Traditional investors often put money into companies focused mainly on the returns they will see, while many nonprofits and government agencies provide funding for programs in return for measurable social impact. A relatively new investment approach, called impact investing, attempts to join business and social concerns.
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The point of impact investing is to fund companies that not only generate financial returns but also create positive social and environmental outcomes that may not be produced without funding. Impact investing has the potential to reach $400 billion to $1 trillion in invested capital and $183 billion to $667 billion in profit by 2020, according to a 2010 report by JPMorgan Chase.
While the general social goals are the same for many nonprofits, governments and impact investors, there is a wide spectrum of specific social goals and means that need to be discussed. Impact investors often are willing to make concessionary investments (expecting below market rates in exchange for greater social impact, such as creating employment that pays good compensation).
Here are two examples: Some impact investors may seek to fund companies that provide electricity to villages in rural Africa, while others may be interested in alternative stoves that protect people who cook in huts from the pollution of open fires. In the first case, the expected financial rewards may vary greatly, reaching market rates in some cases. Because cook stoves, in the second case, have many nonprofit backers, there are some places in the world where it is hard to make a big profit selling the alternative cooking systems.
Some investors are even more philanthropic and are willing to take long-term losses to support extremely social companies, but many others still require a business plan that offers market rates. In general, most impact investors actively seek companies that generate strong financial returns while also making a difference. The growth of this side of the impact investment world has become more pronounced as leading investment banks such as UBS have moved into the space.
A two-part mission is often difficult to accomplish. One choice impact investors have to make is around the size and types of companies they will choose. Since the impact companies promising returns at or above market rates are often already scaling in size, they have less trouble acquiring funding from either type of impact investor — those seeking more financial rewards and those looking for more social or environmental gain.
Because there are shortages in some nations of large impact companies, some have noticed that impact investors have two options: they can either accept lower returns in exchange for a social impact from larger, better-known companies, or they can search for smaller, riskier firms that offer both impact and a return.
Do the difficulties facing various types of impact investing lead to failure for the broader community? The main answer to this question grows out of the example above. Bigger, more stable and well-known impact companies are poised to make an even larger difference because they have relatively little difficulty acquiring funding. In fact, many impact companies receive funding at lower rates than they would have if they had been working in less impactful industries. Who would have thought that in certain regions there would be a surplus of capital for companies that are trying to make the world a little bit better place?
John Hoffmire is director of the Impact Bond Fund at Saïd Business School at Oxford University and directs the School of Business and Poverty at the Wisconsin School of Business at UW-Madison. He runs Progress Through Business, a nonprofit group promoting economic development.
Josh Palkki, Hoffmire’s colleague at Progress Through Business, did the research for this article.