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:
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.
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.
Locality. These enterprises usually operate in the slums and rural areas where the poor live. This is their marketplace.
- 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.