Impact Investment: When is it feasible?

[Maliha Islam]

Impact Investment: When is it feasible?

Legal and/or other feasibility requirements

Local regulations and markets determine the investment climate, the availability of financial products, and the prevailing–mandatory or voluntary–fiduciary, environmental and social standards. Regulators can provide tailored incentives (e.g. tax breaks) or provisions for impact entrepreneurs and investors within their jurisdiction, but there is no specific or additional legal requirement for impact investment. A common provision for impact investment organizations is that social and environmental impact goals are built into legal documentation, as well as a requirement to report on impact.

Minimum investment required and running costs

The specific project and business model determines the investment requirement along with the relevant market size, maturity and other factors such as human capital or political and commercial risks. While larger companies may require financing of US$10 million or more, SMEs tend to require between US$25,000 and US$2 million. The cost structure and amount are also linked to the target investor and the asset class of the financial product. According to UNDP, deals in Africa vary from US$50,000 to a few million in the case of early stage impact funds and foundations, and up to US$200 million in the case of private equity funds and institutional investors. Data from the GIIN ImpactBase show that deals tend to be larger in developed markets than in emerging markets. The median value of an impact investment deal as reported by GIIN is US$ 2.8 million. This includes a range of non-profits at the lower end of the spectrum with US $1.8 million deals, to insurance companies with deals in excess of US$ 44 million.

Impact investment has a capital cost for the investee. While impact investors have diverse expectations about financial returns, according to GIIN, most prefer to operate at market rates. What impact investment often does is thus to expand access to capital, even when the investment positions are high risk. Despite the preference for market rates, about 40 percent of impact investors are willing to accept a return on investment that is lower than the market rate. The pooled internal rate of return for the Impact Investing Benchmark is 6.3 percent (compared with a commercial benchmark of 8.6 percent) and higher in emerging markets (7.7 percent) than in developed markets (4.7 percent).

While aggregated data provide little evidence of additional costs, impact investment might result in short term higher-cost transactions compared with traditional investment because of to the implementation of rigorous social and environmental reporting requirements and the conduct of extra due diligence processes.

In what context it is more appropriate

Impact investment is appropriate where private capital can address social and/or environmental challenges in innovative ways, while still pursuing commercial viability. Impact investment can address public failures, but it is by definition not a solution when there is no viable business opportunity. Impact investment is not a substitute for the provision of social services or philanthropy. Rather, it aims to complement and broaden the range of available options to promote sustainable development, drive innovation and achieve a positive social and environmental impact. Impact investors can also pave the way for larger public interventions, by underwriting risks that cannot be taken up by public intuitions in the first instance.

Source: http://www.undp.org/content/sdfinance/en/home/solutions/impact-investment.html