NexThought Monday: Social Financing: Three Opportunities and Three Questions
Combining the creation of social impact with financial returns is hard. Demonstrating social impact can be just as hard, and using impact analysis to actually improve a social investment strategy so that it creates greater social impact and financial returns is even harder. This is the challenge social financiers set themselves and social impact analysis is needed to help them rise to meet it. Social financiers have challenged themselves to demonstrate social impact, and social impact analysis is needed to help them rise to meet the challenge.
All investments have both positive and negative social consequences; however, social financiers seek to intentionally create positive social impact in addition to financial returns from their investments. This intentionality in investment goals – especially when impact is the primary objective – opens up new spaces for both impact and financial value-creation through
- the exploitation of new synergies,
- deepening resilience and
- building the capacity for adaptation.
Synergistic gains arise when an investment strategy relies on social and financial returns supporting each other. That is most effective when social financing of impact and more traditional investment activities inseparable. For example, an investment in energy use reducing retrofits reduces carbon emissions by directly reducing the need for carbon-emitting electricity while also providing a financial return through cost savings on electricity expenditures. Contrast this with making carbon-intensive mainstream financial investments and using the proceeds to buy carbon offsets where it is not always clear that the net impact of this approach will end up even being carbon neutral. In addition, the creation of new synergies through social financing can generate returns that exceed an approach that channels the gains from investments to philanthropic purposes (i.e., a CSR strategy).
Over time, social financing has the potential to create greater resilience than strategies that seek social impact and financial returns independent of each other. When investments geared toward financial-only returns see negative economic shocks, such as a price spike in a key input, additional risks can emerge. For example, some companies may prefer to cut corners on environmental protections rather than post weak financial returns for their shareholders.
Negative financial shocks for organizations that only seek social returns, such as the unexpected loss of a major donor, can lead to a reduction in social service provision or organizational collapse. The effect of the resulting loss of services upon which beneficiaries rely can leave those former beneficiaries even more vulnerable than they were before the charity’s intervention. In contrast, an investment that seeks both impact and financial returns has social capital that can help it weather economic storms. That is, it is able to turn to those who see the social benefits from its activities for support during bad economic times and can reduce the risks placed on beneficiaries as a result of having independent sources of financial strength.
For example, a food retailer that serves an otherwise food-insecure neighbourhood may be able to raise enough money through loans from members of the community it serves if a temporary spike in electricity prices would otherwise place it in financial jeopardy.
Beyond just being able to resist negative external shocks, social financing can increase the adaptive capacity of an investment strategy over a long-term time horizon. Engaging in social finance can shed new light on a social issue, revealing lessons that may not have been apparent otherwise. The value of this learning is unlikely to stay confined to social impact, as new insights will frequently bring to light untapped market opportunities that can then be leveraged to increase financial returns.
So what does this mean for impact analysis?
First, it is necessary to understand the purpose of an analysis in order to choose the right assessment tools. A very basic reason for measuring impact is accountability. Trust is important in any social financing relationship, but as a Russian proverb (made famous in the English-speaking world by Ronald Reagan) goes, “trust but verify.” However, the purpose of impact analysis is more than verification, it also involves learning and innovation. Given the multipurpose nature of impact analysis I suggest that there are three overarching questions that impact investors need to ask:
- What are we doing?
- How important is it?
- What should we be doing?
At its simplest, asking “What are we doing?” is about demonstrating to social financiers that they “got what they paid for.” Much of this work is just verification and seeing if investees were able to meet or exceed predetermined impact goals. The Impact Reporting and Investment Standards (IRIS) is an example of a set of metrics that enable social financiers and their stakeholders to use a common language when discussing social impact, easing the verification process.
Asking “How important is it?” relates to the strategic question of how social financiers set priorities. Inherently the question of how important social and financial returns are relative to each other must be considered. Valuation methods, such as Cost-Benefit Analysis (CBA) and Social Return On Investment (SROI) analysis, standardize metrics by setting them relative to the financial return. The methods that comprise the valuation measurement approach allow impact analysis to inform the prioritization of social financing opportunities and how they are operationalized.
Finally, the “What should we be doing?” question asks whether social financiers truly understand their role in the systems they seek to change. When unsuccessful, social financiers not only need to understand why, so they can reshape their investment strategies, but also to ask if their goals are really the ones that will help those they are seeking to help. When successful, social financiers should be ready to move their goalposts, as they have likely triggered new challenges or opportunities for change. This suggests a move beyond monitoring and prioritizing toward intuiting and meaning-making. Here we live in the realm of case studies, storytelling and putting decision-making power in the hands of those on the receiving end of an investment’s social impact.
Missing any of these three questions weakens a social financing investment strategy. Avoiding the “What are we doing?” question leaves an investment strategy vulnerable to fraud and incompetence. Avoiding the “How important is it?” question leaves an investment strategy incapable of focusing on its most important objectives or uncritically leaves a social financier to increasingly focus on financial objectives because they are the easiest ones to measure. Finally, avoiding the “What should we be doing?” question leaves a social financier vulnerable to the possibility that they are efficiently following an ineffective strategy. For impact analysts, it is critical that none of these questions is left behind.
Sean Geobey is research manager at Waterloo Institute for Social Innovation and Resilience. He will host a workshop at the Social Impact Analysts Association’s (SIAA) 2014 Annual Conference, Talking Data: Measurement with a message, which will be held on Nov. 3-4 in Toronoto.