In my last post, I raised three questions about the role of impact capital in three specific scenarios: Early-stage, high-risk impact investing; investments in more mature companies; and impact investments in organizations that will likely need ongoing support. I addressed the first scenario by arguing that impact investors and philanthropies should, as a central part of their efforts to drive scalable social change, invest in early-stage ventures that have the potential to open new markets.
In this post, I’ll examine the second scenario: Investment in more mature companies.
Scale capital: Does investment in established solutions make sense?
What about investments in more mature organizations? What role can (and should) impact capital play once a company is up and running?
As Monitor’s “From Blueprint to Scale” report makes clear, the bulk of impact investing typically goes to more mature companies. That’s predictable: Investors (impact or mainstream) look for strong successes. When a business model has been tested or validated and achieved scale, there’s greater line of sight to success.
At first blush, this tendency seems to make perfect sense from a social impact POV as well. Impact investments in mature companies that serve the poor reach millions of needy people, right?
But look one level deeper and the case is less clear cut. Consider: once an organization’s model and its viability are established, private capital will flow in. Do impact investors really add anything by staying in the space? Or could their dollars be more wisely allocated elsewhere?
The development world has helped shape impact investing as a potentially great tool to drive lasting change. Now is the time to establish practices that can help ensure the sector fulfills its promise.
Impact investing at scale: The additionality factor
Our thesis is that impact investors do indeed have a valid role in the scale space—as long as we follow certain guidelines.
1) We have to clearly define social ROI and prioritize it on par with financial returns.
2) We have to ensure that we don’t simply displace more mainstream investors.
3) We must have true “good cause” for being in this space. In other words, we must articulate and hold ourselves accountable for the achievement of clear, measurable goals about what our funds contribute over and above private capital. In the development parlance, this requirement is often referred to as the “additionality” or “incrementality” factor.
Such additionality might include:
- Penetration into new sectors: This approach involves exporting proven solutions into new environments, for instance from rural to urban environments. The foundation invested in Waterlife India to test the viability of importing clean water kiosks from a rural environment (where Waterlife had a well-established business model) to an urban environment. In our urban microfinance program, we took a different approach to the challenge of sector penetration, opting to support new, institutions that had an exclusively urban focus, rather than working with large rural MFIs.
- Design and standardization of customer-centric practices: In our work in urban microfinance, this meant providing “patient capital” to mature microfinance institutions to allow them to invest in understanding customer behavior, so they could design, deliver and encourage the adoption of needed products such as microsavings accounts or mobile banking. The goal is to ensure that companies evolve practices that are responsive (and responsible) to low-income customers’ unique needs.
- Outreach to poorer customer segments and support for lower pricing: In India’s education technology sector, this might mean making low-cost capital available to established ed tech companies so they can design and deliver high-quality, affordable solutions to budget schools, which typically serve very students from very low-income families.
Where does philanthropy fit in?
Granted that adding an additionality factor can limit returns, it remains a critical differentiator of impact versus traditional investments: Indeed, it’s only if we hold the impact sector to an additionality requirement that we can fully unleash impact capital’s potential power.
Philanthropies are in a unique position on this front. If we’re to use investments to make the most of our social mandate, we have a clear obligation to set guidelines around additionality. In doing so, we avoid the risk that philanthropic dollars will simply replace viable commercial capital (an outcome that runs exactly counter to our big picture goal of catalyzing transformative social change.)
We also help chart a course forward for the field as a whole. The development world has helped shape impact investing as a potentially great tool to drive lasting change. Now is the time to establish practices that can help ensure the sector fulfills its promise.
This post is part of an occasional series on mission-related impact investing, and on its role as a tool for extending and accelerating social progress that directly benefits children and families living in urban poverty.