Impact investing is reliant on social enterprise

I have felt detached from the term ‘impact investing’ since I first heard about it. My first interaction was during a panel at NYU in 2013 where I listened to a Managing Director from the Rockefeller Foundation discuss the range of impact investments undertaken by the foundation and then, very pointedly, said ‘this will always be a niche area’.

What has happened now is that impact investing, as a topic for discussion, has exploded. The actual investment dollars have perhaps lagged the rhetoric but they have grown. Proponents have called for 2-7% of total global funds to be allocated to impact which could be anywhere from $1.4 to $5 trillion.

I don’t doubt the enthusiasm for impact investing. It is enticing to aim for financial return and intentional social/environmental impact, certainly I have tried to build those elements into my career. What I am concerned about is that the impact investing concept, as it currently described, relies on social enterprise as its primary investment.

Social enterprise, like impact investing, has grown in prominence and number of organizations. A survey in the UK defined social enterprises as:

• Share of income from trading/commercial activities at least 50 per cent and
• Rules/restrictions to use surpluses/profits chiefly to further social/environmental goals or past surpluses/profits are chiefly used to further social/environmental goals.
• Type of social or environmental goals that the organisation/business has and whether
  social/environmental goals are of greater or equal concern compared to financial goals.
• Using the standard SBS questions asking for charitable status and legal form

The results of the survey were that 9% of UK businesses were considered to be social enterprises. The type of businesses were mainly health, education and the arts. 25% of the businesses had any employees. There were good indications that social enterprises had a greater focus on innovation compared to the existing small-to-medium businesses.

So here we are. Impact investing has to find investments for a growing pool of capital that intentionally generate social and financial returns. Social enterprises are growing to fulfill that need.

Except, they are mainly focused in education, health and the arts which are not traditionally deep investing areas. They are not in the traditional high-risk high-return areas of IT and biotechnology. They are not, on average, large companies with some amount of liquidity (or even publicly traded). Many of them have charitable status which has implications for shareholder returns. Smaller companies also have trouble affording basic governance structures. Many elements of the standard due diligence process for investors (credit ratings, profit margin) may be de-prioritized so that the investment can be done.  The reliance on social enterprises means that impact investing is exposed to risks which the broader investment market has addressed. It could even be seen as a movement backwards in the sophistication of investing.

This may all change as social enterprises push into more sectors and grow in size. But there is currently an interesting mis-match between the sheer size of investment dollars that are talked about in impact investing and the niche nature of social enterprises. It may be that the investment community are rapidly picking up the low hanging fruit of social enterprises and a lack of deal flow will halt the longer term growth of impact investing. Or the standard for impact investing might fall so that many more enterprises will qualify for impact investing. Or we will see a well spring of social enterprises that rival the scope and scale of existing enterprises in a revolution of corporate form and purpose. We shall see but it s a big bet for the vocal impact investing community.