Written by Arvind Agarwal, Founder & CEO, C4D Partners
The impact investments sector in India has faced several challenges and establishing itself as a strategy has posed the biggest of all. The problem here originates from the opportunity itself. As vast as the country is, it comes with a diverse range of social issues that vary from region to region. Though this provides many opportunities for impact funds to address, this also restricts the sector from defining itself in one voice.
Today, there is a contrast in the definitions of impact investing at the individual organization levels. This unclear classification has made way for greenwashing. For instance, a company providing jobs in Mumbai city cannot be defined as a social enterprise, but a company doing the same in the state of Manipur would qualify. Similarly, a company employing a marginalized community (for example, people with disabilities) in Mumbai would be eligible as a social enterprise. This blurred understanding posed a big challenge, and suddenly, impact investors were competing with funds that were into greenwashing for fundraising.
Furthermore, ESG investing played the most significant part in diluting the role of the impact investing sector. Where we stand today, ESG investing should have been a reality already, and no business must be allowed to operate without a working ESG policy. Impact investing players, on the other hand, should go more granular, concerning themselves with what aspect of the social issue they want to target through their strategy. Impact investing should be a sub-set of ESG investing.
Now the question remains, how can the impact investing sector establish itself as a strategy that can bring about the necessary changes in society? The solutions for this, as elaborated below, focuses on the impact investing players.
1. Fund-level Structural Changes: Stakeholders of the impact investment ecosystem need to come together and identify an operational structure for the objective they want to achieve. Working with the existing private equity and venture capital fund structure will deliver the same outcomes. The best bet is to urge regulators for changes in the “Social Venture Fund (SVF)” AIF category. Currently, SVF has statements like “SVF can receive and give grants” and “The fund manager will target muted returns.” To begin with, an AIF should not be in the business of taking and giving grants. They have to offer market-adjusted returns to ensure broader participation in such funds. Investing in social enterprises might have the same unsystematic risks but lower systematic risks, which justifies lower returns compared to other ventures whose sole focus is financial returns. Impact fund managers should focus on lowering the mortality rates in their portfolios rather than generating higher returns on individual investments. This strategy will automatically help them compete with venture capitalists.
2. Impact-generating Business Models: Impact funds should look for ventures where social value is embedded within the business model, thereby strengthening this connection. Correspondingly, the ultimate social value of the investment should be magnified through its investment. If a business is creating impact by doing something not embedded in the business model, then sooner or later, either the impact or both the impact and the company will cease to exist. Historically, the sector’s biggest mistake was supporting businesses where the impact was not an integral part of the business model. This multi-focused approach to creating impact should be left to the not-for-profit sector as they have the bandwidth and a track record of performing much better in generating impact outside business models.
3. Business Models Solving Sectoral Pain Points: Any social enterprise’s success depends on the scale and competitive advantage in the long run. Therefore, a unique business model wrapped around a societal problem should simultaneously solve at least one sectoral pain point, or it will struggle to achieve scale. Companies that do not follow this approach should not take investments from impact funds or venture funds and are better off taking investments from sources that are not structured as Alternative Investment Funds (AIF), like foundations, family offices, etc.
4. Financial Discipline: Investors should follow the same financial discipline when investing in social enterprises as they do with venture funds. The objective of an impact fund is to balance impact and financial return for sustainability, but the discipline should be no different. Social enterprises should understand the circle within which an impact fund manager has to operate. Lack of proper financial discipline concerning investments, monitoring, and exits will lead to lesser trust in the sector, and eventually, it will cease to exist. The impact investing industry is currently at this crossroads, and it is essential to bring the necessary discipline to establish itself as a strategy.
Final Recommendation
The need of the hour is to create a dedicated industry body for the impact investment sector that works towards bringing stakeholders together, identifying gaps, and proposing structural changes to ensure that the end objective of the industry is met. Investors in an impact fund can also play a significant role by ensuring an alignment between the fund manager’s incentives and the fund’s objective. Furthermore, impact fund LPs should also ensure that there is an allocation for monitoring and evaluating underlying investments of the fund that will help portfolio companies, funds, and LPs themselves for better market positioning and provide a competitive edge. It is time to move on from following the strategies of venture capitalists and operate like an “Impact Capitalist.”
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