Also known as socially responsible, sustainable, double, triple (or quadruple) bottom line, or ethical investing, impact investing is defined by the Global Impact Investing Network as “investments made into companies, organizations, and funds with the intention to generate measurable social and environmental impact alongside a financial return.”
Most such investors cite their focus on environmental, social, and/or governance (ESG), with varying emphasis on one, two, or all three factors.
The History of Impact Investing
Although the term “impact investing” only dates to 2008, the investing philosophy has existed in various forms for centuries.
In early iterations of this investment strategy, those providing capital to business actively sought to avoid impacts that could cause harm. In the 1700s, Quakers and Methodists were admonished to avoid investments and businesses that harmed others. These included:
- slave trading
- owning tanneries
- investing in items such as guns and tobacco
There are also, more recently, financiers who actively sought to make their money at the same time that they were doing good. Ben & Jerry’s Ice Cream — one of the better-known socially responsible companies — has a three-part social mission. Its values include:
- “Promoting business practices that respect the Earth and the Environment”
- “Actively recogniz[ing] the central role that business plays in society by initiating innovative ways to improve the quality of life locally, nationally, and internationally”
Today, impact investments are on the path to becoming increasingly mainstream and increasingly popular. Such investments can be made in either emerging or developed markets, and investors may target a range of returns from below market to market rate.
Three Types of Impact Investors
Impact investors generally fall into one of three categories: impact-first investors, investment-first investors, and catalyst-first investors.
Impact-First Investors
These investors primarily seek to maximize the social or economic impact of their investment. Financial returns, if there are any, are a secondary goal.
Foundations are one of the more common examples of an impact-first investor.
Under U.S. law, foundations must annually distribute five percent of their assets. So-called program-related investments (PRI) into socially responsible investments are one way foundations can distribute that money. As an added benefit to foundations, PRIs are exempt from the excess business holding tax.
In contrast, mission-related investments (MRI) do not count toward the five-percent requirement because they are intended to generate revenue as well as accomplish mission; however, foundations may use both PRIs and MRIs simultaneously.
Investment-First Investors
These investors strive for market-rate or premium returns on their investments, with a positive social or environmental impact as a secondary goal. Employing this strategy, investors measure the performance of their investments by not only the financial bottom line, but also social impact, and are increasingly focused on measuring and reporting on ESG in the same way as financial returns.
DBL Investors and Generation Growth Capital are examples.
Catalyst-First Investors
Catalyst-first investors want to give or invest in collaborations to build the impact investing industry and infrastructure. These investors typically give equal weight to both social impact as well as financial returns.
Other Players in the Impact Investing Sector
Self-designated impact investors and socially responsible organizations don’t operate in a vacuum. There are a number of other players whose participation helps support and grow the sector. Among the key participants:
- Commercial Markets: Important in later stages of scaling up impact investing industry sectors, commercial markets prioritize returns over social impact.
- Development Banks and Institutions: An excellent source of funding for impact innovators, however their participation is typically limited during high-risk early-stage investing.
- Foundations: Thanks to U.S. laws requiring foundations to annually distribute at least five percent of their assets — which can take the form of PRI initiatives — foundations can invest in for-profit organizations that are committed to delivering a positive social impact.
- High Net-Worth Individuals: These investors tend to embrace innovation and have high risk tolerance. They are often willing to experiment with market-based and for-profit approaches to achieving social impact.
- Ethical Banks: Working alongside impact companies, ethical banks frequently invest in local initiatives, enabling them to create real change at the local — if not global — level.
- Microfinance Institutions: Recognizing that small loans can have a tremendous impact on low-income populations, microfinance institutions provide financial services to the poor and are effective at reducing poverty in developing countries.
- Social Stock Exchanges (SSEs): Using SSEs, investors can buy shares in a social business just as investors focused solely on profit would do in the traditional stock market. Some are only open to accredited investors. The four best known SSEs are the UK’s Social Stock Exchange, Singapore’s Impact Exchange, Canada’s Social Venture Connexion, and the U.S.’s Mission Markets.
- Government: Social impact bonds from government institutions provide capital to social service organizations that are successfully improving outcomes. Commonly, investors provide initial external financing and receive a return from bond payments only upon the achievement of agreed-upon outcomes.
Considerations for Impact Investors
Before making any impact investments, individuals and organizations should ask themselves some questions to help hone in on the most appropriate opportunities.
First, consider the choices for an impacting investing philosophy:
- Are financial returns more or less important than the company’s impact-related mission?
- Does the investor want to focus on specific areas of impact, such as social goals, environmental goals, or specific geographic areas?
Individuals and organizations making large-scale impact investments — including those who are providing startup financing or those purchasing significant equity stakes in a business — will want to give addition consideration to maximizing the impact of their investment.
For example:
- If the company is a startup, what corporate form should the new entity take?
- How should transactions be structured?
- What can both the organization and the investor do operationally to improve the social and environmental impact after the investment has been made?
- How can the company’s social and/or environmental impact be measured and reported to ensure that there is accountability?
Going Forward
With the wealth of options for those interested in impact investing, the most important tool is an adept advisor to assist in weighing options, structuring transactions and financing, and overall corporate governance.
Morrison Foerster is one of the most knowledgeable firms in this space. The firm represents:
- nonprofit and for-profit social enterprise companies
- impact investors
- venture funds
Our work spans all aspects of impact investing, including advising companies on corporate forms and structuring transactions to help ensure impact.
For more information, contact impactinvesting@mofo.com.
