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What is Impact Investing & When to Use it?
Table of Content
In today’s world, people are becoming more aware of the need for social and environmental responsibility. As a result, impact investing is becoming more popular to fund businesses while making a difference in society. Impact investing funds seek to create both financial and social returns. It’s a way to put your money to work while positively impacting the world.
If you’re interested in impact investing funds but need help knowing where to start, this beginner’s guide is for you. In this post, we’ll cover the basics of impact investing, including what it is, how it works, and how you can start your own small business. Whether you’re a seasoned investor or just getting started, this guide will help you understand the basics of impact investing and how it can benefit your business and society.
The Concept of Impact Investing
Impact investing puts social and environmental factors at the forefront of investment decisions. It’s a way of investing that allows you to align your values with your investment portfolio and support companies and initiatives creating positive change in the world. Unlike general investment strategies, whose sole focus is on generating a financial return, impact investing firms seek to create a measurable and intentional social or environmental benefit alongside a financial return. It means that impact investing firms can support businesses and organizations working towards a more sustainable future while also earning a return on their investment.
The primary goal of impact investing funds is to create positive change by allocating capital toward initiatives that promote sustainable development, social progress, and environmental well-being. These investments can encompass various sectors, such as renewable energy, affordable housing, education, healthcare, clean technology, and microfinance. Impact investors actively seek out and support projects, organizations, and businesses that address social and environmental challenges while aiming to generate measurable, beneficial outcomes.
Impact investing can take many forms, from investing in social enterprises and startups to creating innovative solutions to social and environmental challenges and supporting established companies in integrating sustainability into their business models. It’s important to note that impact investing is not limited to a specific asset class or investment strategy. It can encompass a range of investment instruments, including private equity, venture capital, debt financing, public equities, and more.
Numerous different investors, both individual and institutional, have been interested in impact investing funds, including:
- Corporations
- Development Finance Institutions
- Diversified Financial Institutions/Banks
- Family Offices
- Fund Managers
- Individual Investors
- NGOs
- Pension Funds and Insurance Companies
- Private Foundations
- Religious institutions
Overall, impact investing expands the scope of general investment strategies by explicitly considering social and environmental impact alongside financial returns, and it seeks to mobilize capital for positive change in the world.
Brief History of Impact Investing
Impact investing is not new; it has been around for decades. The origins of impact investing can be traced back to the 1960s and 1970s when investors started questioning their investments’ negative social and environmental impacts. It led to the emergence of socially responsible investing (SRI), where investors started excluding specific industries like tobacco, alcohol, and weapons from their portfolios. In the 1980s, the focus shifted to ethical investing, where investors began investing in companies aligned with their values, such as protecting the environment, promoting social justice, and respecting human rights.
The term “impact investing” was first coined in 2007 by the Rockefeller Foundation to describe investments to generate positive social and environmental impact alongside financial returns. Since then, impact investing has gained popularity and has grown into a more structured industry with dedicated impact investment funds, financial institutions, and impact measurement tools. The Global Impact Investing Network (GIIN) was founded in 2009 and has been instrumental in promoting and supporting impact investing globally. Today, impact investing has become a mainstream investment strategy, with investors looking to create social and environmental impact while earning financial returns.
How Impact Investing Funds Differ from General Investment Strategies
An important distinction between traditional or general investment strategies and impact investing funds is how they calculate return on capital. General investment strategies focus on key financial metrics. On the other hand, impact investing firms look at both financial ratios and the social and environmental impact created. It means that impact investing firms will often use a range of metrics to evaluate their investments, including social and environmental performance indicators. While general investment strategies primarily focus on maximizing financial gains, impact investing considers financial and non-financial outcomes.
Impact investing funds often take a long-term perspective. Investors understand that social or environmental impact may take time to materialize fully, and they are willing to remain invested for extended periods to achieve both financial and impact objectives.
Furthermore, impact investing funds involve rigorous measurement and evaluation processes to assess the social or environmental impact created by investments. Investors use various metrics and frameworks, such as the United Nations Sustainable Development Goals (SDGs) or the Global Impact Investing Rating System (GIIRS), to track and report the impact generated by their investments.
Different Types of Impact Investing
There are a variety of different types of impact investing that you may come across. The most common include:
- Community investing is a type of impact investing that involves investing in local communities. It can include investing in affordable housing, community development projects, and small businesses. The goal is to create positive social and economic impacts in the community.
- Debt financing is a type of impact investing that involves lending money to a business or organization with the expectation that the loan will be paid back with interest. It is similar to a traditional loan, but the goal is to support businesses with a positive social or environmental impact.
- Equity financing is another type of impact investing that involves buying ownership of a business or organization. It means that you will receive a share of the profits but also a share in any losses. This type of investment is riskier but can also offer higher returns.
- Microfinance is a type of impact investing that involves providing small loans to entrepreneurs and small businesses in developing countries. This type of investment can help to create jobs and stimulate economic growth in areas that need it most.
- Social impact bonds are a type of impact investing designed to fund social programs. Impact investing firms fund a program and receive a return on their investment if it meets specific predetermined outcomes. This type of investment is often used to fund programs that address issues like homelessness, education, and healthcare.
Understanding the different types of impact investing can help you choose the right investment strategy for your small business while contributing to positive social and environmental outcomes.
The Top 5 Impact Investing Firms
The amount of money financial institutions like impact investing firms manage for their clients is called assets under management (AUM). AUM is the total market value of all the investments managed by a fund or family of funds, a venture capital business, a brokerage house, or an individual licensed as a portfolio manager or investment advisor. Here are the top five impact investing firms according to the value of their assets under management.
BlueOrchard
Founded in 2001 and headquartered in Zurich, Switzerland, BlueOrchard has around $9.8 Billion in assets under management. It is the first commercial manager of microfinance debt investment globally as part of a United Nations project. BlueOrchard focuses on fixed-income investments that provide both financial and social returns. Their portfolio includes:
- Climate Finance: Investments in renewable energy, energy efficiency, and other climate-related sectors.
- Microfinance: Loans to microfinance institutions that provide financial services to underserved populations.
- SME Finance: Loans to small and medium enterprises that drive job creation and economic growth.
BlueOrchard rigorously measures the impact of each investment to ensure it achieves both financial and social goals. For each sector, they have developed impact indicators to track progress, such as:
- Installed renewable energy capacity and CO2 emissions reduced
- Number of microloans disbursed and number of end borrowers reached
- Number of SMEs financed and number of jobs created or sustained
BlueOrchard also conducts regular social audits and client satisfaction surveys to monitor impact over time.
Triodos Investment Management
More than a dozen sustainable investment funds are managed by Triodos Investment Management, a branch of Triodos Bank, which has its headquarters in Zeist, Netherlands. Since 1980, it has had around $5.89 billion in assets under management across Europe, emerging markets, and renewable energy. The firm focuses on financing companies in sustainable energy, organic food and agriculture, and microfinance.
Triodos evaluates impact based on their “Triodos Impact Prism.” This framework assesses a company’s impact on people, the planet, and prosperity.
- People consider factors like working conditions, education, and community involvement.
- For the planet, they review environmental practices, natural resource usage, and pollution. To qualify for Triodos’ funds, companies must demonstrate “positive impact” in at least one prism dimension, like providing renewable energy access or organic farming techniques.
- And for prosperity, they analyze the return on capital calculation.
If a company isn’t meeting impact goals, Triodos sets impact objectives and monitors progress through annual reports and site visits. Triodos will work with them on corrective actions or divest their funds. Triodos is using money to transition to an economy that benefits both people and the planet by financing sustainable companies and holding them accountable.
Community Reinvestment Fund
Founded in 1988 and headquartered in Minneapolis, Minnesota, USA, Community Reinvestment Fund (CRF) is the largest nonprofit Community Development Financial Institution (CDFI) with around $3 billion in assets under management.
Community Reinvestment Fund measures success based on the following:
- Impact: CRF tracks the number of affordable housing units and community facilities financed and the number of low-income individuals served. They aim to support underserved populations and revitalize communities.
- Additional capital: CRF measures how much additional private and public capital their financing has leveraged for projects. For every $1 CRF invested, $3 additional capital is raised.
- Repayment: CRF monitors the repayment and default rates for the loans they provide. Maintaining strong repayment rates, currently over 99%, allows CRF to recycle capital and fund more projects.
- Client satisfaction: CRF regularly surveys its clients and borrowers to gauge satisfaction with their financing programs and services. They aim over 90% of clients to rate them as “good” or “excellent.”
- Operational efficiency: As a nonprofit, CRF aims to keep administrative and operating costs under 5% of its total assets under management. By running an efficient operation, more money can go toward financing impactful projects.
CRF is a leader in providing affordable and responsible capital for community development. Their success in attracting private investment, achieving strong repayment rates, and keeping costs low has allowed them to scale their impact across all 50 US states. For those looking to invest in underserved communities, CRF is a model for how to effectively and responsibly provide financing to drive social change.
Reinvestment Fund
Reinvestment Fund is a Philadelphia-based nonprofit financing institution for community development founded in 1985. It focuses on investing in underserved communities to provide affordable housing, healthcare, education, and jobs. With around $1.2 billion in assets under management, Reinvestment Fund leverages private capital to invest in underserved people and places, helping to close racial and economic gaps in opportunity and access.
TRF conducts research and analysis to identify investment opportunities and evaluate various projects’ potential social, economic, and environmental impacts. This analysis helps guide TRF’s investment decisions and ensures that investments align with its mission and goals. It collaborates with community organizations, government agencies, financial institutions, and other stakeholders to leverage resources and expertise. These partnerships help maximize the impact of investments and facilitate comprehensive community development.
Furthermore, TRF employs rigorous impact measurement methodologies to assess the outcomes and effectiveness of its investments. It allows them to track progress, make data-driven decisions, and continuously improve their strategies for positive social change. It’s important to note that while TRF focuses on generating positive social and environmental impacts, it also emphasizes financial sustainability. By blending philanthropic and investment capital, TRF aims to create a sustainable model that attracts private investment to underserved communities.
Vital Capital
Vital Capital is one of the most significant impact investing firms headquartered in Zurich, Switzerland. The development of infrastructure, housing developments, agro-industrial ventures, renewable energy, healthcare, and education are Vital Capital’s primary investment focuses, with over $350 million in assets under management. The Luanda Medical Center in Angola and Water Health International are two of the fund’s investments.
To determine success, Vital Capital evaluates investments based on two factors:
- Financial returns: They aim for risk-adjusted market rates of return to prove the viability of impact investing. Vital Capital believes demonstrating solid financial performance will attract more mainstream investors to the impact investing space.
- Impact metrics: They measure impact according to non-financial metrics like jobs created, renewable energy produced, hectares of land conserved, and people gaining access to education or healthcare. Vital Capital reports on impact using the Impact Reporting and Investment Standards (IRIS) and the United Nations Sustainable Development Goals (SDGs).
Vital Capital’s approach shows that impact investing doesn’t require sacrificing returns. You can achieve financial and social gains with the right investment strategy and diligent management. Their success is paving the way for more prominent investors to follow suit and put their money where it matters.
Please note that the impact investing landscape constantly evolves. The rankings and composition of impact investing firms may change over time. New firms may emerge or gain prominence. So, conducting further research to get the most up-to-date information on impact investing firms is always a good idea.
Investment Loan Requirements of Impact Investing Firms
Impact investors consider both financial and social returns. Before providing impact investment funds, they look at things like:
- The company’s mission and purpose. Is it trying to solve a social or environmental problem?
- Risk and return potential. While the impact is essential, investors still want to see a path to getting their money back with a reasonable return.
- The leadership and governance. Do executives and board members have a proven commitment to impact?
- Clear metrics. Can the company demonstrate the social or environmental outcomes it’s achieving?
The top impact investing firms use a variety of criteria to measure the social and environmental impact of their investments. The main investment loan requirements include the following:
Social Impact
Impact investing firms align investments with the United Nation’s 17 Sustainable Development Goals. These include:
- No Poverty
- Zero Hunger
- Good Health and Well-being
- Quality Education
- Gender Equality
- Clean Water and Sanitation
- Affordable and Clean Energy
- Decent Work and Economic Growth
- Industry, Innovation, and Infrastructure
- Reduced Inequality
- Sustainable Cities and Communities
- Responsible Consumption and Production
- Climate Action
- Life Below Water
- Life on Land
- Peace and Justice Strong Institutions
- Partnerships to Achieve the Goal
It means that impact investors want to fund companies and projects that will positively affect the world. They look for businesses that are working to solve social or environmental problems.
Experienced Leadership
Impact investors tend to favor companies and funds with experienced management teams with a proven track record of success. They want to see that the leadership has the knowledge, skills, and determination to overcome challenges and achieve social and financial goals. If you have an accomplished team that has successfully launched other startups or new initiatives, impact investors will probably have more confidence in your ability to execute.
Financial Return
While impact investments may not consistently deliver the same return on capital calculation as purely profit-driven investments, they aim to generate competitive financial performance while making a positive difference. Impact investing firms typically seek market-rate or below-market-rate returns as part of their investment loan requirements. These balance their financial goals with their impact objectives. Impact investors understand that the underlying business model must be financially viable to scale and sustain impact. If your company has a solid financial outlook and growth potential, impact investors may see you as an attractive investment opportunity.
The average return on capital calculation expected by impact investors can vary depending on several factors, including the specific impact investment strategy, the targeted sector or industry, the investment timeframe, and the investor’s risk tolerance. More than 88% of impact investors indicated that their investments met or surpassed their expectations, according to the Global Impact Investing Network. According to studies, the median impact fund realized a return of 6.4% as opposed to non-impact funds’ 7.4%. It’s important to note that impact investing typically involves a dual objective of generating positive social or environmental impact alongside financial returns.
Measurable Metrics
To evaluate the social impact of an investment, impact investors rely on measurable metrics. They look for companies and funds that have identified key performance indicators (KPIs) to track progress against social and environmental objectives. Providing quantitative impact data and evidence of outcomes appeals to impact investors, including evident due diligence and financial feasibility study. If you have such a metrics-driven approach, highlight that in your pitch to impact investors.
Some impact investing firms may commission independent 3rd-party evaluations by organizations like the Global Impact Investing Network (GIIN) or Tideline to assess the impact of investments. For example, BlueOrchard Finance publishes annual impact reports with audits from independent evaluators. Others may solicit feedback from clients and investees to understand their perspectives on the impact and areas for improvement. For example, Community Reinvestment Fund surveys clients to assess the impact of their investments.
The top firms recognize that rigorously measuring and reporting impact is critical to maximizing their effectiveness and accountability. Combining these methods can provide transparency into how capital is being deployed to drive social and environmental change.
How To Get Started with Impact Investing
Impact investing is an excellent way of supporting small businesses and creating positive social and environmental change. Getting started might seem daunting if you’re new to impact investing, but it’s much easier than you think.
The first step is to do your research. Find out which impact investing options are available to you. Various platforms offer impact investing opportunities, so exploring your options is essential to find the one that best suits your needs. Consider impact investing if:
- Your company has a clearly defined social or environmental mission. Impact investors want to see how your business model and operations generate impact. Be prepared to report on crucial impact metrics and outcomes.
- You have exhausted other funding options. Impact capital can be more patient and flexible, but obtaining it takes work. Tap into impact investing only after exploring loans, crowdfunding, venture capital, and other traditional sources.
- You have a viable business model and path to profitability. While the impact is essential, investors still expect a financial return on their capital. Show how you will achieve sustainability and scale your business.
- You are willing to engage investors as strategic partners. Impact investors often provide hands-on support to help maximize impact and financial success. Be open to mentorship and guidance on scaling your social enterprise.
While impact investing is not for every company, it can be an invaluable source of funding and support for mission-driven startups. Suppose you meet the criteria of impact investors and are committed to generating positive change. In that case, exploring these investment options may lead to new opportunities to grow your business and increase your impact.
Once you have found a platform you like, start investing a small amount of money. This way, you can test the waters and see how impact investing works before committing to more significant investments.
Before you invest, make sure you fully understand the investment opportunity. It includes understanding the business model, the social and environmental impact, and the financial returns. Be prepared to ask questions and seek expert advice if needed. It’s also important to set realistic expectations for your investments. Impact investing is not a get-rich-quick scheme, and it’s important to remember that you’re investing in both financial returns and positive social and environmental impact.
To attract impact investing funds, you need to demonstrate the potential positive impact of your company or project. Financial modeling can help determine critical metrics that illustrate your impact goals and how you plan to achieve them. For example, if your company provides affordable housing, model how many low-income individuals or families you aim to house over 5-10 years. Or, if your project expands renewable energy access, model how many people will gain electricity and emissions reductions.
Finally, be patient. Impact investing is a long-term strategy, and it may take time to see the full impact of your investments. But with patience and a commitment to creating positive change, impact investing can be a powerful way to fund small businesses while making a difference in the world.
Now Go Forth and Invest with Impact!
The top 5 impact investing firms have different approaches to defining and measuring success. While their methods differ in scope and specifics, they share the goal of generating positive social and environmental impact alongside financial returns. If you’ve been curious about impact investing but need help figuring out where to start, these industry leaders can serve as inspiration. Their diverse impact areas and investment strategies demonstrate how to align your money with your values. And by supporting firms like these, you know your investment dollars are being put to work for the greater good. Impact Investing funds offer a unique opportunity for small businesses that positively impact society. Start making a difference today!
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