Has impact investing lost its way?

Impact investors seem to be focused on financial return rather than helping social entrepreneurs solve problems at the base of the pyramid

Illustration: Kishore Das

Our team at Kinara Capital has just closed a new round of equity. Our last round of funding had included a minority investment from a group of angel impact investors — basically, individuals who are investing their own funds in social enterprises. The group of angel investors we worked with comprised investment bankers from different parts of the globe and for whom Kinara Capital was their first foray into impact investment. 

When a new lead investor puts a term sheet together for a substantial amount of money, there is one caveat: all current investors, including this group of angels, were required to accept a new set of terms. These new terms did dilute the stake of the current investors marginally more but the infusion of capital would help push our company to the next level. All our current investors saw the bigger picture and the value of the new investment, except for the group of angel investors. They held up the entire deal for several weeks and it was in that moment of turmoil that I realised who the real impact investors in my company were. 

What makes an impact investor? 

Much like the much-abused term social enterprise, impact investing has many definitions. The general belief is that impact investors are different from traditional investors in three main ways: 

• They measure success by the social or environmental impact generated by the enterprise they are backing. 

• They have lower financial return expectations than a commercial venture. 

• They have a longer term horizon for returns because they are often backing entrepreneurs and ideas that are tackling tough problems in developing economies without much of a support eco-system around them. 

Impact investors tend to be early-stage investors — anywhere from $10,000 to $10,000,000 at the absolute top end. Most of the investment amounts are small, with $100,000-$250,000 being the sweet spot. At the time when he or she is carrying out due diligence, a typical impact investor spends time asking and challenging the value of the social impact that a particular idea will deliver. When this alignment of patient capital backing social impact businesses comes together, it can be powerful: new social ideas get a launching pad and investors get the impact they seek.  

Takes two to tango 

In my previous article Will the real social entrepreneur stand up? published in Outlook Business on June 7, 2014, I wrote about how social entrepreneurship today is becoming a trend. Well, it takes two to tango. That trend extends to impact investors too. The past four to five years have seen an emergence of impact investors: individuals who are self-motivated, angel investing groups, and angel networks that typically draw high-net worth individuals, family foundations and philanthropic organisations. Many of these understand market realities and are keen to play a role in generating social impact. In recent years, even traditional investors — including venture capital and private equity firms — and fund managers are jumping into making impact-driven investments. 

The challenge is that the impact space has attracted a new breed of impact investors who are more focused on financial return rather than social entrepreneurs solving difficult problems at the base of the pyramid. At conferences, forums and conclaves, these impact investors are swapping stories on how their impact-driven portfolios are delivering significantly better results than the commercial market portfolios. This, in turn, is attracting new folks to the mix. And pretty soon, we find private equity investors with a focus on the emerging markets are rebranding themselves as impact investors. 

This revision of attitude is detrimental to social entrepreneurs, who are often in uncharted territories addressing systemic problems and are not just trying to define and market new products but also creating the distribution and support systems. The social entrepreneurs are experimenting with ideas that have a high probability of failure, especially if they don’t get the right support. Therefore, impact investors need to take a long view on their investments and not seek short-term financial gains or demand the type of fast growth one might expect from a typical business venture. But the new breed of impact investors does not have the latitude or the wherewithal to support this reality. They are often driven by traditional PE structures with limited partners and general partners, fund horizons and return commitments to their partners. This model is so finance-first that their first priority is to protect their investment. Once their investments are protected, this impact investor demands scale and fast growth, which could steer the social enterprise away from their target segment to achieve these results. These expectations are unrealistic and pressure social enterprises to deliver revenue, shifting their focus away from social impact, which often becomes a secondary, if not tertiary, goal. 

I is for impact 

All self-labeled impact investors need to take a step back and revisit their primary motivation to invest in social enterprises. If there are those who really want to do good for society, I urge them to evaluate organisations based on their potential to generate social impact and be patient about their investments. There can still be rules, milestones, and checks-and-balances in place. However, the emphasis for investors and social entrepreneurs should primarily be on making a long-lasting impact that will change lives of the underserved people and communities. At times, this may not come fast or easy and may require openness to new ideas and ways of operating. There are many individuals and institutions that fall under this category and I have experienced their generosity and singular focus on social impact first-hand when faced with tough scenarios in my social business. 

This is not to say that finance-first investors do not have a place here. To the contrary, we need commercially-minded PE folks too — after all, when a social enterprise moves beyond creating a solution, it needs the commercial markets to help it scale. But a social entrepreneur needs to know upfront if the potential investor is impact-first or finance-first in their leanings. Perhaps it is time to define a new nomenclature for different types of investors interested in social change in order to create transparency and alignment between investor and entrepreneur motivations and objectives across enterprise phases and investment stages.