Earlier this year, we looked into the state of impact investing and observed that many global investment banks, such as Deutsche Bank, Morgan Stanley Smith Barney, and Goldman Sachs, were diving into the impact investing arena. Deutsche Bank established a £10 million Impact Investment Fund, Morgan Stanley Smith Barney assembled an Investing with Impact Platform, and Goldman Sachs is experimenting with a controversial impact investment tool called Social Impact Bonds.
There is a general understanding of the potential for profit for impact investors – between $183 billion to $667 billion to be exact – and up to $1 trillion of invested capital over the next ten years, as stated in a report released in 2010 entitled Impact Investments: An Emerging Asset Class. The lure is essentially the possibility of making money and doing good, as these investments are funneled into projects like delivering healthcare or distributing renewable energy, hence the name “impact” investing.
Billion Dollar Prediction, Million Dollar Reality
Great market potential, great cause, it all sounds good so far, right? But wait a minute. Despite all the fluffy goodness about impact investing, the action is missing. Where are all the deals? Money – at least the amount that matches up to the potential of impact investing – doesn’t seem to be leaving investors and flowing into social enterprises. Acumen Fund, a pioneer in the area of impact investing, made roughly $81 million in 72 enterprises since its beginnings in 2001. Gray Ghost Ventures, another pioneer investing in low-income communities, invested roughly $100 million since 2003. One of the bigger investment firms, Omidyar Network, put in $545 million since 2004, but this number is still far from the billions as predicted.
Dissecting the Problem
If we trace the problem, it would fall somewhere along an economic concept called supply and demand. The supply side is about having compelling investment opportunities and the demand side is about having people wanting to make impact investments. In order for impact investing to flourish, the two have to meet, but given the missing action there is obvious disconnect between the two sides.
An article in the Stanford Social Innovation Review entitled Closing the Pioneer Gap looks thoroughly into the disconnect using Husk Power Systems as an example.
Husk began as an idea to use rice husks – an abundant supply often considered as waste – to produce renewable energy for villages in India who have no access to electricity. The three social entrepreneurs behind this idea, Gyanesh Pandey, Ratnesh Yadav, and Manoj Sinha, built low-cost generators, a power plant, and strung up power lines on bamboo poles to power up 400 homes.
In 2007, when the trio had spent nearly all the money in their bank accounts to put their idea into practice, they assembled a business plan and entered three business plan competitions from the University of Texas, the University of Virginia, and the Massachusetts Institute of Technology, in which they won and took home $97,500 in total prize money. The money was used towards a second power plant, and at that point they started approaching investors to seek investment in their company. Roughly $170,000 of personal savings and prize money was invested into the company, and between the two pilot sites they were providing 800 customers in Bihar, India with clean, renewable energy.
But guess what? The only thing they received from investors was interest, no action. Husk’s situation is not unlike other social enterprises. Investors are simply reluctant to invest in early-stage companies. The reality is that impact investors’ primary goal is to generate a financial return, even though they may care about social impact. And because social enterprises – especially those that tackle the challenges surrounding poverty – face many obstacles, such as poor infrastructure, customers with limited buying power, nonexistent supply chains, and an inability to attract talented managers, their costs of doing business are higher and come with additional risks, meaning investors will rarely be able to realize high returns.
Husk had to acquire a steady source of rice husks, string wires on bamboo poles to connect every house in the village, create payment systems for customers without credit history, and recruit and train employees from a thin pool of talent to run the plants. As a result, investors would avoid making an investment or invest at a later stage, even though the business requires early-stage investment the most and shows potential. Looking at both pieces of the puzzle, there is a lack of compelling investment opportunities and investors willing to put money into social enterprises, of which most are early-stage. The result is a standstill.
If there’s no action, why would anyone predict this to be a multi-billion dollar industry? Some of the newer, more aggressive funds and financial institutions are adopting a wider definition of “impact investing” to include investments in more traditional businesses in developing markets, such as real estate and shopping malls, where there is no doubt potential to create positive impacts on society. However, the missing action is in inclusive businesses, which are at risk of getting overlooked because of other financially lucrative opportunities in the broader definition.
The challenge right now is to move beyond the standstill. As Omidyar Network puts it in their new report entitled Priming the Pump: The Case for a Sector Based Approach to Impact Investing, it is about “priming the pump” and making sure there is a healthy sector. Matt Bannick, co-author of this report, explained at SOCAP last month that too many of us are just waiting around for lucrative, investable deals in comfortable market conditions, but no one is actually doing the hard work.
“It’s as if everyone is waiting around the proverbial water pump – for this flood of high social impact, high financial return investments to come through, and nobody’s actually doing the hard work to prime the pump,” says Bannick.
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