5.2 Role of Impact Enterprises
5.2 Role of Impact Enterprises
Impact enterprises are a central component to mainstreaming impact investing. Over time, as these organizations grow and their sectors expand, they will be better positioned for commercial capital. Despite natural growing pains that many impact enterprises experience today, there are a few key actions they can take to ensure that they are ready for capital infusion from mainstream investors.
Recommendation 1: Build capabilities that make it easier for investors to allocate capital. It is an ongoing challenge for impact enterprises to raise finance from traditional sources of capital. Impact enterprises, like all businesses, seek financial terms that meet their underlying cash flow and strategy. Similarly, investors seek to make investments with familiar term sheets and financing structures. As has already been discussed, impact investing is anything but familiar. Thus, while investors become more familiar with impact investing and the sector grows, impact enterprises will need to build capabilities and be open to innovative financing mechanisms. For example, revenue-sharing agreements – or royalties paid on income earned – offer an innovative means for impact enterprises to receive financing.85 They do not require a liquidity event, such as an initial public offering or an acquisition by a private equity firm, in order for the investor to generate cash flow, and thus are more attractive than equity capital. They are also more attractive than debt capital as these agreements do not have the fixed costs associated with traditional loans. Although such agreements would not be relevant for certain business models, they illustrate an alternative form of financing that could help accelerate capital flow into impact investments. Both impact investors and impact enterprises will need to be open to such innovations.
Recommendation 2: Proactively measure and report on social and environmental impact. As discussed in Section 3.2, for certain impact enterprises, the social and environmental objectives are directly tied to the business model; in such instances, measurement of these indicators may be no different from measurement of the business indicators. However, even in these instances, it is important for enterprises to proactively measure non-financial metrics – including the difficult metrics that are not directly tied to the business model – in order for the sector to achieve a level of accountability and transparency. In addition to measurement, reporting of the impact metrics will help to drive further accountability and transparency among organizations claiming to be impact investment targets. Certain organizations are helping promote sector accountability and transparency. B Corp (introduced in Section 3.2) evaluates the social and environmental impact of companies and funds and assigns them a score based on certain criteria.86 GIIRS measures the social and environmental impact of funds and companies and provides comparable and verified metrics and ratings.87 ANDE has convened an impact assessment working group to drive consistent assessment practices and standards, and publishes an annual impact report that tracks the effects of investments in small and growing businesses in emerging markets. These organizations are certainly helping, but impact enterprises will need to willingly enrol in such approval processes, and thus need to begin, or continue, to proactively measure and report on their social and environmental impact.
Recommendation 3: Strive for competitive differentiation and strong financial management. Mainstream investors most often withhold investment in impact enterprises (especially in frontier markets) because of their lack of financial discipline or clear competitive advantage. Adding to this criticism is the potential oversaturation of impact enterprises that have similar social objectives and that “compete” in similar sectors or geographies. To address this criticism, impact enterprises should be diligent to carve out a unique competitive differentiation in their respective markets to ensure sustainable financial viability. Similarly, they should be diligent to seek out collaboration opportunities to achieve the benefits that derive from size and scale.