This article was originally published by Stanford Social Innovation Review on July 11th, 2012 with the headline: The Trouble With Impact Investing, P3
When you do a three- part series called "The Trouble with Impact Investing," people might reasonably conclude that you just don't like impact investing. Not so—I think that if we do it right, impact investing might do a lot of good. At the Mulago Foundation, we've done three deals with good results and there are more in the pipeline.
The trouble isn't with the idea itself, but how it's played out so far. I've worked with more than 200 social entrepreneurs in the past couple of years and talked to lots of investors. Here is how we could blow it:
1. We're not serious about impact.
When it comes to impact investments, the business model is usually the primary focus, and enterprises place surprising little emphasis on assuring real impact. Too often, the case for impact is pretty sketchy. A few examples:
- Financing a mosquito net factory to combat malaria, when the issue is distribution, not supply.
- Improved woodstoves presented as a means to prevent deforestation, when there isn't a shred of evidence to connect the two.
- A carbon finance deal to give away water filters to prevent emissions from wood-fired boiling, even though people in the area don't boil their water.
Moreover, while the philanthropy world is still pretty bad about measuring impact, the impacting investing world is worse. Real impact measurement is a drag on the financial bottom line and investors are usually willing to assume it's there, so few feel compelled to do it. What's weird to me is that while all impact investors know that you could never maximize profit without measuring it, they often fail to recognize that the same is true of impact.
2. There's no real market here.
Financial markets work because, despite hiccups, money flows effectively toward profitable firms. Philanthropy is hugely inefficient because there is no analogous market for impact. How an efficient market is supposed to emerge in impact investing remains murky. Talk of double and triple bottom lines is unhelpful -- for a market to work, there can be only one bottom line, and it's either profit or impact. One solution might be that impact investors decide what level of return they need, and then search for the firms that offer the most impact at that expected rate of return. Or maybe they decide on an expected level of impact, and shop for firms that can give it to them at the best rate of return. Whatever workable solutions emerge, impact investing will be pretty useless unless it can function in a meaningful way as a market for impact -- and no solution will be workable unless impact is consistently measured and reported.
3. For-profits tend to drift off the target population.
Impact investing isn't necessary unless there is some degree of market failure to overcome. Overcoming market failure is risky and expensive, requires innovation and R&D, and generally provides low returns on investment. We've seen too many for-profits drift up the socioeconomic spectrum in response to the needs of investors, and too many firms fool themselves about reaching deeper into the poverty strata once they are established with the more affluent. Investors need to commit to -- and firms need to hold the line on -- serving the original target population.
4. Impact ends up scattered and limited.
Philanthropy can make a real difference when it is directed toward scalable solutions and broadly applicable social innovations. Boutique projects don't really move the needle. The same is true for impacting investing. Investing business-by-business in scattered geographies isn't going to make much difference. We have to catalyze industries. It's a useful exercise to ask, "Does this model have the potential to make a big difference for a million people and, if so, just how would that happen?" Rarely does that happen with a single firm. What it will take is clustering businesses, building value chains, and spurring competitors. We're going to have to be more clever.
5. We're too risk averse.
Studies and surveys point to huge sums poised to flow into impact investment. I find that it's more useful to watch what people do rather than listen to what they say. And what they're doing is...not that much. Startup for-profit social entrepreneurs have a hard time getting funded at all, while impact investors pile onto a very few enterprises that seem like safe bets. (The TONIIC group provides a refreshing counter-example, with a bunch of funded start-ups and an accelerating pipeline.) A lot of the investors I talk to complain that they can't find enough fundable deals, and a lot of funds don't seem to be spending much money. It seems to me there are three possible explanations: 1) investors aren't serious about trading return for impact; 2) it's a lousy field of would-be investees; or 3) we're too afraid of risk. Given the good intentions of the investors I meet and the brilliance of the social entrepreneurs with whom I work, I'm placing my bets on #3.
Impact investing should be about trading some amount of profit to make good stuff happen that wouldn't have happened otherwise. These are early days in a brave new world, and that makes it all the more important is that we understand our real impact and figure out how to apply real market dynamics. So: spend your damn money, put impact first, measure what happens, and share your results. We can still fix the things we've gotten wrong, and if we do this right, it might go big.