(Illustrator by iStock/SvetaZi)
On the heels of the 2015 Paris climate agreement, environmental, social, and governance (ESG) standards exploded onto the scene as a way for companies to focus on sustainability in business decisions and for investors to prioritize socially responsible companies. In the years that followed, trillions of dollars poured into ESG funds.
But cracks started to emerge. As journalists looked under the hood of ESG funds, they found investments in oil and gas majors. In 2021, Tariq Fancy, former chief investment officer for sustainable investing at Blackrock, the world’s largest asset manager, penned a scathing essay that the ESG label was being used to dupe the American public with greenwashing. Backlash against the consideration of social factors in investments also began to grow; in recent years, 19 US states have passed 42 anti-ESG laws preventing public fund managers from taking social considerations into account.
At its core, ESG’s problem stems from a lack of clarity. There are, of course, innumerable instances of ESG-focused funds leading important change globally. Many have helped reform operational and governance standards within corporations, and forced internal dialogue and measurement efforts to gauge social progress. But in the absence of clear, value-based standards, it’s often just a buzzword. Its loosely defined, “yes and” posture allows companies and investors to toss it around to validate their commitment to social good without having to meet specific requirements. Companies’ loquacious race to classify themselves as “ESG-approved” has led to justified attack, with shareholder support for ESG declining and institutional investors citing ESG fatigue.
The ESG movement may be too far gone to revive. But its fate can help shape the development of another type of impact financing: catalytic capital. A sharper, shared understanding of this form of risk-tolerant investment, which takes on risk to validate a new business model or market with the aim of ultimately drawing in more capital, can dramatically increase the volume and scope of funding for social impact.
The Power of Catalytic Capital
To scale promising social enterprises, leaders of social change need access to context-appropriate capital—funding that considers and addresses the unique risks and needs (such as limited liquidity and longer timelines) that ventures in challenging markets face. This type of investment is widely known as catalytic capital and is remarkably good at market building. According to Convergence, every $1 of catalytic capital mobilizes $4 of downstream traditional investment for social impact efforts.
A compelling example is FarmWorks, a social enterprise that provides farming inputs, finance, training, and market access to smallholder farmers in Kenya. In 2020, the company’s co-founders Yi Li and Peter Muthee began looking for investors who understood the unique needs of building an agricultural business in the region. FarmWorks’ business model was fundamentally different than the high-margin software businesses typically favored by venture capital. As Li explains, "To sell a kilo of tomatoes, you're growing another kilo of tomatoes," underscoring the methodical nature of agricultural scaling compared to typical venture-backed businesses. Building FarmWorks also meant developing extensive logistics networks, managing relationships with thousands of farmers, and operating warehouses across the region.
Like many social ventures in emerging economies, the company also faced limited supply and payment infrastructure, complex distribution channels, and customers with constrained purchasing power. Its path to profitability would be longer, and its exit strategy less defined than what traditional investors typically sought. As Li told us, "For businesses like FarmWorks that are not disrupting a model but are significantly improving the efficiency and scale of possibility [in] a traditional sector, patience is required.”
In 2021, Acumen’s Resilient Agriculture Fund stepped in to provide pre-seed, patient capital, a form of catalytic capital geared toward longer horizons. This allowed the team to honor their ambitious mission sustainably without short-sighted pressures of quick exits and high returns. The company used initial funding to grow its services into an integrated suite of end-to-end support, including financing for low-cost machinery and reliable access to markets, and became the largest domestic distributor of fresh vegetables in Kenya within four years. Today, it works with 3,000 farmers to bring produce to market, and sells more than 1,000 tons of local staples and high-value crops monthly. A recent $4.1 million, pre-series A funding round—led by Acumen Resilient Agriculture Fund and supported by Livelihood Impact Fund, Vested World, family offices, and angel investors—signaled confidence in both the company’s market opportunity and ability to scale systems-level impact.
Estimates vary, but proxies suggest that catalytic capital constitutes less than 0.01 percent of global investment capital. And while the impact investing market has grown to approximately $1.1 trillion, only a fraction of this sum can be considered catalytic capital. This scarcity of flexible funding for early-stage social ventures that are working in challenging but promising markets isn't just about numbers; it represents a tremendous amount of transformative impact left unrealized.
Deepening Our Definition
On the surface, the definition of catalytic capital may seem clear: flexible financing for impact ventures that investors can tailor to take on unique risks. But go a level deeper, and questions proliferate. What kinds of risk? What kinds of financing? Different organizations perceive catalytic capital differently. For example, some emphasize concessionary returns that trade lower financial gains for social impact, some focus on taking on greater market risk, and some aim to benefit specific groups of people. Some argue that any concessionary instrument (including a loan or a grant) qualifies, while others insist that the investment must pull more traditional financiers into these markets via blended transactions or follow-on investments.
During our time as MBA candidates pursuing social impact research, we’ve spoken with many investors and professors experienced with catalytic capital who believe some definitional flexibility is good. Rather than gatekeeping on semantics, they believe maintaining some openness to different forms of catalytic capital helps bring more investors into the market. We don’t necessarily disagree. But they also recognize the downsides of ambiguity. Inconsistent definitions present a number of problems. For example, it’s time-consuming and challenging for social entrepreneurs to look across the wide range of impact capital providers to identify who might be the right investor for their unique needs. Catalytic investors meanwhile struggle to collaborate on deal flow to solve market gaps, and follow-on or commercial co-investors struggle to compare deals side-by-side. The result is an inefficient catalytic capital market with limited impact.
Delineating catalytic capital by the mechanisms through which it operates, however, can improve everyone’s understanding, more efficiently match market needs with particular investor flexibilities, and ultimately scale more impact through greater capital flows. For example, a biotech startup developing a maternal health diagnostic may need highly flexible, long-term capital due to high R&D costs, regulatory hurdles, and a delayed path to revenue. This would make it better suited to non-concessionary patient capital. In contrast, a community-owned broadband provider serving rural areas might achieve steady revenue relatively quickly through subscriber fees but operate with intentionally limited margins to keep services affordable. While it can generate cash flow, its social mission caps its returns. This makes it a better fit for concessionary capital that prioritizes impact over market-rate returns. Both models create meaningful impact but require different capital structures to thrive.
Catalytic capital is intended to “go first”—derisking an asset or market with the goal of attracting additional investments, often from conventional investors who wouldn’t otherwise participate. It’s thus important to ensure that conventional investors can compare deals apples-to-apples—including elements like impact metrics, mobilization goals, or market forecasts—so that they don’t walk away from the market altogether.
Better Definitions Toward Better Markets
As noted earlier, investors aren’t monolithic. Catalytic and commercial investors have unique preferences; their motivations, risk appetites, and returns expectations differ. One catalytic investor may be willing to seek concessionary returns on loans, while another might sacrifice on return horizons. Co-investors are similarly diverse; what makes an investment too risky for one commercial lender will differ from another. And certainly, investee needs vary widely.
In addition, while many impact investors do great work determining the needs of specific markets to close financing gaps, they often do so in silos. No coordinating body actively tracks and shares financing gaps across markets or maps where specific investors are most willing to take on specific risks. Given this, a lot of great deals that aren’t a fit for one investor likely die when a better-suited capital provider might have carried them forward.
Clearer definitions can address these market failures in several ways. For one, they reduce transaction friction for entrepreneurs. Entrepreneurs are too often left in the dark, unable to determine which capital stacks and investors best match their business needs. Better definitions for the type of risks individual catalytic investors are willing to take on equips entrepreneurs with the knowledge they need to find the right investors.
In addition, they improve market efficiency by better matching capital to opportunity. Although the motivations and capabilities of catalytic investors vary widely, they often cluster around similar opportunities while leaving other needs unmet. More clearly distinguishing the different dimensions of catalytic capital can help them identify the right fit.
Clearer definitions also enable better investor coordination. When investors can clearly articulate their risk appetites and preferred impact dimensions, they can more effectively combine forces. They help align traditional investors with relevant catalytic investors who have the right tools to sufficiently de-risk specific areas of concern.
A Definitional Framework
Given this opportunity to create a more robust and responsive impact capital market, we propose a new framework for defining catalytic capital that has two parts: requisite properties and dynamic attributes. We do not propose this framework with the expectation that it answers every ambiguous question around catalytic capital, or even that this is the “right” set of guardrails for all catalytic market participants. We hope this framework can serve as a starting point for discussion on the anatomy and gradient of catalytic investments, with both traditional and non-traditional dimensions. It also aims to strike a balance between rigor, clarity, and flexibility.
The first part, requisite properties, offers a baseline understanding of what catalytic capital “must be and do,” and includes three criteria:
- Additionality: It must fund ventures that wouldn't otherwise receive sustainable funding from traditional investors.
- Mobilization: It must attract additional capital from other investors.
- Impact: It must increase the quantity or quality of social or environmental outcomes, helping transform the market longitudinally.
The second part of the framework then proposes that catalytic capital must be dynamic in at least one of five (but usually more) specific attributes:
- Subordination, or the order in which debt is paid out, or the preferential treatment in equity investments. Catalytic investors might take first-loss positions, protecting other investors and helping attract additional capital.
- Returns, or the profit derived from an investment, typically benchmarked against an investor's internal rate of return. Catalytic capital might accept below-market returns to prove a model's viability.
- Timeline, or the investment horizon until exit or payback. Agricultural businesses like FarmWorks, for example, often need more time to align with growing seasons and market development.
- Liquidity, or how quickly investments can be converted to cash without significant loss. Catalytic capital often accepts limited liquidity to support long-term growth.
- Investees, or the recipients of investment, which might include emerging managers, founders, or beneficiaries. Catalytic capital often supports historically overlooked founders or communities.
This chart illustrates the dynamic attributes of catalytic capital—subordination, returns, timeline, liquidity, and investees— that can flex to meet the needs of underfunded ventures. Unlike the requisite properties that define what catalytic capital must achieve, these dimensions reveal how it may vary in practice. (Image courtesy of Savannah Baum, Olivia Rosen, Sean Sellers & Billy Silk)
An investment does not need to fall in the leftmost box of every dimension in the chart to be catalytic. Indeed, many catalytic investments incorporate more traditional features across several dimensions. For example, investors might consider an investment that deviates meaningfully from at least one standard commercial norm (the chart’s rightmost boxes) somewhat catalytic. A debt instrument with conventional liquidity and a standard return timeline might offer concessionary returns and take a first-loss position in the capital stack (the order in which investors are repaid if the company defaults) if the investee defaults.
Investors might also consider an investment that is non-concessionary but allows abnormally long timelines for return catalytic. For example, an investor in carbon projects might demand strong returns (say, a 15 percent internal rate of return) but allow investees to repay them over 15-20 years instead of the more traditional 8-10 years. Understanding where an investment falls within this taxonomy enables more effective market engagement, offering a shared language and clearer perspective on what type of catalytic capital is and is not being deployed.
The Path Forward
In the absence of widely adopted, data-driven approaches or logic-tested theories of change, investor commitment to ESG has proven fleeting. Better definitions and specific language can help catalytic capital avoid the same fate, and provide a more reasoned commitment to market development and systemic change. The framework presented here is not an exercise in dogmatism, attempting to set forth rigid definitions that limit participation. It is an attempt to support the discipline and rigor of like-minded entrepreneurs and investors in pursuit of more effective collaboration. Incremental changes, driven by clearer frameworks and objective standards, will ultimately lead to much greater impact than chasing buzzwords or hype.
More stories like that of FarmWorks are waiting to be written, and their chapters can unfold when visionary entrepreneurs align with the right investors and timing. Some may want ambiguity to persist in the name of inclusion, but allowing anyone to call their capital catalytic risks a more troubling exclusion: holding communities back from building and sharing a more prosperous future. Developing a shared understanding in service of better coordination is an important next step in the field’s evolution.
Read more stories by Savannah Baum, Olivia Rosen, Sean Sellers & Billy Silk.