By Nandita Ramanathan, Consultant, Asha Impact
As a novice in the impact investing world, what became immediately apparent to me is that impact investing is not an asset class of its own. The principles of traditional investing apply just as well. For example, all investors consider an enterprise’s maturity, and consequently, the round of investment (seed, series A, B, C) the enterprise requires.
Impact investors simply apply an added lens of social impact to their investment strategy.
With this in mind, let’s explore two popular approaches to impact investing.
The mission-driven impact investing approach is most popular in the United States and most commonly followed by philanthropies and foundations. These organizations typically have a defined mission (example: eliminate malaria, alleviate abject poverty, improve literacy levels) and pursue a range of interventions — both for-profit and non-profit — to achieve this mission. These interventions could include grants, impact investments, capacity building programs and research. These organizations believe that by pursuing a holistic approach, they have a better chance at overcoming a social challenge. That said, some critics argue that grants and other non-profit solutions are inherently unsustainable.
Simply put, mission-driven investing refers to the use of investments by foundations as tools to achieve their philanthropic goals.
Sector agnostic approach
Unlike foundations and philanthropies, commercially oriented impact investors tend to prefer a sector agnostic approach.
In this approach, investors are focused on making profitable yet impactful investments. By being sector agnostic, they protect themselves from the risks posed by a particular sector, and simply look for the best investment that suit their impact criteria. A perceived drawback here is that these investors are unable to bring deep expertise to support their portfolio companies.
While sector may not be a focus, investors typically focus on:
- Management Team: Investors will typically be keen to know the management team’s experience in the industry in which they operate, education backgrounds, commercial acumen, experience running other enterprises, social impact motivation, ability to achieve the enterprise’s goals etc.
- Impact Thesis: As social impact is the lens that is specifically applied in impact investing, it is important for an investor to understand the enterprise’s impact thesis, or theory of change. The enterprise may be focused on empowering a certain community (example: women, low income groups etc.), or tackling a problem of access (example: access to capital, medicines, affordable housing), or monetizing a socially beneficial process (example: waste management). The investor will need to analyze whether the enterprise’s impact thesis aligns with their impact criteria.
- Financial Performance: The investor will be keen to understand the unit economics (profitability of selling one unit of product or service) of the enterprise being evaluated. When making equity investments the investor will want to identify attractive exit opportunities and upside potential, and while extending a loan the investor will want to determine the enterprise’s ability to service debt.
So which approach should you take? Is one approach better than the other?
As an impact investor, you will want to think about what impact means to you. Impact could mean diving deep into one social problem and identifying multiple critical solutions to overcome it. Or it could mean identifying and supporting innovative and sustainable enterprises that are trying to solve a range of social challenges.
Whichever path you choose, social impact is your destination!
Please send in your thoughts and comments to firstname.lastname@example.org.