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

Impact investing is not a new phenomenon in India. It came into existence in the early 2000s alongside the concept of the for-profit social enterprise. From then on, India witnessed a perceptible shift in the willingness of investors to support impact-oriented business models.

In the early years, these impact investors focused on supporting enterprises across the spectrum. However, today most impact investors are primarily channeling capital towards scalable and financially sustainable business models only. Additionally, the majority of this capital has been invested in the financial services sector, due to the maturity the sector has demonstrated.

Unfortunately, other sectors like agriculture, health care and clean energy have not scaled enough, because of their inherent business characteristics and want of longer gestation. Lack of adequate patient capital leaves these impact industries high and dry.

According to a McKinsey report from 2017 titled “Impact Investing: Purpose-driven finance finds its place in India,” impact investments in India have witnessed ~14 percent compound annual growth rate from 2010 to 2016, and are expected to reach US $8 billion by 2025. However, the on-the-ground reality is not so rosy.

Attracting Investment – a Social Enterprise’s Greatest Challenge

Social enterprises, like other commercial enterprises, must pass impact investors’ litmus test of “scalability-profitability-exit” criteria. Yet social enterprises face various headwinds as they scale:

• Limited number of impact investors: The growth in the number of social enterprises in India has outpaced the growth in the number of impact investors – thereby increasing the inherent gap between the demand for and supply of impact capital. In India, there are only a handful of active impact investors who are backing small- to mid-sized social enterprises.
• Impact investors moving from Series A to Series B / C: While the overall quantum of impact investments in India has grown in the past, the number of investments has stagnated. Reports estimate that currently, the average ticket size of impact deals in India is ~US $17 million, which indicates that impact investors are moving away from Series A investment and are instead backing large-sized and scaled-up social enterprises. Hence the early stage impact investing space is getting vacated, creating a vacuum.

Meanwhile, as mentioned above, sectors other than financial services have not demonstrated business maturity, scale and economic viability, leading many investors to shy away.

Key Considerations for Successful Fundraising

While there is no secret sauce for successful fundraising, there are certain guiding principles that social enterprises in India should keep in mind before a fundraise can be considered.

• Impact – An outcome, not an input

Most impact investors seek a market rate of return with measurable impact, therefore focusing on impact creation as the single most critical driver of investment would prove fatal. Economic viability has the potential to achieve the desired impact at scale.

• Quantum – Knowing how much to raise

Equity-raising capital is a balancing act between valuation (stake dilution) and the quantum, with assessing the quantum of funds being key. An over-estimated quantum of funds may mean a controlling stake in an early stage social enterprise, which will repel almost all impact investors from investing.

• Timing – Knowing when to raise + proving the business model

Given the current market dynamics, it is imperative for social enterprises to get bootstrapped and start small – to prove the business model. Yet many enterprises tend to seek funding at a relatively early stage, with unproven unit economics. Impact investors are no different from commercial investors in their preference for backing enterprises with proven business models and clear paths to profitability.

• Diversify your target list of investors – targeting institutional vs. non-institutional investors

Depending on the scale of the business and the quantum of funds needed, enterprises should target an appropriate set of investors. For a lower-sized quantum, family offices or high net worth individuals could be approached. Larger institutional funds should ideally be targeted after reaching scale and a path to profitability.

• Defining an exit plan for institutional investors

A timely and profitable exit is one of the most important criteria for any institutional investor. Once the pre-clearance on the business model and growth is obtained, the decision to invest hinges on the potential exit options for the future. Social enterprises need to chart out a clear strategy for the modes of exit to the impact investor. Any restriction on the exit mode (i.e. divestment to a strategic investor) would put off potential investors.

Social enterprises, if well-funded, have the potential to create significant and meaningful impact. However, reducing funding bottlenecks is clearly the need of the hour. We need a larger pool of impact investors with more patient capital to bridge the burgeoning funding gap. Innovative financing structures that address the funding needs of social enterprises at different stages of the business life cycle can go a long way toward achieving impact at scale.

Gagandeep Bakshi is Director of Intellecap.

Sameer Gaud is Associate Director at Intellecap.

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