Date: July 10, 2012
By: Jesse Grainger
Shannon Mudd is head of Haverford MI3 (Microfinance and Impact Investing Initiative) and Visiting Assistant Professor of Economics at Haverford College located just outside Philadelphia. His research focuses on banking, international finance, and development economics. In addition to his academic pursuits, Prof. Mudd has also served as a consultant for various international governments and development projects, as well as an analyst for the Federal Reserve Bank of Atlanta.
How important are accelerators to the future of impact investing?
From my understanding, accelerators respond to two major issues in the sector, locating good firms and addressing the transactions costs associated with due diligence.
What I hear from investor managers is that there are funds available to invest in impact firms in the small and growing business sector. The problem is finding promising investments, especially in firms that have business models with the potential to achieve significant scale. This is the first area in which accelerators play an important role. They develop networks both on the ground among entrepreneurs and in the financial sector among investors. They then help facilitate connections between the two. This specialization by the accelerators lowers the time, resources, and costs of finding good matches.
Another issue that frequently arises both from investors and entrepreneurs is the high cost of the due diligence process. Investors worry about how due diligence costs reduce returns. Entrepreneurs are concerned about the time involved in responding to multiple investors seeking information that is not always readily at hand. Some business accelerators are already helping, particularly with early-stage entrepreneurs, by preparing them to go before investors and conducting some due diligence themselves. There may be potential for accelerators to expand this role by serving as a clearing house for information across investors to reduce the duplication and redundancy of requests to the entrepreneurs.
How do you think Impact Investing in Action has helped to build the field?
The Impact Investing sector is still nascent. As was emphasized at the conference by Andy Lower and others, the eco-system needs to be built out. What happened there was good communication of different experiences, perspectives and needs across the diverse types of players.
On a more practical level, I have heard reports of strong interest and continuing talks among many of the entrepreneurs and investors in attendance. The matching process is always difficult and such gatherings can be quite efficient.
And personally, as someone new to the industry, the discussions were very instructive at a high level, without becoming incomprehensible due to internal, sector-specific jargon with which only those already in the know are familiar. I also met some very interesting people with whom I expect to stay in touch as my own work in the area develops.
What are the main challenges facing impact investing?
Impact investing is a single term that describes a wide variety of different types of investments in terms of targets, sources, social impacts, structures, etc. This conference was mostly focused on small early-stage investment opportunities as opposed to investments in established, larger scale firms. There is a real concern that this small, early-stage impact investing may not be self-sustaining because small scale firms cannot produce sufficient returns to cover the transactions costs that are relatively fixed and independent of scale (due diligence, legal constructions, etc.).
The VC model in standard investing works because of an expectation that, while the vast majority of investments may not cover such costs, one or two may result in a very high payoff, allowing the portfolio to earn a positive return commensurate with the risk. I am unsure such high payoffs can be expected in impact investing. I do not envision firms earning very large returns (even when they do make it to scale) and become wildly successful. So, dealing with these transaction costs is where partnerships with philanthropists may be key. But in what form will these partnerships arise? Government subsidies can hinder an industry from reaching scale when its intervention is limited in size and scope, especially when subsidy recipients become unwilling to accept market rates from more plentiful commercially-priced funding. Might the same risk arise from philanthropic support? This is an interesting question that needs to be addressed.
What does the future hold for the impact investing movement?
The future is promising. The infrastructure is being built. However, I could not help but feel, at least at this small, early stage part of the sector, that there is a discontinuity between the push for standardization in metrics and the investors’ primary focus on the entrepreneur.
Overall, however, what I find compelling about impact investing is that it explicitly allows investors to have goals beyond simple financial returns. As individuals, we make decisions about where to sell our labor based on many factors beyond just salary. Impact investing recognizes that many of us would like to do the same when selling our capital, i.e., take into account other factors in addition to financial return when choosing our investments. When investors have goals beyond profits, this explicitly allows firms to pursue goals beyond just profits. There will be tradeoffs and this will have to be dealt with in the governance of the firm. But when firms are closely held, there is definite scope for multiple objectives to be pursued and we can see firms organized effectively to achieve a double bottom line, i.e., do well financially but also work to address its social and/or environmental objectives.