Impact investing is experiencing spectacular growth, as the concept keeps on capturing the attention of global investors. The Global Impact Investing Network (GIIN) estimates the current size of the impact investing market at $1.164 trillion. However, while so many find inspiration in making an impact, there is still a great deal of confusion, both among the investors and the startups that seek capital. This lack of certainty concentrates on the very subtle but significant difference between impact investing as a great financial instrument and a philanthropic tool. But in reality, it can be both, which is why it is essential to approach impact investing with consciousness and understanding of anything from the overall purpose of the investment strategy to unintentional negative impact.
Venture philanthropy vs impact investing: what is the difference?
Several aspects contribute to the confusion around impact investing. For starters, some investors believe that there is a clear distinction between investing in for-profit and donating funds to philanthropic causes. But according to Sapna Shah of the Global Impact Investing Network, the binary between investing and philanthropy is a false one. The contrast between traditional grant-making and investing with impact is primarily about the amount of engagement from the investor’s side, as well as the level of commitment and transparency from the financed enterprises.
The lack of role-understanding from both sides then translates to the other common confusion that simply reduces to low clarity. Not every venture is impact investing — some are purely philanthropic. This means the investors should not expect high returns and get satisfaction from the impact itself. Otherwise, the impact startups that did not meet expectations get left out as a result of funding discontinuation.
“We take the view that if you’re going to give money away, just give it away rather than disappointing people long-term. If you want to help people but only fund them through ‘impact startups’ that might never make money, they’ll end up disappointed when you eventually have to pull the plug.” -Gareth Ackerman, Chairman of Pick n Pay.
How a lack of clarity can affect startups
It isn’t just about the lack of funding. The way investors perceive philanthropy and impact investing directly reflects on the structure and operation of the ventures they fund. Jimmy Scavenius, the founder of Kwerafund, an organisation that uses income-sharing agreements to make education accessible in Malawi, experienced the effect of the lack of clarity firsthand.
Due to the range of his previous experience, Scavenius was able to see both sides:
“Often pure philanthropy and free money isn’t sustainable as this can create dependency and complacency, but at the same time, many investors are still not ready to direct their funding toward impact areas.” — Jimmy Scavenius, the founder of Kwerafund.
Raising capital is not always easy, even considering the numerous potential commercial vehicles available for startup funding. However, while the impact ventures are unable to accept tax-deductible donations when they operate for-profit, there are still options to qualify for various philanthropic grants and, at the same time, the ability to continue to raise the more traditional debt and equity capital.
Kwerafund is an excellent example of how donation funding can be more effective than securing an impact investment. But although this initially led the project to convert from a company to a non-profit organisation, Scavenius still believes that there is still a lot of potential to move beyond the purely philanthropic cause. He explains that it is up to the socially-oriented entrepreneurs to ensure that they can be self-sustainable in the long run and then create a pull market.
How investors should approach impact investing
When investors are looking to get involved in impact investing, it is crucial to look slightly outside of the purely philanthropic realm. Because while asking yourself, “Will I make an impact?” is noble and important, the next question should always be “Will I make a profit?”. What’s more, the consideration-selection stage should focus on several other aspects, including the grand purpose of the investor, the expectation evaluation, and the account for potential negative impact.
The first thing to do is to establish the general outlook of the investing company on the impact-to-return ratio. As previously mentioned, not every venture will make it to the scene of skyrocketing returns, in which case the investment will be on the more philanthropic side.
“Are they [investors] undertaking this exercise because they want to create a particular impact first and foremost while hopefully generating some financial return, or are they focused on generating good financial returns by investing in more impactful businesses? Both options are available, but it helps both the family and, ultimately, the company or fund they are investing in if their expectation is clear at the outset.” — Catherine Grum, head of Family Office Services at BDO, UK.
Grum also suggests starting with identifying the objectives behind each virtue, for instance, the specific issues that, in the investor’s opinion, deserve the most attention. Once the purpose is clear, the search for the most suitable financial tools will become more accessible and more productive.
Impact measuring and management
The next step is to set up the appropriate impact investing measuring and management practices. According to a survey by GIIN, investors are getting progressively better at foreseeing the potential outcomes of their funding activities; however, there is still a lot of room to grow.
The main concern of the survey participants is so-called impact washing, which is the false statement of the companies and funds about the impact they make. So far, impact investing specialists are offering to adopt more participatory strategies by being more present and employing third-party evaluators to measure the rate of impact.
The lack of transparency and the impact washing comes down to another significant concern for anyone interested in impact investing: the hidden negative implications. However, this issue arises from far more other factors than simple dishonesty, for example, the general exclusiveness and privacy of many impactful investments.
Besides, some impactful ventures can be both positive and negative, depending on the measurement scale. While some companies are making a tremendous environmental impact, they might be unintentionally hurting the local society or vice versa. For now, the most common solution is once again — wholehearted engagement. By combining the expertise of their advisors with the energy and purpose of impact organisations, investors can minimise the risk of taking part in negatively impactful projects.
The future of impact investing
Impact investing remains an up-and-coming field, as global investors can significantly benefit from the right mix of philanthropy and profiting, as long as their objectives are clear. The definition of the overall purpose will make the rest of the process, such as tool and strategy selection, much more accessible.