Impact Investing 101 — Part 2
Looking to raise funds for your social enterprise? Remember to include the following information in your pitch deck.
You can read Part 1 here.
5. Conditions for impact investing
As stated in Part 1, impact investing pursues a double-bottom line: financial and societal return. Thus, SEs must prove that they can achieve both objectives to secure funding.
a. Business Viability
As impact investing looks for financial return, a viable business model would be an important guarantee for investors. There are several ways to solve a social issue, and social entrepreneurs must find the most feasible one to implement. I will take a real case as an example.
In September 2020, Patamar Capital (an impact fund in Southeast Asia) invested in Kim An Group, a SE in Vietnam that connects formal financial institutions with micro, small and medium enterprises (MSMEs). Important factors for the fund’s investment decision were a suitable go-to-market strategy, a proven product, and the ability to scale up. These show the importance of having a viable business model in securing impact investment.
As each impact investor could require different financial return rates, the definition of “a viable business model” could vary. However, based on the expected financial return of each investor, I believe that social entrepreneurs could predict whether their enterprises could generate enough profit to meet the financial requirement of that investor, hence knowing the viability of their business model.
Felix Oldenburg, Ashoka’s Germany Director, argues that impact investing would not work for SEs intending to give away their ideas and aiming for free ideas replication elsewhere. I agree with his idea as this type of SEs could hardly scale up; “scale up” here means that the original entrepreneur will be the one who scales it and retains some forms of ownership of the enterprise branches.
As such, I infer that this kind of enterprise may operate in a small community and generate limited streams of revenue and profit for the owner, hence failing to meet the expected financial return of impact investors. Therefore, for any enterprise falling into this category, impact investing may not be the right choice.
Nascent SE is another type of enterprises that may be unsuitable for impact investment. However, unlike the above-mentioned SE, this type of SE may aim to seek impact investment at a later stage. In the meantime, these early-stage enterprises can apply for grants, strategic or venture philanthropy.
With these funding sources, enterprises can scale up and become ready for impact investment. One noteworthy point is that these enterprises may fail to reach the investment-ready stage simply because they do not find ways to improve their business models. As such, they may stay dependent on grants or charitable funding forever.
b. Societal Impact
Measuring and assessing social and environmental impact is the second half of the formula, complementing financial return in proving a SE investable. Currently, the impact investing community has not reached a consensus on the framework and tools for managing and evaluating impact. Theoretical work and practical applications may also differ. In this section, I will describe some popular work on impact assessment as a starting point for social entrepreneurs to explore further.
Theoretically, some researchers argue that SEs must demonstrate two types of impact: the product impact and the operational impact. The former is defined as the impact of goods or services provided by SEs. The latter comprises of the SE’s impact on the health and job security of its staff members, its influence on the economic condition or other facets of the well-being of the community where it is located, and its operational effect on the environment.
Underlying this framework is the distinction between outputs and outcomes. Outputs refer to products or services provided by SEs while outcomes refer to the impact of these outputs on enhancing our lives. As such, SEs have to assess two aspects: (1) measuring outputs produced and (2) measuring the contribution of these outputs to the outcome.
If the quantity and quality of products/services is the answer to the first question, research methods in social science such as randomized control trials could help answer the second question. As social science methods are quite costly, I suggest using social returns on investment (SROI) as another valid tool for impact assessment.
In practice, different impact investors could employ different tools to measure and evaluate impact. According to the Global Impact Investing Network (GIIN), some popular ones are UN SDGs, IRIS catalog for metrics, and IRIS+ core metric sets.
In my opinion, none of these methods is perfect. For example, some researchers argue that systems such as IRIS and GIIRS could be useful in measuring outputs but lacking in measuring outcomes. However, to secure funding, social entrepreneurs should not waste time finding the perfect method. They should instead follow the tools and framework recommended by their target investors.
Social enterprises are organizations that pursue both financial viability and societal impact. This double bottom-line mission makes it difficult for SEs to raise funds from traditional investors while grants or philanthropies are not optimal options either. As such, impact investing could be a more effective source of funding. This field pursues an analogous double bottom-line: financial return and social-environmental impact.
Since the term was coined in 2007, the field has achieved impressive growth. Several enablers such as rating systems and investor networks have been established to enhance the ecosystem while traditional private and public organizations have joined the field.
When social entrepreneurs explore impact investing, it is worth noting that there are two types of investors: impact-first and finance-first investors. As their names suggest, they set different priorities and financial return rates. This can help entrepreneurs identify the right impact investors for their enterprises.
To secure funding, social entrepreneurs should prove that they have viable business models and create societal impact. Regarding the former, the definition of viability may vary depending on the specific impact investor (especially regarding that investor’s expected financial return). Nevertheless, SEs supporting free model replication by others and nascent SEs may not be suitable for impact investing.
In terms of the latter, there is no mutual agreement on impact measurement in the impact investing community, thus posing challenges for SEs. Therefore, SEs are recommended to follow the framework and tools set by their target investors. Some methods suggested in this essay could be a good starting point for social entrepreneurs to explore further.
Regarding the benefits of securing impact investments, SEs can receive both the monetary value and non-monetary ones such as technical assistance and protection of the SE’s social mission.