It’s Bigger than Silicon Valley – But is it Right for You?: Assessing a Move to Impact Investing
If you were to picture a social enterprise and then a Silicon Valley tech firm, what images would come to mind? Many would imagine a small-scale social business working in cramped offices in an emerging market on the one hand and a lush, sprawling IT campus on the other. And in some cases, those stereotypes would be true.
However, it may surprise you to learn that, in the aggregate, social enterprises now account for 3 to 5 percent of the U.S. GDP – twice as much as Silicon Valley. Ninety-one percent of millennials would rather buy from companies associated with a social cause. Investing in impact-driven businesses isn’t an act of charity – it’s a smart financial strategy that can help de-risk a portfolio and also lead to significant returns. And the rapidly growing market for impact-driven business represents a significant opportunity for forward-thinking investors.
Entering the impact investing space requires investors to navigate a complex web of unfamiliar metrics, regulations and strategies. In the process of working with some of the leading investors within the impact investing space, I’ve had an opportunity to observe and identify some key themes and questions that I recommend any new or aspiring impact investor consider before sealing the deal on an investment opportunity.
No. 1: What am I trying to accomplish here?
It seems like a silly question for a serious investor to be asking, but impact investments are by their nature complex undertakings. You are looking to simultaneously turn a profit (which is hard enough) and further a mission-related objective (e.g. help address climate change, work toward alleviating poverty, etc.) – ideally in a way where the mission drives financial returns and vice-versa. Without having a clearly defined set of objectives, it will be nearly impossible to craft an effective strategy for harmonizing, aligning and driving both profit and purpose.
No. 2: Where do I find myself on the spectrum of multiple bottom line investing?
Impact investing has become an umbrella term that encompasses a wide variety of investment strategies across a range of asset classes, seeking to drive results that range from concessionary to above-market returns. Once you have identified your “why,” it’s helpful to start thinking about how priorities rank for you. Some investors, mainly foundations and other non-profit organizations, recognize the value of using for-profit deal structures and incentive arrangements to really help drive social change. Some call this venture philanthropy, and examples include PRIs (program-related investments), below market-rate loans, and various forms of credit support. Others seek financial returns but are willing to concede return – or speed of return – in order to obtain real and measurable impact. The slow money movement is a great example of investors driving change with patient capital.
Many investors view the deployment of their capital as a solely for-profit exercise, and while not trying to achieve a certain mission-related goal through their investments, many recognize the value in environmental and social alignment, as well as good governance, all as ways of reducing risk in their portfolio. (Read more on ESG below). At the far end of the spectrum are those investors who see financial opportunity in investing in companies that are developing innovative solutions to some of society’s biggest challenges. These impact investors recognize that if their investments are successful, meaningful change can result while generating strong financial returns.
No. 3: ESG?
As mentioned above, some investors looking to get started with mission-aligned investing might want to begin by evaluating the environmental, social and governance (ESG) performance of existing and potential investments. Companies that take environmental impact, social benefit and good governance standards seriously tend to be lower-risk and to outperform their competitors in the long term. Such investors can look for companies that measure their environmental footprint and that employ governance standards such as corporate responsibility and transparency.
Almost any investor can structure impact into their portfolio by prioritizing companies with strong ESG standards. These companies may not have impact at the core of their business model, meaning social/environmental return isn’t necessarily inherent to their model. Consider a business that sells products or services that are not naturally connected to any impact mission (i.e. a “regular” company), but which undertakes to cut its carbon emissions, takes an equal wages pledge, signs on to the UN Sustainable Development Goals, or obtains a “B Corp” certification. All of these can be signals of an organization’s intention to act in accordance with environmental, social and/or good governance principles. Seeking such companies can be a good place to start and can be rewarding – both personally and financially.
No. 4: Do all stakeholders share a common vision for impact?
Don’t take it for granted that the various stakeholders involved in a deal share a common understanding of what it means to be “impact-driven” – or a common vision for what the nature of that impact should be.
Entrepreneurs should set clear expectations for investors regarding the nature of their social impact goals, and investors should clearly communicate the social returns that they expect their investments to generate. In my experience, it is crucial to set accurate expectations up-front to align incentives and objectives, and to avoid uncomfortable (and potentially costly) conflicts as the investment relationship progresses.
No. 5: Is there a clear relationship between the organization’s financial and impact goals?
Companies that have not built impact into the economic engine of the business run the risk of pitting social and financial goals against each other, to the detriment of both. Beware of companies that use tactics like “greenwashing” to paint a false image of social value for the sake of their brand’s reputation. The sniff test is a good early indicator here. And of course, there is no substitute for good investor due diligence.
Consider, on the other hand, a business whose social mission is wrapped into its business model – for example, a company that sets out to reduce energy consumption and waste by retrofitting buildings with LED lights and motion sensors. With every new contract that the business wins, it increases both its revenue and its social impact. The business’s financial performance is dependent upon its ability to achieve its impact goals. This integration of social and financial performance simplifies the process of determining an investment’s overall ROI. Many savvy investors look to invest in companies whose financial success is dependent upon their social success.
A Bright Future for Impact Investors
Impact investing is proving itself to be one of the most significant contemporary vehicles for positive social change. As social entrepreneurs tackle problems as diverse as water sanitation in Nigeria and government transparency in America, opportunities exist for investors to drive change in whatever social issues matter most to them. This industry is still on the rise, and all indications point to continued rapid growth and increasing demand.
When done well, impact investing can be a personally and financially rewarding way to make the world a better place.
Chintan Panchal is the founder of law firm RPCK’s New York office.
Photo by Elijah Hiett via Unsplash