impactinvesting

Defining Social Impact Investing

by Dennis Shaughnessy

Defin­ing Social Impact Investing

Sep­tem­ber 29, 2013 

            The impact invest­ing area with the social enter­prise space is receiv­ing a lot of atten­tion lately, and for good rea­son.  There is great poten­tial for accel­er­at­ing global devel­op­ment by deploy­ing pri­vate cap­i­tal to achieve social good, so long as it is done in an informed and respon­si­ble way.

            Here are some ques­tions and thoughts to con­sider in con­nec­tion with defin­ing the emerg­ing field of social impact investing.

            1.  What is social impact investing?

            In the most basic sense, social impact invest­ing is invest­ing for social impact and finan­cial return.  How­ever, there are many ques­tions that need to be answered to fully under­stand this definition. 

            Let’s dis­pense with the first and biggest ques­tion.  Yes, impact invest­ing can and in some cases should result in lower finan­cial returns than tra­di­tional finan­cial invest­ing.  Why?  Because for most but not nec­es­sar­ily all impact invest­ments, the investor is expect­ing the enter­prise to com­mit resources to impact as a pri­or­ity over profit, and the result will most often be lower prof­its, and there­fore lower val­u­a­tion and returns.  In some cases, this won’t be the plan or the out­come, as we’ll see later, but to expect impact and equal or some say greater finan­cial returns is incon­sis­tent with core idea of impact first, returns there­after.

            2.  Should we define social impact invest­ing (SII) broadly, or narrowly?

            A broader def­i­n­i­tion is the way to go, at this early stage.  For exam­ple, if we exclude pub­lic com­pa­nies, then it’s a very nar­row def­i­n­i­tion.  If we restrict it to only social enter­prises, then it’s even nar­rower.  If we exclude grants or dona­tions to non-profit SEs, then the def­i­n­i­tion is nar­rower still.  I would sug­gest a def­i­n­i­tion that is more inclu­sive than restric­tive, if not to encour­age more investors to par­tic­i­pate and allow the sec­tor to grow.  The sec­tor can only ben­e­fit from an inclu­sive approach that helps to edu­cate and inform investors of all types about the ben­e­fits of a more thought­ful and human-centered approach to investing.

            3.  What about the envi­ron­ment and “green” companies?

            Worth goals and com­pa­nies, but for our pur­poses, we’re focused on the social or devel­op­ment side of impact.  The envi­ron­men­tal side is more devel­oped, and eas­ier to iden­tify in many cases, with the lead­ing sec­tor being alter­na­tive energy.  On the devel­op­ment side, poverty alle­vi­a­tion, edu­ca­tion and lit­er­acy, acces­si­ble health care, clean water and san­i­ta­tion, and improved agri­cul­tural out­comes are the lead­ing sec­tors for social impact investors.

            4.  Should we dif­fer­en­ti­ate CSR/CSI and SRI?

            Yes, but not exclude them from a broadly struc­tured def­i­n­i­tion, and portfolio. 

            CSR, or now often cap­tured with the term “triple bot­tom line” strat­egy (so-called “profit-people-planet” model), is a pos­i­tive step for­ward as com­pa­nies con­tinue to pur­sue strate­gies that go beyond a sin­gu­lar focus on profit.  Com­pa­nies with strong CSR pro­grams, like Tar­get and its 5% of net profit CSI com­mit­ment, are deserv­ing can­di­dates for invest­ment by socially moti­vated investors.  Target’s com­mit­ment is clearly not a fash­ion or pass­ing fad, but rather a multi-decade core value that reflects the company’s val­ues and defines its rela­tion­ship with its cus­tomers and communities.

            An SRI approach using an aggres­sive ESG screen is a pos­i­tive com­ple­ment to affir­ma­tive impact invest­ing, and allows more investors to par­tic­i­pate in the sec­tor.  The more tra­di­tional neg­a­tive screen only ver­sion of SRI is not a fit, as it allows many com­pa­nies into a port­fo­lio only because they avoid cer­tain mis­steps and regard­less of whether they affir­ma­tively pur­sue pos­i­tive social out­comes as part of their busi­ness model.

            5.  Can cer­tain indus­tries con­tain only impact enterprises?

            Gilead is an exam­ple of a world-class bio­phar­ma­ceu­ti­cal com­pany that is focused on cur­ing or treat­ing dis­eases that impact the world’s poor, like HIV/AIDs and other infec­tious dis­eases.  Since its mis­sion is to help those who are dis­ad­van­taged, dis­en­fran­chised or suf­fer­ing, does that make an invest­ment in their com­pany an “impact” one?

            The best answer would seem to be to give the busi­ness mis­sion a good deal of weight, but also to look at the entire busi­ness strat­egy of the com­pany before reach­ing the impact con­clu­sion.  Con­sid­er­a­tions like a com­mit­ment to afford­able access to a drug, con­tri­bu­tion of patented tech­nol­ogy to a pool or other struc­ture to enable part­ner­ships and col­lab­o­ra­tions that allow greater reach to the poor­est patients, and the cre­ation of a mean­ing­ful foun­da­tion to make grants and facil­i­tate access are all con­sid­er­a­tions (and in each case, sup­port the Gilead case for impact).  One might also look to gov­er­nance issue to com­plete an analy­sis, leav­ing ques­tions in this case about appro­pri­ate exec­u­tive com­pen­sa­tion prac­tices in light of the spe­cial mis­sion of the enterprise.

            6.  How is strate­gic phil­an­thropy different?

            Phil­an­thropy involves struc­tured giv­ing to char­i­ties.  Many of the con­cepts of impact invest­ing and social enter­prise apply to strate­gic, or large-scale struc­tured giv­ing.  Foun­da­tions like The Rock­e­feller Foun­da­tion and the Bill & Melinda Gates Foun­da­tion are lead­ing the effort to define the impact invest­ing space, often com­bin­ing phil­an­thropic giv­ing with smaller “pro­gram invest­ments” to stim­u­late growth in a sec­tor and con­tribute to the finan­cial sus­tain­abil­ity of both non-profit and for profit/impact enterprises. 

            The dif­fer­ences between the so-called “phil­an­thropy v2.0” and impact invest­ing are becom­ing more blurred, espe­cially for the new foun­da­tions cre­ated by the newly wealthy tech­nol­ogy entrepreneurs.

            7.  How is impact measured?

            It’s an impor­tant ques­tion, maybe the most impor­tant one in the field.  New stan­dards are emerg­ing for impact invest­ing, and the orga­ni­za­tion called GIIN (Global Impact Invest­ing Net­work) is lead­ing the way, with its IRIS (Impact Report­ing and Invest­ing Stan­dards) model.  Oth­ers are con­tribut­ing as well, with stan­dard­ized mod­els and in some cases pro­pri­etary ones.  Mea­sur­ing impact with the speci­ficity and con­sis­tency of finan­cial return mea­sure­ments is the goal.

            8.  Does tra­di­tional diver­si­fi­ca­tion apply?

            Yes, it should apply.   So, in our exam­ple, Tar­get is a value com­pany that offers income (div­i­dends), with a strong CSR com­mit­ment and a triple bot­tom line strat­egy.  Gilead is a growth com­pany with high cap­i­tal appre­ci­a­tion oppor­tu­nity and a busi­ness model that has social (health) impact as its core mis­sion.  Own­ing a value and growth stock with CSR and core mis­sion com­mit­ment is a solid diver­si­fi­ca­tion strat­egy for an impact investor, defined broadly.

            9.  Can pri­vate invest­ments be included?

            Yes, but access is the key.  For start-ups that are not well known and offer last “glam­our” than the fast grow­ing War­by­Parker, impact cap­i­tal is a neces­sity, in both debt and equity form.  Impact investors can have a direct invest­ment link to social busi­ness, mean­ing a for profit/impact first pri­vate businesses. 

            The chal­lenge with the high pro­file social busi­nesses is access to invest­ment oppor­tu­ni­ties, as there is a great deal of pent-up demand among high net worth investors for high pro­file, lower risk pri­vate equity invest­ments in lead­ing social busi­nesses like War­by­Parker.  An impact investor can seek out socially dri­ven ven­ture funds (LPs), sim­i­larly socially dri­ven angel invest­ment funds, and of course develop an angel invest­ment fund or his or her own allow­ing for direct early stage invest­ing in social busi­ness start-ups. 

            The key for growth in the impact invest­ing indus­try is for more and more War­by­Park­ers to be started by a new gen­er­a­tion of social entre­pre­neurs who under­stand the power of the for profit/high impact busi­ness model to con­tribute to global development.

            10.  Should char­i­ta­ble giv­ing be a part?

            Yes, but only if its struc­tured giv­ing (akin to a grant from a foun­da­tion) to a social enter­prise, rather than any charity. 

            A social enter­prise is a non-profit that uses busi­ness prin­ci­ples to insure sus­tain­abil­ity through effi­cient use of cap­i­tal and the pur­suit of mission-driven income gen­er­at­ing activ­ity where pos­si­ble.  In our case, Room to Read fits the def­i­n­i­tion, though their IGAs are very lim­ited rel­a­tive to their cur­rent rev­enue.  Rather than make a small gift, impact investors should always look to make larger, more mean­ing­ful “grants” that insure track-able impact report­ing against attrac­tive strate­gic goals.

            11.  What about the “MSV” prin­ci­ple that binds pub­lic companies?

            We’re begin­ning to see that the idea of a com­pul­sory “max­i­miza­tion” the­ory of cor­po­rate finance in which only share­holder returns drive all man­age­ment deci­sions is being chal­lenged, in the­ory and prac­tice.  The sec­tor can play a role in encour­ag­ing boards of direc­tors to envi­sion their company’s strat­egy in more expan­sive terms that includes a know­ing exchange of profit or return at the mar­gin for soci­etal con­tri­bu­tion.  In doing so, they will in turn con­nect with a more engaged gen­er­a­tion of cus­tomers, employ­ees and investors who wish to see their val­ues incor­po­rated into cor­po­rate strat­egy as well as prod­uct and ser­vice design and offerings.

            12.  Is the B Corp des­ig­na­tion a mean­ing­ful one?

            Yes, increas­ingly so.  The B Lab has cre­ated a cer­ti­fi­ca­tion that goes to an enterprise’s social and envi­ron­men­tal impact.  While it is a rel­a­tively new devel­op­ment in the field, the cer­ti­fi­ca­tion can be a use­ful indi­ca­tor when con­sid­ered among oth­ers when an impact investor makes choices about where to allo­cate funds.