Our Next Initiative: Impact Investing for Poverty Alleviation in India
By Russell J. deLucia, PhD., S3IDF — Innovation Director & Principal Founder
Looking Back to Look Ahead
S3IDF US is in the early stage of developing our next innovation for poverty alleviation — an “impact-first” impact investing initiative with a priority, but not exclusive, focus on India. This new initiative will expand, not supplant, our market-based philanthropic projects and programs that employ our SMBA (Social Merchant Bank Approach®), which is now well-established in our India operations.
This time, my colleagues and I are without the polymath inputs of my S3IDF co-founders, the late Professor Ramesh Bhatia and the late T. L. Sankar but I believe both of them would be very supportive of this new initiative. I cannot articulate some of my perspectives below without acknowledging how their insights so aided in my and S3IDF’s growth and development. They helped us push for inclusive development and kept us on the path of innovation in support of poverty alleviation.
Poverty Specific Realities in India
In recent decades, India has made significant overall economic progress. Unfortunately, this progress has not been truly inclusive. By some measures, inequality of income and wealth has worsened and the rate at which extreme poverty is diminishing has slowed. The disparities between Indian states in most measures of the Human Development Index (health, literacy, etc.) have not narrowed, as one would hope. This is despite the large significant all-India and statewide expenditures from the public purses of various government development entities, international donors, and others such as local and international philanthropic players.
Putting the focus on specific sectors and communities does not always show an encouraging picture, however, particularly over time. Unfortunately, due to policy and market failures and sometimes a lack of enforcement of legal or regulatory structures, there remains marginalized people in all of India’s communities. Perhaps the most startling example are the marginalized peoples found in various segments of the waste management sector, though clearly there are numerous rural agriculture communities with many poor farmers, landless farmworkers, and other poor people, a sad fact that should be mentioned as their total numbers are so large.
In addition, today we face new challenges due to extreme droughts and floods. These events often disproportionately impact poor communities and highlight this century’s interlocking crises — food and water security — that are not unique to India. Regrettably, a look at intervention programs and policies, where they exist, shows that they generally do not feature inclusiveness.
I have heard the argument that those in charge of existing poverty alleviation resources could do a better job, but the reality is that just executing existing activities more efficiently is not enough. Rather, to be more effective, existing and growing evidence suggests that, in many situations, well-designed and executed “holistic” initiatives are needed. Such initiatives that address the complexities of the ecosystems that trap the poor and marginalized can be successful when employing solution approaches that employ “blended finance.” Blended finance is a mix of philanthropic and/or development capital that is combined with various sources of private capital. This mix can, in numerous situations, earn financial returns that fall along a “continuum of returns,” ranging from a return of invested capital to a full risk-return adjusted commercial rate return. An important caveat is that even when this blend includes philanthropic and/or development capital covers much, if not all, of the pre-investment project and/or program investment, such blended finance efforts cannot return risk-adjusted commercial returns for impact investments.
Realities Regarding Resources to Support Poverty Alleviation
Picking up on the realities above, in particular the last one, the hard reality is that there is simply not enough philanthropic and/or development capital to overcome the market barriers, inefficiencies, and policy failures that continue to keep many poor and marginalized people and communities in India in poverty traps. The admittedly very significant resources from three widely encompassing classes of traditional support sources — a) government entities (state and federal), ii) international donors and iii) philanthropic sources (local and international) — are still insufficient.
In India, even the new, growing fourth support source of Corporate Social Responsibility (CSR), when it is channeled toward poor and marginalized people and communities, is inadequate to solve the enormity of the challenge, but it can help.
To these four classes now must be added another widely encompassing class of support — impact investing. The GIIN — Global Impact Investing Network — which is dedicated to increasing the amounts and effectiveness of impact investing, states that “[i]mpact investments are investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return” (author’s emphasis). Globally, the asset class of impact investments has grown dramatically over the last decade plus. Recently enough, Indian entities characterizing themselves as impact investors have emerged, along with an association called the Impact Investors Council (IIC).
Available information, though limited, suggests that in India, as is the case elsewhere, impact investors do not always fully evaluate what financial returns are realistic when working to address the complexity of the most intractable social problems. Publications, including the Brookings India “The Promise of Impact Investing in India,” appropriately note the need for the development of the ecosystem of impact investing in India but often fall short of fully discussing the investment criteria needed for poverty alleviation and what are appropriate associated return expectations. There is a tendency to overlook the fact that addressing complex issues in the world’s difficult-to-serve communities simply costs more and is often associated with more investment risks, both factors result in lower financial returns.
Pertinent (& Positive) Realities
For many years, academic institutions, and in particular, their research groups, have been the incubators of concepts that evolve into social impact businesses. This has been the case in both India and elsewhere, including the Greater Boston and Cambridge, Massachusetts areas in the US, particularly in competitions and initiatives aimed at fostering innovation in many areas of society, both in the industrialized and developing world. Of particular note for the discussions herein are impact competitions aimed at addressing problems, such as global warming, a supply of and access to clean water, and other needs critical to sustainable and inclusive economic development.
There have also been changes in the Indian regulatory environment and enterprise-promoting initiatives that have streamlined the processes for small/start-up firms looking to raise capital and/or secure various types of technical assistance. The changes, in general, are aimed at fostering India’s overall development and while they have mostly fostered purely commercial entities, some changes have opened opportunities for entities with social as well as commercial objectives. Three examples warrant noting here:
Startup India is an umbrella action plan of initiatives of the Central Government launched in 2016. It aims to facilitate a culture of innovation and startups in India. Current start-up recognition includes entities up to 7 years old (10 years for biotechnology). The Central Government’s many program initiatives provide various types of support and allow for easing of the regulatory burden involved in both licensing/compliance and financing. Under Startup India, India’s Convertible Note Mechanism can be used. This allows startup companies to raise funds in the form of debt that can be converted to equity with the exact conversion decisions postponed for a specified period of time. Most states have produced their own Startup policies; some have their own programs and/or are homes to incubation or other initiatives that are part of the Startup umbrella of activities.
Alternative Investment Funds (AIF). AIFs, which can be registered as a trust, limited liability partnership, or a company, are governed by the 2012 SEBI Alternative Investment Funds Regulations and regulate privately pooled domestic or foreign investments. Three categories of AIFs exist, though Category I AIFs offer the greatest opportunities for impact first investors. Category I AIFs are structured to finance startups, early-stage ventures, social ventures and small and medium enterprises (SMEs) that the Government of India deems to have social or economic benefit. Category I AIFs include SME Funds, Social Venture Funds, Venture Capital Funds, Infrastructure Funds, and Angel Funds.
Of particular interest to impact-first investors are Social Venture Funds, which may provide muted returns for their investors and can also accept grants so long as no profit or gains should accrue to the grant provider. Social Venture Funds can also give grants to social ventures, subject to clear and full disclosure in the placement memorandum.
Farmer Producer Organizations/Farmer Producer Companies. Farmer Producer Organizations (FPOs) are legal entities owned and managed by farmers and other producer groups that share common concerns such as artisanal fisherman, cottage industry weavers, and others. FPOs can be registered under various legal forms — a Cooperative Society (CS), Section 8 Company, Societies, and Trusts — with a few of these intermediaries/collective entities starting to come into being some decades ago. Reportedly, there are some 5,000 FPOs across India.
These intermediaries provide a mechanism to aid the many millions of often-poor rural producers who can have market surpluses yet struggle with little market power. There are various government programs and entities aimed at strengthening FPOs so that they can so benefit their members. FPOs, given their structure and support, should be able to provide value in the supply, production, and market chains in which producers operate from input procurement to output marketing. While in theory operating as a group has the potential to yield greater market power, especially if the group has appropriate operational systems and can harness technical and financial mechanisms for the benefit of its farmers, this has not always proven to be true in practice. In reality, only a small fraction of the FPOs have developed the capability to provide such value on any significant and independent basis.
A Producer Company (PC) is a special category of an FPO that is registered under the Indian Companies Act. An FPO originally registered under other legal registrations can become a Farmer Producer Company (FPC). FPCs are a category that has shown dramatic growth in numbers in more recent years, but they are still only a fraction of the total number of FPOs. In principle, the FPC structure offers more possibilities to develop systems to create and share benefits amongst its members with less political interference. Some FPC success stories bear this out. What is clear when thinking from the perspective of “impact-first” impact investments is that attention should be on FPCs and some other entities which have been through the process of creation (generally with outside help) and curation (again, with outside help, almost all of it grants) to the point where they are commercially viable.
FPCs are structured to take all forms of actions to increase value and value-added capture (e.g. packaging, branding, improved market access, and milling or oilseed extraction, etc.) when the support comes from an “activist” impact-first investor. An important matter that will need consideration it the “taxability” of returns. All agricultural income is tax-free at the farm-level and at the FPO-level for some (e.g. cooperatives) but this is not the case for FPCs except if they were created from a cooperative.
Defining an “Impact-First” Impact Investment Initiative
As S3IDF US begins to develop its impact-first impact investment initiative, my colleagues and I are focused on the aforementioned serious poverty alleviation challenge as well as the potential for blended capital and innovative financing mechanisms to address the complexities of the ecosystems that trap the poor and marginalized and prevent them from accessing meaningful opportunities for improved lives and livelihoods.
We are taking on the role of an activist “impact-first” investor and are beginning “impact-first” transactions through our nascent portfolio, though it warrants underscoring that, at this stage of the initiative, my colleagues and I are still defining the details of the initiative’s future development.
Domain Knowledge and Sectors or Areas of Concentration
Through our nearly 20 years of operating experience, S3IDF US has gained domain knowledge in a number of sectors and areas of economic activity, which we will continue to leverage for our impact-first investments. Looking ahead, we intend to:
i) Integrate our experience developing and executing — with partners — a portfolio of successful community-driven pro-poor small-scale blended finance investments that directly impact poor and marginalized households and communities
ii) Continue to deeply engage with a range of Indian public and private sector stakeholders and partners to support impact-first enterprises, helping to ensure that the development of impact investing ecosystem in India will reflect best practices for inclusive development
iii) Extend our involvement with knowledge-sharing and direct capacity building by our monitoring and participating in the Greater Boston area hotbed of innovative initiatives, some of which have poverty alleviation as their focus.
iv) Focus on sharing lessons learned as impact first investors that will allow our innovations and experiences to produce “new islands of excellence” that will contribute to the further development of the impact investing space and will honor the memory of the two S3IDF co-founders I mention above.
Driven by the aforementioned factors, the sectors or areas of our impact investing are:
i) Agriculture, with a focus on making rural livelihoods improvements for marginalized smallholder farmers and also improving value chains
ii) Waste, specifically improved employment opportunities for waste workers as well as more efficient and fair waste management systems in urban and peri-urban areas
iii) Energy and Other Sectors, where productive use of know-how, equipment, technology, and creative business models can greatly enhance lives and livelihoods of un- or under-served communities
Investment Criteria and Metrics
There are two categories of criteria that our current impact investments are gauged on, all in the overall criteria of pro-poor and pro-environment.
The major metrics are:
i) Provision of gainful employment
ii) Delivery of infrastructure and related selected other services to those who are un- or under-served
iii) Local public health and environmental benefits as well as global environmental impacts
iv) Partial or total ownership of the assets by marginalized or disadvantaged individuals and/or groups
v) Priority is given to supporting women as beneficiaries and/or through execution of the investment, when appropriate and feasible
In addition to the major criteria above, our selection and prioritization of specific impact investments are to be reflective of one or more of the following:
i) Innovation in the enterprise’s use of technology or knowhow (new or unique application) and/or the enterprise’s business plan
ii) Potential for significant positive disruption in an existing “ecosystem of poverty” and/or the potential for widespread replication
iii) Enterprise and/or entrepreneur has/have a successful execution track record
iv) “Skin in the game” meaning that the entrepreneur puts in some mix of cash, sweat equity and involvement commitment to the enterprise
v) Governance and enterprise mandates emphasize inclusiveness and provide clear benefits and impact (especially for collective entities)
vi) Possibility for the investment to mobilize additional financing for the enterprise and/or specific projects the enterprise executes (such as accessing grants for blended financing or accessing local or international debt or equity).
In addition, for potential investment opportunities, we also expect to consider and prioritize the following enterprise features:
i) For-profit registration, though an enterprise need not be a social enterprise so long as it has clear poverty alleviation impacts that are achieved by its operations.
ii) Both asset light and asset heavy, however, given likely necessary allocation or even rationing of available investment funds and assuming transaction target impacts being equal (though this is rarely the case), an enterprise that is asset light and others that can more readily achieve leveraging should be favored.
iii) Locally focused since unlike so many impact investors we should not be fixated on scaling and the “small and growing business” mantra, especially when scaling means multiple geographies (breadth over depth of impact). Many “local enterprises” working in and for specific areas and with particular communities can over time have significant and increasing impact on these communities. Moreover, they often also lessons for other analogous “local enterprises” and as activist investors, we can, with partners, facilitate the transfer of learning from these lessons.
iv) Employee-owned enterprises (in whole or in part) should be favored when possible given the importance of asset ownership in escaping from poverty. Also, when there is the possibility of introducing some asset ownership in the business plans and/or operations plans, it should be raised and if the enterprise entrepreneurs are open to it, we should facilitate this as part of the investment transaction.
Perspectives on Pipeline and Portfolio Building and Scaling the Initiative
Based on my decades of on-the-ground work as a development consultant, S3IDF has (since its founding) focused on the need for innovation and stood firmly by the idea that merely pushing a new concept is not enough. My colleagues and I strongly believe that demonstrating efficacy using a “learning by doing” (as we are doing now) in our nascent “impact first” investing initiative can result in direct live and livelihoods improvements while also inspiring other poverty alleviation players in the international development space so that they might join our initiative or one that could morph from it.
Indicative and Evolving Pipeline
When my colleagues and I first began internal considerations of our “impact first” initiative, I prepared a long list of an indicative pipeline that after more discussion with the relevant enterprise founders could become a pipeline of investment deals. These indicative pipeline possibilities emerged from S3IDF’s network and were selected based on their enterprises’ missions and activities (existing or proposed). At this early stage, a “guestimate” of potential deal-specific investment amount size was made — and sometimes preliminary thoughts on debt versus equity. This process of possible deal identification continues with inputs from my colleagues and ideas from a few of our trusted partners.
At the same time, this early potential pipeline discussion was happening, parallel internal research and dialogue was focused on questions and issues such as “How activist an investor should S3IDF be?,” “Who else is operating in the ‘social first’ impact investing and/or blended capital space?,” “Which groups could we and should we learn from?,” and “What are the realities regarding the regulatory constraints faced in both the US and India?” These aforementioned matters continue to get further investigation and consultations (including with legal experts in both India and the US).
As expected, addressing poverty alleviation innovation via an “impact first” investment initiative will not be simple but the challenges can be overcome with the right partners and with tailored blended financing appropriate to characteristics and stage of development of social enterprises that are focused on addressing the poverty realities pointed to above.
Moving Forward: “Learning by Doing” with Portfolio Deals and More
As S3IDF US has been positioning to actively pursue an impact investing initiative, we have also been investing in a few social enterprises using processes that are analogous to those employed by other funds and impact investors. This “learning through doing” process has benefited markedly from research on industry practices and extensive legal consultations (e.g. our term sheets reflect much learning from what others have done and our legal advice regarding deal structuring for US versus Indian entities) as well as our nearly 20 years of direct work on financial engineering on deals on both the micro/-small-scale enterprise level and the fund/facility level.
To date, we have made a couple of investments and are about to close on a few others. These deals range from those that are registered in India only to those that are US-based with operations in India to those that are registered in India but whose plans include the creation of a US subsidiary.
Looking forward, we intend to continue to “learn by doing” as we leverage our domain knowledge and make more initial investments, which will, we expect, allow us to demonstrate success and also to argue more effectively for development players to enter this under-capitalized segment of the overall impact investing asset class. Together we hope to collectively provide more investment capital and to further iterate on necessary financing structures that are critical to meeting poverty alleviation objectives.
In the coming months, my colleagues and I plan to pursue the following paths:
Path I. Financial Closure on Deals in Process
We are currently in investment discussions with the founders of several social enterprises that meet our general criteria and we plan to move to finalize terms in the coming weeks while also opening up new discussions with others in our pipeline. These deals will bring actual poverty alleviation impacts as the operations of these investees’ social enterprises go forward. S3IDF US will be ensuring that these impacts are measured and documented. In addition and very importantly, we will gain additional data on detailed transaction efforts differentiated by investment deal type, characteristic, and associated costs, which will further inform our decisions around setting various priorities and possibilities of co-financing and leveraging.
Path II. Adding to Indicative Pipeline and Moving More Investment Possibilities into Detailed Discussions
Our decades of experience working with entrepreneurs as well as our recent work to prepare for our impact investing initiative makes clear that we must undertake thorough due diligence and characterize and rate candidate investment possibilities. Our learnings also indicate that these thorough assessments must be made even as new social enterprises enter the pipeline and continue through the phases of detailed discussions prior to negotiations and then to the negotiations themselves. It is imperative that potential investments not only be assessed based on their impact potential and business model but also on their placement within the larger market and the likelihood that they fit the appetites of particular partners or groups of partners.
Path III. Continuing Prior Research and Assessment and Commencing Dialogues with Possible Partners
S3IDF US has identified and compiled a considerable base of information on legal and contractual mechanisms and has also identified a number of like-minded entities that have the potential to become possible partners. Partnerships could take the form of co-financing on either a deal-by-deal basis or co-managing a fund. Partners could also serve as knowledge leaders, working with us and others, to influence and reshape the impact investing asset class in ways that will focus more on new financing structures for poverty alleviation and mobilizing additional new capital through blended finance. This research, information and now dialogues will both complement and expand our domain knowledge.
Path IV. Further research and consultations on morphing the initiative into an AIF
It was clear when we embarked on this new S3IDF US “impact first” impact investing initiative aimed at poverty alleviation in India that we would need to marshal more financial resources if our results were to be numerous enough for “islands of excellence” to emerge and to be viewed as examples that others might follow/adopt. Consequently, our process from early on has been to identify legal and other transactional mechanisms that will allow us to create a fund rather relying solely on deal-by-deal co-financing. One of the strongest opportunities is through the aforementioned AIF structure.
Next Steps
The usefulness of articulating these perspectives as my colleagues and I continue down these Paths as part of our new initiative relate to i) seeking constructive feedback; ii) identifying possible partners for our initiative; and iii) seeking the suggestions of others to dialogue for the previous i) or ii).
We look forward to utilizing our domain knowledge and positioning S3IDF US to pursue opportunities with like-minded partners around an “impact first” impact investing initiative for India.
