Impact investing has been gaining purchase among venture capitalists and investors of late. But what is impact investing, and how is it different from traditional investing? One also comes across a few other terms, such as ESG, and SRI, which makes this idea a little blurry with no defined boundaries. The concept also receives flak and cynicism, with experts calling them “greenwashing.” This write-up focuses on differences between various images around impact investing and highlights why it may be the way of the future.
What is impact investing?
Impact investing is an investment strategy that aims to create positive social and environmental benefits in addition to returns that beats the market. All businesses today have profound social and environmental effects and are also affected by social and environmental forces. If we understand this impact and channel the resources toward measurable goals while generating social, environmental, and financial value, this falls into Impact investing. To clarify, “Impact investing” is not a charity, and neither should be seen as concessionary capital. It is grounded in the principles of financial returns and looks for specific areas which can spur the impact.
Do VCs have an impact?
Traditionally VCs see themselves as impact investors as they are able to bring disruptive ideas to life while delivering beyond market returns. However “Impact” was never a variable or a core-driver for the VC firm. Venture Capital has an inherent element of impact, as they think like futurists and allocate resources to most novel, unseen and untested ideas. Some of the biggest names today that have disrupted our lives, such as Uber, Google, etc., are the fruits of Venture Capital. They argue that the ability to fund startups that drive change via technological developments increases demand and employment opportunities is nothing different from social revolution. Markets over a period of time become lazy and uncompetitive. The conventional players focus on incremental innovation. Here is where challenger brands powered by VCs disrupt the market, passing the value to customers. Are these not impactful for society and the economy as a whole? The answer is yes, they are, and Venture Capitalists have a role to play, and they should continue their vital role in society. However, there may be a better way of doing things – “Impact Investing.”
Why has impact investing been gaining traction recently?
Failure of the welfare state: The failure of the state to solve pressing problems and the widening of the difference between haves and have-nots is real. For some reason the welfare state model that evolved in the late 1940s has not been able to solve these problems. Government seeks help from private corporations in deploying capital for social causes. The welfare state model of government cannot bridge the gap of inequity.
Millennials and Generation Z have different values: Entrepreneurs of the current generation and Millenials, more than ever, believe in working towards a cause. More than financial returns, the purpose and mission drive them. They are also risk-takers and do not shy away from standing for a cause. Impact investing principles resonate with their principles.
Innovation-led growth: Growth has stagnated in many parts of the world, as many economies are reeling under recessionary pressures. Organizations must foster innovation by partnering with local and regional organizations, entrepreneurs, and government entities to drive growth. Fulfilling the unmet needs of a large section of the poor and deprived population calls for disruptive sustainable solutions. Innovation around social revolution could be the new agent of growth.
Sustainable Development Goals: We need to come together sooner to solve some pressing issues that our Planet faces today. These global goals to be achieved by 2030 will require greater attention and capital allocation than ever. The stakes are high, and we need more time to digress. The current crisis is the fallout of extractive capitalism that aims to create profits without concerns for the environment and society. Impact investing is a sure way of future capitalism.
Impact Investing as a Strategy
Impact investing is more inclusionary and deliberate in its ideas by focusing on problems around poverty, inequity, unemployment, and climate action. Impact investors intend to bring social or environmental change. Other investment strategies, such as ESG and SRI, are more exclusionary because they avoid investing in companies not aligned with moral, ethical, or environmental guidelines. Venture Industry uses these terms interchangeably, and that is where they face the flak of “greenwashing.” Impact Investing as a strategy can attract capital and talent and ward off the cynicism around this if we bring more clarity to our mission, the purpose of impact, and the expected financial return. Impact investing firms should anchor themselves on these guidelines to beat these challenges.
1) Intentionality – Impact investors are focused on social good, and so they have an “impact first” rather than a “finance first” mindset. Impact investing firms should align with socially motivated investors or LPs on specific goals to achieve. We are likely to achieve results that can be measured with intentionality.
2) Measure impact – Quantify the metric for the sector where you would like to see the impact. This may not be in terms of financial return but could be on social returns, which could differ for different sectors. This has to be separate from market return. This way, we will be able to attract both socially neutral and socially motivated investors.
3) Avoid the risk of misallocation – Investment follows the conventional wisdom of competitive market and risk-reward trade offs. Impact investors should align their investment strategy with growing competitive needs with large social benefits, thus increasing the likelihood of success of the investment. Markets use the likelihood or risk to allocate resources and, therefore, will attract more capital and avoid the risk of misallocation.
Conclusion
Impact investing is a good way of problem-solving and is a good business. To truly appreciate its value, I believe we will have to understand the impact it can make socially or environmentally. At the heart of impact investing is the community and the challenges facing them. It is time we integrated Impact consequences into all our decisions making in business, and it could be the new way our economic and financial systems can work for everyone.
References:
- Michelle Zhou. Nov. 2022. Investopedia.com. ESG, SRI, and Impact Investing: What’s the Difference? https://www.investopedia.com/financial-advisor/esg-sri-impact-investing-explaining-difference-clients/
- https://thegiin.org/impact-investing/need-to-know/
- Paul Brest & Kelly Born. 2013. ssir.org. When can impact investing create reral impact? https://ssir.org/up_for_debate/article/impact_investing