Impact Investing

Impact Investing: Time for New Terminology?

If we are to effectively grow the impact investing community, we need more clarity about what impact investing is—and isn’t.

In recent years there has been a real buzz about impact investing—an investment approach that intentionally seeks both a financial return and a measurable social impact. But there is little consensus over what impact investing actually is. Tesla with its solar energy cars; biotech companies with tuberculosis, HIV, and malaria vaccines; and others claim to create impact. In a recent brochure, Goldman Sachs claimed that it was producing huge, global social impact through its investment activities in infrastructure, energy, and telecom.

So what is an impact company?

The Rockefeller Foundation coined the term “impact investing” about 7 years ago, but the core concept is much older. Earlier practitioners called the practice “social venture capital” or “social ventures.” Like all terminology, each of these words has its advantages and disadvantages—and too narrow or broad a definition makes it virtually useless. The advantage of having everyone agree on terminology is of course that those working in this asset category can speak a common language and better attract new participants. The disadvantage of “impact investing” specifically is the hype behind it—today, people are calling all kinds of investments impact investments (it sounds much cooler at parties!), and its meaning and usefulness as a result is less clear.

Not all businesses that have an impact should be classified as impact investments. The mobile phone, for example, has had a positive impact on the lives of billions of people. But investments in Nokia and Samsung products are not impact investments. The clean tech and biotech products I mentioned above aren’t either. Otherwise, theoretically any legitimate business could claim it was “an impact company.”

Perhaps it’s time for a change—back to “social ventures” anyone?

So then what is impact investing?

I would like to propose a definition, and then offer four tests to determine whether a business qualifies as an impact investment.

The definition: An impact investment is a for-profit business with measureable social outcomes that intentionally and primarily addresses the social need of the poor and marginalized. It is investing for a financial and a social return primarily among the poor and marginalized. Any environmental impact is a bonus.

Mobile phone, pharmaceutical, and clean energy companies do not design or produce products primarily for the poor and marginalized. They are for the rich, the middle class, and—if affordable—only then for the poor. The locality of their operations also show they are not primarily targeting the poor. By contrast, a mobile phone, medical, or clean energy company intentionally located in the slums primarily to serve the poor would be an impact investment.

The four criteria:

  1. Profitability. Impact investments are commercially sustainable and profitable businesses. Depending on the investors, different levels of financial returns are acceptable. Some foundations require only that their capital is returned; others require a near-market rate of return. Some put social impact before financial return, others the other way round. There is room for both.
     
  2. Intentionality. This is inherent in the definition above: These are businesses specifically designed and purposed to tackle issues of poverty such as human trafficking, water, sanitation, primary education, and health. Tackling these social issues is their core business.
     
  3. Locality. These enterprises usually operate in the slums and rural areas where the poor live. This is their marketplace.
     
  4. Accountability. Apart from standard financial reporting, these businesses report against simple and agreed social metrics.

Impact Investing is not corporate social responsibility (CSR). CSR is a charitable activity engaged by corporations to show they are good citizens and is a peripheral activity to the company’s core business. There is growing cynicism about CSR, because all public companies now have a CSR report in their annual accounts; it is beginning to look more and more like “C-PR.”

Impact Investing is not socially responsible investing (SRI). SRI, or ethical investing, is a negative screening of industries deemed unethical, such as tobacco, arms, or casinos. Impact investing is about positively doing good rather than “doing no harm.” SRI would not meet the intentionality test on poverty alleviation.

Impact Investing is not private equity with environment, social, and governance (ESG). ESG are sustainability factors that can be layered on to investment analysis to identify companies with better long-term performance. They are not primarily designed to address the social needs of the poor. The recent B Corporation certification is a movement for companies to be better corporate citizens with regards to ESG and sustainability.

Impact Investing is also not green or renewable energy. Big wind farms, and solar panels and electric cars are not impact investments. While these businesses may create employment, they primarily target environmental impact and largely benefit the rich and the middle classes. If Tesla is an impact company, Honda, Nissan, and Ford could make the same claim. They too have “green” cars. By contrast, off-grid solar power companies serving the rural poor would qualify as impact companies.

How do social enterprises fit into the impact investing universe?

Social enterprises (SEs) are enterprise-based solutions to tackling social problems. They are usually started with grant capital, and the social mission is more important than the financial returns. SEs tend to be small and not easily scalable. A few impact businesses start out as SEs but later take in private capital to fund growth to become commercially sustainable. Impact investments can scale-up SEs so that they become profitable, and we hope this happens more in the future.

The Role of Metrics

The social metrics reported by a business help determine whether it is an impact company. But there is no consensus here either. A number of organizations, including the Global Impact Investing Network (GIIN), have tried to standardize the reporting of social metrics so that investors can compare the efficacy of impact investments. But in general, impact companies as defined above do not have the internal capacity or skills to collect and analyze complex metrics. Neither do they have the funds to pay others to do it.

The Transformational Business Network, which targets workers’ poverty, have their own unique set of social metrics. For example, members track the number of staff members living in standard brick housing, because improved housing is correlated to improved health and is much easier to measure. Members also measure who owns cars or motorbikes, and houses, to get insight into changing fiscal disciplines without being intrusive. And critically, members track each person’s tax contribution to the national economy—important because, while the right level of taxation and the wisdom of governments to use the tax revenues are valid issues, unless revenues are sufficient, governments will need aid or bail-outs.

Others argue that we should move away from measuring outputs to outcomes—for example, that we should measure increases in educational standards to assess educational impact, instead of the number of pupils in school. These different measurement approaches further confuse the meaning of impact.

If we are to effectively grow the impact investing community—and drive the most possible impact—we need consensus on what impact is and what it isn’t. I hope this post will help stimulate discussion.

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COMMENTS

  • Guillermo's avatar

    BY Guillermo

    ON October 2, 2014 02:58 PM

    I appreciate the efforts to come up with a definition that helps us clarify what we are talking about when we say ‘impact investment’, and I agree that the Teslas, biotechs, and of course Goldman Sachs are probably out of the scope of this nascent field.
    However, I think that this definition is too skewed towards investing in developing countries (especially with the aspect of ‘locality’). Instead, I think we should embrace the social enterprises and impact investors that have developed countries as their marketplace, be it employing vulnerable people, working for financial inclusion, or promoting social change in many ways.

    Thanks.

  • BY Brendan Ferguson

    ON October 2, 2014 03:55 PM

    An interesting article, thanks Kim.

    I think the ‘profitability’ criteria is too narrow and should instead be framed with reference to ‘financial return’.  If we confine impact investments to those concerning ‘profitable businesses’, then we exclude public sector impact investing activity. 

    Those who invest in social impact bonds – for instance – are seeking both financial and measurable social returns.  What do we gain by excluding this form of investment from our conception of impact investing?

    Brendan
    Social Ventures Australia

  • Nancy Steele's avatar

    BY Nancy Steele

    ON October 2, 2014 04:30 PM

    Thought provoking and a good attempt to separate out the competing definitions.

    I object, however, to your requirement that impact investing only “addresses the social need of the poor and marginalized” and the later implication that a business seeking to improve the environment is primarily benefiting the middle class or rich. Tell that to an island nation that is going to lose 100% of its land because of sea level rise or a child suffering from neurological damage because of lead poisoning caused by substandard housing or mining residue.

    Reducing an environmental impact (impacts are generally thought of as negatives) is not a bonus, it is an essential part of improving human health and wellbeing.

    Your definition is too narrow and needs to be informed by the recognition that environmental health equates to human health.

  • The narrower the definition the better - the broad definition is why we have ended up with every Tom, Dick and Harry labelled impact investment. - which is not a problem except it makes the term quite meaningless.

  • BY David Lynn

    ON October 3, 2014 02:06 PM

    Thank you for stimulating discussion on this important topic.

    Like other commenters, I think the focus on poor and marginalized is too narrow.  The winning part of your definition is the required intentionality and putting the social aspects as a primary guide.  That is what throws out a Nokia or other companies where the positive social impacts are ancillary to the core business.

    I think a contrasting example would be in agribusiness: new farming methods and machinery that significantly reduce water consumption, pesticide use, land use, and increase yields would not be directly focused on the poor and marginalized.  However, the business creating these tools would be a viable impact investment if the primary and intentional goals and metrics of the business was to reduce water, pesticides, and agricultural land.

    I also think an important distinction is that the social impact business line has to be direct.  A Tom’s Shoes, for example, where the purchase on one side is only the means of generating capital for the social side, would not qualify.

  • BY Peter Berliner

    ON October 3, 2014 02:14 PM

    Don’t overlook the important role of nonprofits such as CDFIs. The type of investee is less important than whether you are actually directing capital to effective enterprises that are ignored or denied by conventional investors. Impact investors are needed both to fuel their efforts and to attract other, less noble, investors. And yes, accountability is critical.  Social outcomes should be tracked and reported as assiduously as financial returns. 

  • BY Eli Malinsky

    ON October 3, 2014 05:18 PM

    My comments are consistent with the others. I really like precision and the effort to limit the scope, but I think locality is too central and the prioritization of ‘helping poor and marginalized’ seems odd - I would consider environment a reasonable goal, too. I really do like the focus on ‘intention’ and certainly, these comments as a whole are a reflection of the entire challenge of definition - so kudos for at least putting something out there.

    The one thing that surprised me, though, was an article devoted to deconstructing/ reconstructing “impact investing” then proceeds to present a definition of social enterprise that is equally debatable. My definition of ‘social enterprise’ does not match the presumed definition in this article.

    And the beat goes on…

  • BY Cathy Clark

    ON October 5, 2014 05:07 AM

    Thanks for a good and provocative piece, Kim.

    As part of the activities supporting the G8 Social Impact Investment Taskforce, about 200 practitioners around the globe actually went through a process to finetune a more collaborative and definitive definition of impact investing. The results of that process, which was as illuminating as it was challenging, are captured in the G8 reports, within the global reports, the country NAB reports and especially in the working group thematic reports. All of those reports are available (and nicely presented) on the Global Learning Exchange/ IIPC website at http://gle.iipcollaborative.org/taskforce-resources/.  I encourage you and others to read them, especially the report on Profit with Purpose Businesses. This report has not yet been officially released by the G8, but a sneak peak has been released by Unltd at this url:
    https://unltd.org.uk/wp-content/uploads/2014/09/Mission-Alignment-Report.pdf

    Many issues arose during this process. But the biggest sticking point was coming up with a definition of impact investing that fit the broad array of activities that we are all undertaking, while still allowing precision so that this activity does not bleed into the often heard “well, if you look at jobs as impact, then pretty much any business with investment is an impact investment.” This has the advantage of universal appeal, but for policymakers trying to carve out a set of institutions they can encourage and for investors and enterprises trying to distinguish their activities and drive a new way of conducting business, it is less helpful.

    You’ll see in the Profit with Purpose business report a more detailed middle ground has been laid out. A few key things I’d call your attention to as you compare your thoughts above with what is in that report:

    1) Remember that impact investing is not defined by JUST the recipient of the investment, as the first bullet of definition implies. Impact investing covers a range of both recipients, intermediaries and asset managers. There’s a really good chart of that terrain on p.3 of the main G8 report. The terrain includes nonprofit and for-profit type ventures in every role - recipient of capital, intermediary working with capital, and even some nonprofit asset managers. What distinguishes an impact investment on the financial side is not the profitability of an individual enterprise, but the intention of the investor and recipient to agree on working to achieve some level of financial return. As I like to say, anything above 0. (and in our Impact Investing 2.0 study, the range of returns was .05% to over 25%). This financial return can come back through a variety of means (also in the chart I mentioned above) which can include, in the case of a social impact bond,  a payment from government to an investor based on the social performance of a nonprofit. No for-profit business would necessarily even be part of that transaction. Your first definition point is too limited given the breadth of the field today.

    Another analogy that came out of these conversations that was useful is to think of impact investing as a big tent. Underneath the tent are all kinds of tables that have their own goals and structures. We need to be very careful to keep the tent definition broad enough to let people in who want to create and finance sustaining impact, but not loosen the definition to include everything. My next points summarize what the group come to as the essential building blocks of the tent definition.

    2) On the social side of impact investing, you hit 2 of the 3 fundamental ingredients (described on p. 14 of the Profit with Purpose report draft link above). The ingredients are intent, reporting and duties. Intent matches your second point, and reporting matches your fourth. More on duties below.

    3) Governance instead of one impact type. The kinds of purposes envisioned by impact investors, intermediaries and enterprises is hugely diverse and cannot be encapsulated by required a focus on locality, the poor, or certain kinds of environmental objectives.  We actually had a very long conversation about the idea behind your point 3.  We decided to go up to the governance level rather than be proscriptive about the kind of impact one needed to have to be part of the big tent.

    Duties is an additional ingredient that the group wanted to call out for those individual businesses involved in impact creation - that they have explicit articulated commitment to the kind of impact they seek to create and that it exists at the governance level of the organization. This kind of explicit commitment to impact at the governance level (or “duties”) can be translated to other players and even structures in the market as well. A social impact or green bond has certain provisions that require explicit adherence to a specific definition of impact. We felt that incorporating a provision at the governance level was more flexible than using one group’s definition of impact.  Different governments can emphasize and reward different kind of impacts much more flexibly (as they already do) and emphasizing governance encourages them to look for ways to build those impact definitions into their fiduciary structures, which is really the long term goal.

    Sorry for the very long post, but I wanted to give some flavor to some very intense global discussions that have been going on around these issues. My colleagues may want to add in their own 2 cents as well!  I also wanted to note that the question of whether corporations, sustainability initiatives and CSR programs belong in the tent of impact investing is still I believe, a bit hazy. And I personally think it should be. I would like to see a world where a corporation is just as empowered as a small investment fund to lay out an intentional definition of impact, build in a system of accountabilility at the governance level, and use all of the metrics and systems the impact investing field is creating to prove its own ability to create impact. And many are starting to do exactly this.

    I don’t really know why we’d want to prohibit that from happening. I think the three ingredients: intentionality, accountability and governance, are more important than the corporate form (nonprofit or for-profit), type of ownership (private or public) or even size of the impact investing organization (small vs. a large multinational corporation able to influence millions through small changes in operational choices). In fact, bringing these tools to the organizations that can address issues at larger scale seems to me to be really smart!

  • BY David James

    ON October 5, 2014 08:42 AM

    As former Investment Banker and someone who dived off a cliff into starting my own Green Tech venture, I can assure you that the attempt to define Impact Investment is commendable.


    However, I should add, that most VC, PE or “whachyamaycallthem” don’t give a damn of our naive attempts to define what Impact really means. What they are only interested is the “returns”. When all you have is a hammer, then everything becomes a nail. Impact Investment is used as a fig leaf by funders.


    There may be some out there that are exceptions and I would love to meet them;
    Impact investing in my opinion must do one thing first: Make an Impact. And before some would say that all investments do make an impact,  I would add there is a massive difference between “Valuation” and “Value Creation”. Funders choose to ignore the latter or do not know the difference.


    If you know what metrics goes into “Valuation” you will know what motivates a Funder. And unfortunately both funders and lay people involved or interesting in Impact Investing are benchmarking companies and technologies based on “valuation”. This is wrong set of metrics because these same metrics when inputted into a true impact enterprise demands PATIENT CAPITAL that “valuation” has no patience for!!  This article in FT should throw more light on this. http://goo.gl/a4e1cf


    Value Creation Funding does not only impact poor communities, it does help rich communities. It must show intervention and complete a Value Chains where none existed previously. Examples could include contributions to health or Climate Change that impacts massive populations or global health.


    For example, funding sustainable building materials that rival high energy/carbon footprints like steel and concrete is Value Creation. Funding natural sugar substitutes with zero calories (Stevia) in a country with a diabetic pandemic to replace toxic sugar cane is Value Creation. Imagine my frustration when VC tell me, let the traction pick-up first. This is a fatal flaw in their thinking and should not be in Impact investing. They are part of the problem.


    Implicit in Value Creation is the Timing of the Investment. Impact Investing should happen before revenue traction occurs or should be secondary to the social or disruptive impact it intends. When traction is achieved, IMPACT BOAT HAS ALREADY SAILED.


    Most companies and technologies that require impact investing produce products or tech breakthroughs that are more expensive than conventional products because prices are inelastic. Revenue or Net Income/Cash-Flow should be secondary.


    I agree that Investing into companies that produce commoditised services is not impact investing. Examples like mobile phones, IT services is not impact investing.


    This distinction between “Valuation” and “Value Creation” will determine what Impact Investing really is.

  • BY Eric Sorensen

    ON October 6, 2014 07:39 AM

    By day 3 of SOCAP last month, I was growing frustrated at the incredibly broad range of investors that are eager to don the flag of IMPACT, such as one director of a $125 million fund that seemed to define an impact investment as any company that is selling any products or services to the lower-middle class and poor.  I began compiling my own mental list of criteria for impact investing, and, as a social entrepreneur, I think that one extremely important criterion missing from the four offered here is the impact of the investment itself. 

    Yes, impact investing is about the impact of the companies receiving funds.  But I believe that our definition needs to also include the caveat that the investment would not have been feasible for a traditional, non-impact oriented investor.  This criterion focuses the definition of impact investors toward the “venture philanthropy” side of the equation, which is where I think it should be.  Impact investing is about improving the lives of the underserved and protecting the environment, particularly in the emerging markets—be it Gary, Indiana or Port-au-Prince, Haiti—where access to traditional financing is rare, and (impact) investors are sorely needed.

  • BY Eli Malinsky

    ON October 6, 2014 08:37 AM

    I think this is a great qualifier and a very insightful point.

  • Paul Brest's avatar

    BY Paul Brest

    ON October 12, 2014 11:50 AM

    I agree with many of the comments., but most fundamentally arguing over the definition of impact investing and especially trying to narrow it are fools errands.
    Any investment that is motivated by the intention to achieve social or environmental good is a potential impact investment. The real questions is one of impact (as Kelly Born and I wrote in these pages over a year ago, http://www.ssireview.org/articles/entry/impact_investing):
    (1) does the investee enterprise produce more socially valuable outputs than would be available without it? and
    (2) does the investment increase those socially valuable outputs more than would otherwise happen without the investment?

  • Hi everyone. Thank you for your feedback. My brief comments to points raised are as follows:

    1.    The ‘Profitability’ criteria obviously includes ‘financial returns’ from social impact bonds

    2.    The criteria allows for impact investments in the high-income countries as long as they meet the other criteria of intentionality of addressing the social issues of the poor and marginalised. We are investing in a 100-seater Call centre in a large prison in one of the high-income countries. So not exclusive for low-income countries only.

    3.    I am sorry if the impression has been given that environmental issues don’t matter. At the Kuzuko Lodge (http://www.kuzukolodge.co.za; www.inqo.co.za) , we have rehabilitated 40,000 acres of old farm land into a game park, running conservation programmes for 3 endangered species. We are also re-foresting 14,000 acres with spekboom, an indigenous shrub (http://www.kuzukoproject.co.za). This will probably be the largest re-forestation project in South Africa. So environmental impact is important to us.

    4.    Our investments in fuel-efficient cookstoves (http://www.theparadigmproject.org) and franchise toilets (http://www.saner.gy) are primarily to address cooking fuel and sanitation issues but have clear environmental impact.

    5.    The terms ‘social ventures, social venture capital’ (which evolved into ‘impact investing’) were used by early practitioners to describe enterprise solutions primarily to address poverty, where environmental impact is secondary. Perhaps we should call this Social Impact Investing (SII). For enterprises that primarily address environmental issues where poverty alleviation is secondary, perhaps we can call them Environmental Impact Investing (EII)??? A bit cluncky but provides some differentiation. Alternatively stick with existing category of CleanTech/Green Energy.

  • Rodney E. Trapp's avatar

    BY Rodney E. Trapp

    ON October 14, 2014 02:07 PM

    While I completely understand the impulse and urge to come up with a neat and compact definition for impact investing, this ‘investment approach’ - as defined in the 2013 report issued by the World Economic Forum Mainstream Impact Investing Working Group http://reports.weforum.org/impact-investment/ - is still very much in its formation stage and has yet to reach maturity despite its rapid growth and evolution.  I actually like the fact that industry actors have the freedom right now to test, to explore and to be a little fluid in their definitions and practices.  Such flexibility allows for swift reaction to address the level of convergence now taking place in the global corporate sustainability movement, the amount of capital that is being directed to the sector as well as the number of social entrepreneurs operating across industry sectors. 

    The narrow definition presented in Mr. Tan’s post does not embrace this convergence.  There appears to be great promise, for instance, in the digital technology space where the coming together of visual artists, designers, engineers and technologists has spawned innovation and scalable initiatives within healthcare, digital media and the gaming industry.  You have investable projects like a video game designed by the Serious Games Institute in the UK which helps teenagers deal with sexual coercion http://www.seriousgamesinstitute.co.uk/news/Do-You-Feel-Pressured.aspx or avatar therapy that is being developed by psychiatrist Julian Leff at the University College London http://newsfeed.time.com/2013/06/05/avatar-therapy-helps-schizophrenia-sufferers-silence-their-demons/.  Tan’s proposed definition would probably exclude investments such as these which certainly have the potential to yield significant social benefits.

    By limiting impact investing to merely addressing the needs of the poor and marginalized, one ignores a wide swath of activities that have a net effect on community and the well-being of individuals and families.  Isn’t that what social impact is really about?  While there are several valid arguments here, I am not yet convinced that this is the right direction for impact investing.  At least not at this stage in the game.

  • BY Brian Axelrad

    ON October 17, 2014 05:55 AM

    I echo the responses from the other commenters ... I would also mention that this piece, while thoughtful, seems to blur the line between the business itself and the investment.  I’d refer you to Paul’s article that he references above as a very helpful taxonomy and its delineation of (a) the investee business, (b) the investor and (c) the investment (the actual capital deployed).  As it relates to the capital deployed, Paul’s article discusses the distinction between concessionary and non-concessionary returns, which is a critical component of any impact investment analysis.  It strikes me as difficult to define “impact investment” without considering these elements in the definition.

  • Lao Tze said: When you define it, you limit it.
    What I worry about Impact Investment is it exclusivity nature.
    When you invest commercially, you want to bw exclusive, the only winner.
    But when you are solving a social problem, you want to let everyone copy you so that the solution can grow leaps and bounds. Our aim is to solve the problem. Making money is only for sustainability of the service provider. But it should not block you from your true mission of poverty alleviation in its greatest sense.

  • BY Kevindoylejones

    ON December 3, 2014 08:57 AM

    I agree with Vineet Rai that we should exclude public sector impact investing. It carries no risk and is not new; it’s just a good allocation of public funds. What’s new is risk capital or debt in new areas. Adding in development dollars or CRA dollars make it seem bigger than it really is. We should focus on what is new; risk capital for good.

  • BY Kevindoylejones

    ON December 3, 2014 09:01 AM

    Is there a hashtag for this discussion?

  • BY Kevindoylejones

    ON December 3, 2014 10:05 AM

    markets thrive from efficient fracturing into meaningful verticals. I like social impact investing and environmental impact investing but I like the intersection of inclusion and biodiversity more. I think refining capital definitions increases efficient flow. Divisions that are endless metric hand jive exercises for oppressive funders who don’t fund metrics but demand them, which causes more mission creep to serve the powerful funder, are the pitfalls to avoid, imho.

  • BY Kevindoylejones

    ON December 3, 2014 10:07 AM

    I agree Cathy Clark, include corporates, but not DFI’s and CRA, is an addition I would make. Smart government money is just that. It’s not what’s new.

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