I just got off the phone with another pissed-off, disillusioned social entrepreneur. She had a promising idea to raise family incomes in a certain East African country. She bought into the impact investing narrative and, spurred by one of the many accelerator programs out there, launched a for-profit start-up. Several years in, she’s passed some key proof points, but is facing a shrinking pool of prospective investors and a weird mix of hard-edged VC-think, non-reality-based due diligence, and a level of funder capriciousness that seems to blend the worst of philanthropy and investing.
I’ve had way too many of these conversations over the past decade. From where I sit – working with early-stage social entrepreneurs focused on the basic needs of the poor — the money just isn’t there. And I talk to a lot of these guys: Mulago has developed a substantial impact investment portfolio and I’ve taught and advised dozens of entrepreneurs working in a wide variety of markets. These are people with innovative ideas who are busting their asses and too often the best advice I can give is “keep your expectations of impact investing really low.”
Keeping expectations within bounds has not exactly been a priority in the impact investing world. Somebody recently sent me the Global Impact Investing Network (GIIN) report that says there’s $502 billion dollars in impact investing money out there. Half a trillion! That’s so insanely out of line with my experience that I actually read the thing, along with a companion piece, “The Core Characteristics of Impact Investing.” As the GIIN defines it, impact investments “target financial returns that range from below market (sometimes called concessionary) to risk-adjusted market rate.” The report makes no attempt to estimate where the money is distributed across that spectrum. Seems like kind of a big omission.
Given what I see and hear in my world, and the whole “doing well by doing good” obsession, I’m pretty sure that spectrum is heavily weighted on the risk-adjusted market rate side. With all that I’ve seen and heard over the last ten years, I wouldn’t be surprised if 80% or more of investors are in fact looking for something close to market rates of return.
This has big implications for the prospect of real impact. Real impact is about “additionality” – the degree to which you’re making good stuff happen that wouldn’t happen otherwise. Market rates of return are what ensue when a bunch of people seek maximum rates of return. That’s pretty much the definition of “what woulda happened anyway.” It’s wonderful when good stuff happens in conjunction with market rates of return, but there’s not much additionality there – real impact requires the investor to take a hit on the rate of return. In other words, real impacting investing is concessionary, and the difference between market rates of return and the return you accept in order to achieve additionality constitutes a kind of philanthropy. Philanthropy is at its essence about making good things happen that wouldn’t happened otherwise, and if impact investing isn’t a form of philanthropy – albeit one that allows you to at least recycle your money – then it really isn’t much of anything.
To be sure, significant business growth and the scaling of high-impact business ideas requires real money, i.e. money looking for risk-adjusted market rates of return. No business will really take off and no idea will get to the point of solving a big problem, without getting to the point where is worthy of market-rate money. The task of impact investing – with all its notions of “business discipline,” etc. – should be to get good ideas to that point where profits and prospects are good enough that the inherent power of markets can take over.
In the settings where Mulago works – poor countries – neither markets nor regulation work very well. The entrepreneurs in our arena with have to come up with profoundly innovative products, technologies, and services to address deeply entrenched problems – and they often have to innovate on the business models to accompany them. It can take a long time to get through all of the iterative cycles of product and businesses model development, not to mention the time and effort it takes to build a high-performance organization in settings where there is a dearth of people with the necessary skills and experience. In other words, it takes – justifiably – a long time for these businesses to get to the point where they are ready to grow and become worthy of real money.
To cover the distance between initial idea and real-money worthiness requires concessionary money – money well below risk-adjusted market rates of return. That is where impact investors can make a big difference. Only a relative few seem to see it that way, though, because at present, covering that distance is like crossing a desert where the oases and waterholes are few and far between. Too many pioneer enterprises fail, too many good ideas die, and too much good stuff just takes too damn long to materialize.
In the past decade many for-profit social entrepreneurs launched businesses in the belief that there was enough “middle money” – impact-driven money that occupies the space between free money (philanthropy and aid) and real money (looking for market rates of return. They bought the hoopla and went all-out in good faith. We’ve really let them down. The money isn’t there.
Businesses that have a reasonable chance of generating risk-adjusted market rates of return are going to attract real money whether they accomplish good stuff or not. It’s a wonderful thing – an essential thing, really – to make good stuff happen with real money. It’s just that you don’t need something called impact investing to do it. You just need investors. On the other hand, if you’re serious about impact – meaning serious about additionality – there has to be an element of philanthropy in your investing. You’re going to have to “do a lot of good by doing not-that-awesome.”
And please – enough of the complicated blended-finance deals. Trying to get shmucks like us to subsidize returns for bigger, risk-averse funders is no substitute for enough impact investors actually doing their job. God bless you for being creative, but it’s essentially an admission of failure. At the request of some of our entrepreneurs we’ve held our noses and signed on to a couple of these deals, but it was painful. If we’re going to give away money, we’d like to go to the entrepreneurs, not to funders with deeper pockets than our own.
I know everyone is weary of debating the definition of impact investing, but it really matters and it’s still worth revisiting. There a lot of talented people out putting heart and soul into high-impact business ideas that have the potential to go big. We can’t let them down; we have to get them across that desert, we have to get them the right money in the right way. It’s time to rein in the hoopla, rethink returns, revisit the definition, and get back to work.