Impact Investing: Crazy or Not?

My name is Patrick Huang and I am a WDI Fellow interning for Village Capital in Mumbai, India for the summer. A relatively young organization in the impact investing industry, Village Capital supports growing social entrepreneurs around the world. Before I get into the amazing work that Village Capital does, I wanted to share what I learned about the industry after attending the Impact Investing in Action conference in Atlanta and the Frontier Market Scouts training program in California.

For those unfamiliar with social enterprises and impact investing, I am defining a "social enterprise" as a for-profit enterprise seeking to achieve returns beyond financial such as positive social and environmental impact while "impact investing" as an industry seeking to finance these social enterprise through debt (loans), equity (ownership), and anything in between. Traditionally, non-profits have pursued social and environmental impact while corporations have focused on financial returns. With social entrepreneurship officially recognized by Bill Drayton from Ashoka, more market-based (see: revenue generation) approaches have flourished partly in response to the unsustainable, grant-funded programs that address poverty. Although this shift may sound appealing, the challenges for social entrepreneurs are staggering.

First, most Base ofthe Pyramid business models generate lower margins and take longer to reach scale, i.e. impact thousands - much less millions - of people. Simply stripping down a product offered in the developed world and selling this in developing countries has proven to be ineffective.  Just like those in developed markets, BoP business models require multiple iterations to refine the product or service for customers' needs.

For entrepreneurs, the nascent impact investing ecosystem offers little support for the more than 85% of start-ups that fail. First off, social entrepreneurs - whether they identify themselves as such - have difficulty finding financing. On one end of the spectrum, traditional investors typically expect a much higher return while non-profit foundations (with a few exceptions like Calvert Foundation) are usually wary of giving grants to for-profit entities. For example, a speaker during the conference mentioned the disconnect between a philanthropic heart and an investor mind: when considering funding to a social enterprise, his board was more willing to give $50K in grants with no opportunity for return rather than a $50K convertible note (essentially debt with the option to convert to part ownership of a start-up) with 2% interest. In addition, social entrepreneurs oftentimes don't even know what a "social enterprise" is or wouldn't naturally associate themselves as such leading to a sense of isolation with little support.

The challenges continue to the investor side. Investors in the US typically invest in multiple start-ups with the hope that one of them generates huge returns by going public or getting acquired by a larger company thereby returning around 100 times the initial investment. For impact investors, however, the return is usually closer to 1X the initial investment leading to a higher risk per investment. In addition, financing options are usually limited as debt is not as viable since the revenue generated by these enterprises is too low to pay for monthly interest payments. Furthermore, the economics of financing these deals are not as compelling as the transaction costs, e.g. due diligence , are just as high for a $300K deal compared to a $1-3M deal.

Despite these challenges, hope prevails; the impact investing industry has taken steps to address them such as GIIRS and IRIS's effort to standardize social metrics and B Corp's certification that allows for-profit enterprises to legally pursue returns beyond financial. In addition, the conference is a good example of industry leaders coming together to discuss these issues and how to overcome them. This conference also demonstrates one of the distinguishing factors for the impact investing industry: collaboration. Impact investors understand that addressing poverty alleviation is multi-faceted and complex; co-investment in enterprises has become common to share risk while validating deals.

Additional support, such as incubators (Hub Ventures) and accelerators, is also increasing especially for earlier-stage enterprises. Village Capital's unique accelerator programs brings cohorts of entrepreneurs together around the world. Besides providing training such as improving business models and learning how to think like investors, entrepreneurs conduct peer reviews to make themselves better. At the end, each entrepreneur ranks everyone (minus themselves, of course) and the top ranked receive funding. With pre-committed capital from investors, Village Capital changes the power dynamic altogether. With 14 programs worldwide, Village Capital continues to accelerate both the industry and entrepreneurs seeking to make a positive impact in the world.

To be fair, critics around impact investing present valid points. Despite these criticisms, impact investing is growing with large institutional support such as JP Morgan and Citibank and will continue to evolve. In my mind, the only question for me is whether I want to stay on the sidelines and wait to see what happens or join and contribute to the exciting and innovative approaches to address poverty. As a speaker during the conference aptly noted: "There are things that are crazy to do. There are things that you would be crazy not to do." Impact investing is one of those things that I would be crazy not to do.