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.