The latest must-read report on impact investing suggests the field needs to invest more philanthropy into building a market for early-stage entrepreneurship. Philanthropic investors should listen.
From Blueprint to Scale: The Role of Philanthropy in Impact Investing, written by Monitor consultants, in collaboration with Acumen Fund and funded by the Gates Foundation, deserves a close read by anyone looking to understand the key challenges and opportunities facing the impact investing field.
The Key Points
The key conclusions of the report are straightforward:
1. Much “impact capital” has been raised, little has been deployed.
There are now over 200 impact investing funds with billions of dollars ready to deploy – but most of that is on the sidelines due to lack of deal flow.
2. Investments that are flowing are increasingly moving toward later-stage businesses rather than to “pioneer” firms, which are often the most innovative and risky.
Case in point: Acumen Fund invested 64 percent of its portfolio between 2001-2004 in early “blueprint” stage companies and none in businesses ready to scale. Between 2009-2011, it was investing twice as much in companies poised to scale rather than in early-stage companies. Why? An axiom of investing: it’s a lot easier to make (and not lose) money the later stage you go. With more impact investors looking for market returns, fewer are willing to take the risks on investing in newer companies.
3. This “pioneer gap” is a serious problem for the industry.
So much of the game-changing innovation happens with new companies, new entrepreneurs, and new models. Socio-economic mobility happens when new entrants are allowed to participate in the market. But if the impact investing industry doesn’t have a pipeline for these pioneer companies, if investors become too impatient for returns and are unwilling or unable to find the right ways to finance companies that need subsidy in order to reach scale, then the part of the industry most focused on impact (the pioneer group) is going to be left behind. This is a major concern right now for many of the original organizations that launched the impact investing movement.
4. There is a huge opportunity/necessity for philanthropy to address this gap and help the industry as it evolves. After all, the report reminds us, it’s estimated that over $20 billion in grants were invested in the microfinance industry before it finally became sustainable and profitable. More capital is needed to grow the institutions that can make the early-stage impact investing market work.
The authors are absolutely correct in identifying some of the key challenges facing the industry: lack of deal flow, lack of absorptive capacity among enterprises, and detrimental business factors (low margins, little IP) that make it hard for investors to make money. Being an impact investor is not easy, you need a stomach of steel and an extraordinarily clear agreement with your LPs on what success means. The report seems to ask impact investors to spend a little more time thinking about what social change really means to them.
We have come to an important inflection point in our industry with the publication of this study. If it does anything, it reminds us that investment capital alone, no matter how much is raised, cannot create the impact investing market. It’s a team effort between all of the industry’s key players: investors, large and small donors, strategic partners like universities, law firms that deploy pro bono hours to the industry, and social entrepreneurs who are working to align the incentives of all these key stakeholders.
The Future of Impact Investing
The report’s recommendations for investors boils down to this: work with funders to help generate more deal flow and think hard about your impact investing thesis because market dynamics make it very difficult to serve the BOP (if that is your goal) and make market returns. For philanthropic investors they recommend basically two things:
- Understand how and when to support individual firms to get to scale including the need to coordinate different kinds of capital.
- Learn how to improve the market for early-stage pioneer companies to create and surface better deal flow. We are still in the nascent stages for both approaches.
The report raises good questions. How do we increase the quality of early-stage deal flow? How do we better coordinate the different types of capital that are often needed to turn a new idea into reality? These questions beg yet another, perhaps more fundamental question: how do we organize this emerging, and still niche, industry into functional sub-divisions that work together? How do we oxygenate it with the trust and data needed to create an efficient market? Put another way, what is the path forward for impact investing so it can meet its promise of creating impact through entrepreneurship?
I’ll try to give some answers to those questions in the second part of this post. For now, the authors of Blueprint (Harvey Koh, Ashish Karamchandani Robert Katz) all deserve our thanks for raising the right questions at the right time.