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Impact Investing 101 — Part 1

Demystifying the emerging field of “investing for good”.

1. Introduction

Social enterprises (SEs) are defined as organizations established to create societal impact. Unlike private organizations, SEs do not aim for profit maximization; financial viability and impact creation are equally important for the existence of SEs. Having this double-bottom line mission, SEs face several challenges. One of them is whether SEs could collect enough profit and secure investment to pay their costs and scale up.

Most SEs could not reach the profitability level required by traditional investors, hence failing to secure funding from these agents. As such, they have to rely on grants and donations. Yet, writing grant proposals could take up a considerable amount of time, which could be better spent on running SEs. This brings up the question of what could provide funding to SEs more effectively. The answer to this question is impact investing.

Impact investing refers to investments that aim to generate both financial and social-environmental returns. As the field is new and many aspects are being conceptualized, many social entrepreneurs may not know about it or fully understand the concept. Thus, this essay aims to provide social entrepreneurs with an overview of impact investing. With an overall understanding of the field, these entrepreneurs (especially those looking to raise funds) may find impact investment a plausible option and consider applying for funding from these institutions.

The essay is divided into four sections. The first one describes the growth of the impact investing field. The second one provides information on types of impact investors. Then comes the benefits of securing impact investments. The last section focuses on business viability and societal impact creation — two important factors that social entrepreneurs should consider when applying for funding from impact investors. Part 1 will cover the first three sections.

2. The growing impact investing field

In 2007, the Rockefeller Foundation hosted an event in Italy, where leading figures in finance, charities, and development discussed how to build and accelerate investments emphasizing social and environmental impact. It was in this event that the term “impact investing” came into existence.

From this point onward, impact investing has gained significant momentum. Several impact investment funds were set up. Approximately 60 new impact funds were launched in 2011. This number showed a rising trend, as the figure was 44 new funds in 2010 and 20 in 2009. Players from the private and public sectors also pay attention to the field. Big banks such as Goldman Sachs and Deutsche Bank have entered the field while universities (e.g. Columbia University) and governments (e.g. the UK government) have established initiatives to support impact investing.

Several enablers have appeared to support impact investors and social entrepreneurs. For example, the Global Impact Investing Network (GIIN) was founded in 2009 to build a knowledge base and facilitate exchange among impact investors. In the same year, GIIN launched an impact reporting tool called Impact Reporting and Investment Standards (IRIS). In 2011, B Lab established The Global Impact Investing Ratings System (GIIRS) that assessed the impact performance of impact funds and companies, serving as a point of reference for impact investors. In 2019, an impact monitoring and management database called IRIS+ was launched to enhance data quality.

In terms of market size, GIIN estimated the global market size of impact investing to be US$715 billion in 2019. In 2015, there were only 4,885 impact investment deals globally and the volume of capital invested was US$14.25 billion worldwide. In 2019, the number of deals reached 6,481 deals while the capital invested rose to US$ 19.55 billion.

Energy, financial services, and microfinance were the three largest sectors within the impact investing field in 2019. The water, sanitation, and hygiene sector doubled in size between 2015 and 2019, thus achieving the highest growth rate.

Between 2015 and 2019, two regions achieving the fastest compound annual growth rate (CAGR) were (1) Western, Southern and Northern Europe with 25% and (2) East and Southeast Asia with 23%.

3. Types of impact investors

There are two types of impact investors. The first one is the impact-first investors, who prioritize social and environmental returns over financial returns. They are willing to take more financial risks for societal impact to be achieved. These investors would accept from negative financial return (-15%) to small return (5%).

On the other hand, finance-first impact investors set financial return as their first objective and societal impact comes second. When these investors assess investment opportunities, they would first evaluate them on a financial basis (i.e. market-rate return), and only when financial objectives are met could they factor in social and environmental outcomes. In this case, investors cannot sacrifice the financial return for the achievement of social and environmental impact.

Some argue that these investors expect between 5–10% financial return rate while others state that some investors would require up to 20% financial return rate in reality.

Types of impact investors. Source: Hebb (2013).

4. Benefits of securing impact investments

There are two values of impact investment. The first one is the monetary value. The value of this one seems obvious, as SEs would receive the money to cover their costs and grow their activities.

The second one is the non-monetary value. One such benefit is the technical and governance support that SEs receive from impact investors. These investors could help early-stage SEs refine their business models and learn technical skills such as IT, risk management, and accounting. Additionally, impact investors can also help high-growth SEs build strategic partnerships and reach more customers.

Another benefit is the reinforcement of the SE’s social purpose. When expanding their businesses, social entrepreneurs may be tempted to change their social mission for higher financial returns, thus failing to deliver social and environmental impact. Impact investors, through some mechanisms such as contractual agreements, help ensure that SEs stay true to their purpose and achieve societal impact.

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