On July 26th, 2013 Peter Buffett wrote an opinion piece in the New York Times that caused a little brouhaha in the philanthropy and social entrepreneurship worlds. The piece drew praise and criticism, notably from Matthew Bishop, and some buzz for a time, and then faded away. For me, the criticism missed the point, which I thought was right on. I decided to write about the topic when one of our young team members from Nicaragua forwarded the op-ed to our whole team. The piece did for him what every good piece will do: it made him feel and it made him think. Even better, it energized him and made him realize that he was not alone.
The recent publication of Blueprint (exec summary here and full report here) comes at an important time for the industry and makes a powerful case for the continuing need for philanthropy in the space.
The report did an excellent job of explaining that there are business models out there that can create massive impact at a fraction of the cost of traditional donor programs, but these models need time to scale before they can be profitable, just like Amazon. What the report alluded to, but did not discuss as much, is an even more important system-change question: how can philanthropy create the Stanford – the fertile ground where an Amazon can not only be scaled, but can take root in the first place?
What is Impact?
Blueprint informs a larger discussion of the meaning of impact investing, a meaning that is increasingly broad as different actors have adopted the term. There are now two generally established camps based on which word you prioritize in impact investing. The first camp (because it came first) sees business as merely the most efficient tool for achieving the only goal that matters – getting the best impact return for the buck. Acumen Fund is one of the most well known of the proponents of this approach, which also tends to define “impact” in terms of products or services sold to the Bottom of the Pyramid (BoP), the poorest of the poor.
One of the most articulate and well-respected organizations in this camp is the Mulago Foundation. In a series of great pieces in SSIR, foundation officers caution philanthropists new to the impact industry to take the time to truly understand what they are trying to accomplish and to be wary of chasing returns in the name of impact. Laura Hattendorf poses a simple question to all would-be impact investors.
Are you a private equity investor in emerging markets? Or are you focused on solving an important social problem at the base of the pyramid?
This question gets to the heart of the simmering battle for the soul of impact investing – is it a radical new way to invest for maximum impact, or is it an asset class (as Wall Street would like to see it) that refuses to cede an inch of profitability? Are impact investors “putting money—loans or equity—into impact-focused organizations, while expecting less than a market rate of return” (Mulago’s working definition) or are they people who recognize “the importance of integrating sustainability themes into their investment portfolios” (Morgan Stanley)?
The Middle of the Bell Curve
Both sides of this debate are doing good work and have perfectly reasonable positions based on their corporate mission. It’s good to have debates to air the issues and create better understanding around the term. But here’s the problem: lost in this debate are the actual entrepreneurs who will determine the long-term success of the impact investing movement. The question of whether you are focused on the BOP or focused on profits is too binary; it omits everyone in the middle. Most of the human potential out there is in the middle of the bell curve, but the debate is focused on the tails.
The vast majority of investible entrepreneurial ventures that are solving social problems are not ones that, with just a little subsidy, can save one million lives in five years or provide Google-like returns. Entrepreneurs who can create those kinds of social or financial returns are few and far between. If you are one of them, and have gotten investment from Mulago or Kliener, then good for you. However, if you aren’t going to create tens of thousands of jobs, but just a couple dozen? What if your product merely addresses existing customer demand, like, say a locally produced vanilla wafer, even though you are operating in one of the poorest regions in the western hemisphere and transforming your community?
Mulago or Morgan?
The fact is, there are many, many entrepreneurs out there who fail the Mulago or Morgan Stanley test for impact and risk/return, but who are nonetheless consciously creating net positive impact, even measuring it — and they don’t need any operating subsidies to have an impact. Many of these entrepreneurs, like dozens we have worked with in Central America, could provide a return of 5% – 15% while generating huge impact in their local community – and maybe eventually the whole region or the world. They may never make it on the conference circuit, but they need to be a part of this conversation. They may not be able to give the perfect reply to a donor’s question on quantitative impact or an investor’s question about risk, other than that they live with these two challenges every day.
It is in these individuals’ attitudes and decision-making ability where transformative impact occurs. Through their success, important things can happen, like building an entrepreneurial middle class, supporting democratic capitalism, empowering citizens and redefining the role of business in society.
Good companies with good managers that judge success based on impact, not just short terms profits, need to be supported just as much as the poster entrepreneurs that win all of the awards. Without direct impact for the BOP crowd, and too small and risky for the market returns crowd, these entrepreneurs struggle to access opportunity.
This is concerning, because they represent the future of business. Whether they collectively decide to incorporate impact into their decisions making — and can access opportunity as a result — will likely determine the long-term success of impact investing. That’s why our debates and reports must arrive at actions that drive capital to this core group.
The Missing Middle of the Missing Middle
The impact investing movement is a big tent, and it’s been stretched as far as it can go with different versions of impact investing. This is a good thing, but let’s remember that most of the entrepreneurs who will create impact with their business lie in the middle of the tent. They are the missing middle of the missing middle – not as sexy or impact-focused as the Stanford or MIT entrepreneurs and they are too small and risky to access any of the capital being channeled by Wall Street into the space. But we overlook this group of entrepreneurs at our peril. System change doesn’t happen without them.
Lack of Pipeline is Impact Investing’s Biggest Problem
The conversation surrounding the recent Monitor report (From Blueprint to Scale: The Case for Philanthropy in Impact Investing) focuses on the role of philanthropy in supporting game-changing business models that might not get to scale without some initial subsidy. In these cases, impact-maximizing investors – that is, investors focused on maximizing impact per dollar invested – need to focus on the goal and not get distracted trying to chase higher financial returns. For example, pretty much all of Acumen Fund’s deals involved some blend of philanthropy and investment, and there should be no apology for this.
But this focus on the proper mixing of philanthropy and investment at the individual deal level can obscure even bigger and, I’d argue, more important issues facing the impact investment industry – lack of good deal flow. Lack of good deal flow will become a bigger problem as more capital is mobilized, but it is only a symptom of a larger problem – the general lack of a support system to generate deal flow at scale.
Imagine Silicon Valley without Stanford. That is the state of the early-stage impact investing movement today. If the metaphor is not clear, read Ken Auleta’s recent piece in the New Yorker.
We need to build Stanford
Just five years in, the impact investing industry has developed a great recruitment strategy for investors, but there is no similar recruitment strategy for entrepreneurs. It’s a reason why many in the industry are worried that impact investing won’t get transformative capital to those entrepreneurs solving problems in the poorest communities and at the earliest stages of their growth – the kind of entrepreneur that can disrupt the status quo. These are the kinds of entrepreneurs for whom the term impact investing was invented. Unfortunately, as Acumen has discovered, analyzing over 5000 companies to invest in just 65, entrepreneurs of this caliber don’t grow on trees.
The success of this movement hinges on the entrepreneurial management team of these impact companies and the collective decisions they make everyday. These are the actions that determine whether the company succeeds or fails and if an investment reaches its full potential.
Impact investing is a team sport consisting of both investors and entrepreneurs. We have built a field of dreams for investors, and they have come and are still coming – more and more every day wanting to be more ambitious with their capital. From Kiva lenders to the sons and daughters of billionaires to college endowments and faith based groups, increasing numbers of individuals, groups and institutions want their money to work harder to solve our collective social and environmental challenges. The stage is set, but if the right entrepreneurs don’t know about it and are uninspired, untrained and unprepared, then all the blended capital strategies in the world won’t make a difference. You can’t complete the impact investing puzzle without good entrepreneurs who share the same vision.
So how do we recruit the best entrepreneurs into the sector and prepare them for investment, especially ones from particularly underserved communities poised for transformative change? How do we build Stanford for the industry? The answers are not easy, and they will be a major topic of discussion at the upcoming Impact Investing In Action conference later this month. With that said, there are many promising solutions that have yet to be explored.
The Need to Accelerate
So, how does the philanthropic community fit into all this? It can help by directly challenging cultural attitudes that are toxic for entrepreneurship and to build formal and informal systems that can filter and sort talent at the local level, like we do in the U.S. New Accelerator models that seek to partner with investors by doing the difficult, early-stage work at scale are a promising development. They develop entrepreneurs while also lowering transactions costs for investors, making it easier for investors to do smaller deals. Ultimately we need to directly recruit entrepreneurs to be co-creators in the success of the industry, in much the same way B Lab has rallied U.S. entrepreneurs.
It is only partially true that we need to inspire more donors and more “impact-maximizing” impact investors to build the industry. What we really need to do is inspire, develop, equip and accelerate more impact entrepreneurs.