give away a major slice of their $140 billion of personal wealth. Many had already signed on to the Giving Pledge, a pact pushed by software tycoon Bill Gates and value investor Warren Buffett. Having convinced theirs peers to give away at least 50 percent of their wealth to charity, Buffet and Gates turned the supergroup’s attention to how to do it well.

According to the Economist, one topic dominated the conversation: impact investing, the lesser-known and perhaps estranged cousin of socially-responsible investing. Impact investors, like our employers First Light and Gray Ghost Ventures, make investments in companies they believe can provide financial return while concurrently tackling some social or environmental ill (so-called “social enterprises”). Major players in the field range from the Omidyar Network, investor in media company Digg to Acumen Fund, our co-investor in a rural, for-profit water purification startup called Spring Health. The industry promises a path by which Giving Pledge-makers can deploy dollars to drive social change in a format they already understand. It’s the best of both the financial and philanthropic worlds, or so it would seem.

But large, individual investors have at least three reasons to approach the phenomenon of impact investing with caution. First, impact investing is a painfully young field. Acumen, the industry’s cheerleader, only just celebrated its tenth birthday. Impact investing professionals are young, too. A typical investment associate is in his or her late 20s, still learning the ropes on the investor’s dime. Many funds are founder-driven, as well. They have yet to develop into the process-driven partnerships of their more commercial counterparts, which can maintain and train bright young staff. The industry’s youth has also translated into an obsession with the sexiest of funding mechanisms: early-stage venture capital, a Procrustean bed for most companies.

The second reason for caution is that practitioners of impact investing and social enterprise have yet to agree on a transparent set of definitions, parameters, or goals. An Internet search for “social enterprise” is as likely to lead to a non-profit urban garden in London as it is to an African mobile payments scheme, and little consensus exists on how investors and companies should balance social impact and financial return. In some firms, this creates a healthy, guiding tension; in others, it amounts to little more than institutionalized schizophrenia. That lack of clarity and transparency – few impact investing firms have profiles on websites such as Wikipedia, CrunchBase, or AngelList –means that entrepreneurs with non-profit backgrounds see “equity” as a fancy new word for “grant,” and newcomers to the sector require months to get up to speed on the layers of meaning behind industry jargon.

Finally, the most important reason for Giving Pledge members to approach impact investing with care is that impact investing has yet to deliver on its promise of combining financial return and social impact. Financially, impact investing has seen little capital returned to investors. Socially, little evidence exists that impact investing is a better way to spend a charitable dollar than old-fashioned charity; at least one family foundation in the U.S. that had invested in over a half-dozen social enterprises in Africa has now pulled out, and now gives grants exclusively to nonprofits.

Given the above, perhaps Mr. Buffett’s personal skepticism is warranted. Skepticism need not give way to cynicism, however. LGT Venture Philanthropy has a crack team in India that makes equity investments and gives grants, and rigorously models its social impact; and Pierre Omidyar’s group has demonstrated commercial-level discipline in its investments in media startups.

There is much good work being done and much good work left to do. As outside investors peer in, they should be ready to roll up their shirtsleeves and help build a field still very much under construction.