Mind the Gap! Five ways to accelerate investing for impact
Investing for impact, where the primary goal is social impact, looks set to grow far more slowly than demand for such finance – unless we make some major changes. Chris West identifies five opportunities to tackle the mismatch.
The mismatch between the kind of finance that most social ventures need, and the capital available isn’t just inconvenient – it’s severely constraining the potential for powerful social impact. Sumerian Foundation co-founder Chris West makes the case for addressing this deep divide now – and identifies five areas of opportunity. The second in our Impact Papers series, in partnership with EVPA, asking honest questions about investing for impact.
Social purpose organisations – which include non-profits, social enterprises and socially driven businesses – offer some of the most disruptive, scalable and innovative ways to address social and environmental challenges. While we need all forms of capital to help them achieve their potential, my experience over the past 15 years of supporting start-up and growing social purpose organisations in both emerging and developed economies is that there is a significant mismatch between their funding needs and the availability of capital.
Why is this? And what can be done to narrow the gap?
The demand side of capital: the future of social purpose organisations
In the next 15 years we will see a growing number of social purpose organisations deploying market-based solutions to address significant social (and environmental) challenges. These organisations will operate with a wider diversity of legal structures reflecting their ‘profit with purpose’ objectives. But they’ll have one thing in common: they will all bring to market new solutions to pressing social issues.
Money alone will never be sufficient to enable these organisations to scale up – they also require non-financial support, such as business skills mentoring, corporate governance, and linkage to markets. But without appropriate and sufficient funding, it’s unrealistic to expect that many of these social organisations will achieve their potential for lasting impact.
And despite their proliferation, scaling up and replicating these innovative business models will continue to be very hard – due largely to inherent high costs, low margins, and frequent pivot points at which the business model needs to be altered to reflect real customer needs. In my experience, most social purpose organisations follow a ‘low and slow’ growth trajectory and either do not achieve financial sustainability in less than 8-12 years, or fail to ever become profitable.
Most social purpose organisations follow a ‘low and slow’ growth trajectory... Many fail to ever become profitable
Those social purpose organisations operating at scale – and with proven business models, a significant track record in revenue generation and/or with assets offering security to a lender – will continue to attract investors with impact. But these are generally outliers. Most start-up and growing social purpose organisations will need to access more long-term, unrestricted grant funding and concessional finance to achieve their potential; this will be most true for those focusing on the most complex and highest impact sectors (e.g. health, education or agriculture). This support can come from investors for impact (see box below).
Investing for impact vs. investing with impact
When the term impact investing was first coined a dozen years ago, it was a niche specialism. Today, it embraces investors with a wide range of objectives, behaviours and intentions, so EVPA and its members prefer to distinguish between ‘investing for impact’ – where the primary focus is on achieving a social impact, with any associated financial returns as a secondary objective, and ‘investing with impact’ – where the primary focus is on achieving a net positive financial rate of return alongside social impact.
The supply side of capital: investing for and with impact
Given the surge of players joining the field of impact finance in the past few years, I expect investment with impact will continue to grow exponentially. I hope – and expect – that more of these funds will shift to being open-ended or evergreen, as this long-term investment structure is far better suited to the slower growth characteristics of social purpose organisations than traditional, shorter term closed-end private equity fund structures.
As the concept of social impact is refined, I believe more fund managers will be required to meet both pre-agreed financial and social impact performance indicators. As a result, social impact will be factored into all traditional investment decisions, while new regulations will start to define ‘impact’ investing products. As impact goes mainstream, more corporates will also support social purpose organisations as they make their supply chains more transparent, thus helping to build the overall market.
I am concerned that structural challenges in many trusts and foundations will limit just how far they can shift from grant giving to wider forms of funding
However, without significant change, I fear that investing for impact will grow far more slowly, despite the urgent need for much more of it. On the positive side, I see more donors choosing to pool capital to achieve shared objectives (following the pioneering example of Co-Impact, for instance). But I am concerned that structural challenges in many trusts and foundations (related to staff skills and capacity, and fiduciary caution on the part of trustees) will limit how far they can shift from short-term grant giving to wider forms of appropriate funding consistent with investing for impact.
As a result, the growing supply of investment with impact will not match the demands of most social purpose organisations. Apart from constraining the future pipeline of financeable transactions for investors with impact, this will mean that most promising social purpose organisations will fail to achieve significant impact.
Mind the gap: Five steps to tackling the mismatch
What needs to happen in the coming years to overcome this significant market gap? While there are undoubtedly challenges in the future of social impact investing, there are also tremendous opportunities. Here are some of the most important points that I believe need to be addressed:
- Research – As a sector we need to listen more to social purpose organisations and use more market-based evidence to inform new structures for investing for impact and investing with impact. The opportunity is there for more demand-side research and performance data on which to build a more appropriate spectrum of investment.
- Advocacy – To overcome the market gap, we need to promote investing for impact among those (such as trusts, foundations and governments) who are willing and able to accept higher financial risk in seeking to achieve greater lasting social impact.
- Governance – There is a need to agree voluntary principles that define the behaviours and approaches differentiating investors for impact from investors with impact, and which also promote incentives rewarding the achievement of both financial and impact targets.
- Learning – All investors that have an intention to support solutions to pressing social issues need access to learning opportunities that help them improve the way they operate as investors for impact. This includes knowledge on different financial instruments, skills support and impact measurement and management. This can be achieved through a community such as the one created by EVPA.
- Collaboration – Perhaps the biggest and most concrete challenge for the future is to foster more collaboration between grant funders, investors for impact and investors with impact. Although connected, these communities are not yet working together, and this creates gaps and inefficiencies in the market. It is only by recognising the value of all players and their specificities that we can move towards the co-creation of those solutions that will benefit people and planet. After all, at the end of the day, we are all beneficiaries.
Do you agree with these five areas for action? What are your concerns for the future of investing for impact? Join the debate on Twitter using the hashtag #ImpactPapers, or drop a line at firstname.lastname@example.org.
Keen to take this discussion further? Hear from thought leaders from around the world at EVPA's 15th Annual Conference, Celebrating Impact, taking place in The Hague, 5-7 November.
This article is part of THE IMPACT PAPERS, a new series in partnership with Pioneers Post exploring, celebrating and asking honest questions about investing for impact – featuring some of the world’s leading thinkers and innovators in the impact space.