The subject of impact investing has popped up in a lot of my conversations this month, in London and in Hong Kong. A multi-family office has clients who are interested in exploring impact investing and wonder where to begin. An impact fund is looking to engage grantmakers to try something different. A social enterprise is hoping to raise funds.
All these are big topics. In this month’s newsletter, we focus on one question – what does impact investing mean for philanthropists who mainly give through grants?
Why impact investing?
Grantmaking used to be synonymous with philanthropy. To do good, you give money to a charity or a university for them to help people and the world. You are not getting the money back, and you are not asking for any financial return. Although you and the grantees would agree on conditions for how the money is used (and in the case of an endowment, they would invest your grant to generate a return), the money is out of your pocket once and for all.
Increasingly, people are asking whether they can make their money walk the extra mile. Is it possible for money to create social impact and generate a financial return at the same time? And if the same pot of money can be used again and again (“recycled”, as people like to say) to do good, wouldn’t that make philanthropy more sustainable?
It affects whoever receives your money as well. If you are making an investment instead of giving a grant, they have to come up with a business model and act on it. Impact investing acts as a nudge to make doing good financially sustainable.
Some examples:
- Prison leavers – instead of just paying for their training, impact investors invest in a café where prison leavers are trained and employed, and where coffee is sold at market prices in a high-street location. Profits after dividends are then reinvested to train more prison leavers.
- Homeless people – instead of providing free accommodation, an impact enterprise acquires properties and rents them out at a discounted rate, without the usual credit checks and full deposits. Profits after repaying loans from impact investors are then used to sustain and expand the operation.
So impact investing is about finding an alternative way to be philanthropic – one where the consumer market and financial returns are part of the driving forces.
How can a philanthropist take part?
There are many players in the impact investing field: asset managers, social entrepreneurs, evaluators and governments, among others. Philanthropists, as capital providers, are definitely one of the emerging players, in London and in Hong Kong alike, where I see strong enthusiasm for impact investing in both the investment and social sectors.
For most philanthropists, the question is: how can impact investing be part of my portfolio of doing good?
Let’s use the café that hires prison leavers as our example again. They have come up with a viable model: the CEO has a track record of opening and running profitable high-street cafés, and they have recruited an award-winning barista who trains the prison leavers at a discounted rate. They have also built a 12-month programme of hiring and coaching prison leavers in customer service, making coffee and managing a shop, to equip them for the job market. For our purposes, we assume that the café is a for-profit company that can issue shares and pay dividends.
Now, as a philanthropist, you want to help the café with impact investing tools. Broadly speaking, you have a few options:
1. Loan
The café may lack the capital to start the business – to decorate the shop and buy machines and furniture, for example – but they are confident that they will start making money in a year’s time. Small businesses find it hard to get bank loans, and personal loans are expensive.
You may want to give them a loan at a lower interest rate and with more favourable repayment terms (for example, they start repaying the year after they record a profit) to support the café’s impact creation. At the same time, you require that the loan is fully repaid, with interest.
2. Equity
Another way to supply the café with capital is to become a shareholder. The café goes through a valuation process to determine how much it is worth. With reference to the valuation, you contribute a certain amount to the company to acquire a certain percentage of its shares. You bear the risk of the café failing, in which case your shares would be worth nothing. On the other hand, there is upside potential: a return via dividends, and someone else buying your shares at a higher price.
You can be a patient shareholder and accept a slower return on investment in exchange for the impact created, unlike a shareholder who is purely commercially minded. If you sit on the board, you can also influence the café to move in directions that are both commercially sound and good for impact.
3. Impact funds
This is an option when you have no particular café in mind, or cannot be sure that your chosen café will be supported. You can invest in an impact fund that supports employment, and the café may or may not be one of the ventures the fund backs. It is unlikely that you will have a say in which ventures the fund invests in, or in how those ventures manage their business and impact. This is undoubtedly a more passive option, but in many cases it also costs the investor less time and effort.
There are also many variations on each option, as well as options between a grant and a loan, such as recoverable grants, and tools like guarantees. What suits best depends on the café’s business model, your risk appetite, and the balance you want between financial return and impact, among other things. These choices are what make impact investing complicated but also fascinating.
Where do I begin?
This was the question the multi-family office’s clients were asking: where to begin. There is no single correct starting point. Any of these is a good place to start:
- Ask: where is impact investing in my portfolio? – you may want to carve out a part of your donation pool to try impact investing, and you may want to do the same with your investment pool to try something impact-related. If you are curious about impact investing rather than entirely convinced, start small.
- Make one impact investment – buying a publicly traded impact fund is one place to start. In addition to investment information like fund size, fees and performance, look closely at the impact: the causes it supports, its impact model and the social outcomes its portfolio is creating. When you review the fund’s financial performance, also review its impact performance, and consider whether you are happy with what you have invested in.
- Explore with your donation partner – if you are already making donations to a nonprofit or social enterprise, it is worth starting this conversation: “If extra capital were to come from impact investing, what would work for you, if at all?” They may be in an area where impact investing seldom makes sense (like disaster relief), or they may have no appetite to create a business model for their services. But a request from an existing donor is a useful nudge. The availability of extra capital, and your continuing support, are incentives for them to explore.
- Learn – impact investing is a rapidly growing field, and everyone involved is learning. You do not need to know everything. Focus on what would make you a better philanthropist – the options, the channels – and look out for people who can be your partners in impact investing.
Impact investing is a powerful tool in a philanthropist’s toolbox, alongside straightforward grants. We are better equipped to be part of the solutions if we have a toolbox that can meet different challenges and suit different circumstances.
This newsletter is general discussion and not investment advice.
What I’m Reading
The Power Law: Venture Capital and the Art of Disruption by Sebastian Mallaby
The Power Law is Sebastian Mallaby’s history of venture capital, tracing the industry from modest beginnings to a global force that has backed some of the world’s most successful companies. Its organising idea is the power law: most investments fail, but a rare success can return more than all the losses combined. That appetite for the improbable is what makes venture capital a force for disruption. By backing early-stage companies such as Apple, Google and Alibaba, investors have funded challengers that upend established industries and reshape the economy and everyday life. Mallaby is also candid about the costs, from the WeWork saga, where the same logic that builds great funds can also fund great disasters, to the industry’s persistent under-representation of women and minorities. Even so, his overall verdict is generous: he sees venture capital as a powerful engine of progress, more so than is usually acknowledged.
Is impact investing too small and careful a player next to venture capital? Impact investors look to change one thing at a time, create a theory of change, measure impact meticulously and sometimes still accept a below-market return. Contrast venture capital, which funded DeepMind, Tesla and OpenAI – companies that, for better or for worse, play an oversized part in shaping the future of humanity.
The Power Law tells the stories of people with huge personalities who relied on gut instinct. Many of them and their companies have grown enormously rich, but only time will tell whether their ventures ultimately do good for the world. Would we rather be small and careful, or big and bold?
At the same time, there is no reason why impact investing can’t learn from venture capital. Not all impact capital has to be concessionary, and impact models can be both profitable and scalable. In fact, organisations like Better Society Capital and its ImpactVC community are bringing the impact and venture worlds together. If there is cross-pollination of ecosystems, capital, talent and ideas, we can truly disrupt for good.
What Happened This Month
The Giving Record was launched this month. It is a platform that collects and tells stories about philanthropy in the UK – the cause, the philanthropist, the donation, the difference made and the charity that makes things happen. The platform hopes to foster a better understanding of what giving looks like in the country and, ultimately, to encourage a stronger giving culture.
One of my favourite parts of being a philanthropy adviser is witnessing changes I have played a part in bringing about. Yet unless those experiences are written down, we can only benefit from what we have seen with our own eyes. The stories on the Giving Record website carry emotional weight, as good stories do.
Philanthropists should not just plan and decide by instinct. There are data and tools that help people give better, and impact investing, as we have discussed, is one of them. At the same time, we should not dismiss the warm glow as one element of our giving. The ability to experience empathy and joy is what makes us human, and it keeps us going as philanthropists.
Does impact investing make sense to you? Do you see impact and investing as best kept separate, or as natural partners?
First published on LinkedIn by Francis Hon: https://www.linkedin.com/pulse/beyond-grant-francis-hon-w3auc