The mission of Small Enterprise Assistance Funds (SEAF) is to invest in and support SMEs as a means of economic growth and development in underserved markets.¹⁵ SEAF, a registered 501(c)3 non-profit global fund management group, has carried out its economic development mission by deploying private sector tools, i.e. launching private, for-profit equity funds in Central and Eastern Europe, Latin America and Asia. 

By the end of December 2012, SEAF’s historical cumulative committed capital reached US$ 655 million, with more than US$ 470 million in debt and equity investments in nearly 400 companies and 214 completed exits. These businesses have created and/or maintained more than 34,000 jobs, developed the skills and increased the wages of their employees, and raised their revenues year-on-year to become stable economic forces in their local economies. We estimate that every US dollar invested in one of our SMEs has generated US$ 13 for the larger community (see “SEAF – The Economic Rate of Return” for more information on the calculation methodology). SEAF’s investors, a combination of development institutions and private sources, have been able to satisfy both their financial and developmental objectives.

While a non-profit group, SEAF is also an investment adviser registered with the US Securities and Exchange Commission (SEC). This unique structure (described in more detail under “Design and Manage Governance to Make It Easier to Achieve a Fund’s Objectives”) allows SEAF to align its mission of achieving developmental impact with generating financial return to its investors through its network of for-profit funds and their underlying investments in SMEs. 

Now on its 32nd SME investment fund, SEAF has had many successes and learned crucial lessons about how to align financial return and social impact. We share four of them below.

Work with Investors Aligned to Your Vision for Change and with Investment Parameters

To meet investors’ expectations, it is critical to work with those that share the same goal of achieving both financial and social returns, as well as the same focus of a particular sector, geography or theory of change. 

Our investors rarely work with us for the sole objective of maximizing financial returns, but rather for a variety of fund attributes. On a high level, investors must be aligned with our vision that SMEs can be engines of prosperity and forces for change in challenging environments; they sense undiscovered value in the less mainstream corners of the global economy. On a more tactical level, investors must be comfortable with smaller transaction sizes, since our funds, most of which make investments of between US$ 1 million and US$ 5 million, are off the spectrum for traditional private equity funds. Moreover, given that we invest in less mature companies and markets, investors need to be at ease with the uncertainty inherent in frontier and underserved markets, as well as in working with earlier-stage companies. 

Historically, only DFIs, existing for the explicit purpose of leveraging finance to achieve economic development, shared our social impact mission. Over time, local investors who want to participate in the growth of their economies through high-potential, home-grown companies have increasingly invested in our funds. These investors include local pension funds and insurance companies, as seen in our Colombian and Peruvian funds.

Recently, family offices, foundations, forward-looking corporations and individuals have seen benefits in focusing on an otherwise hard-to-reach sector, population or geography. These investors often do not identify themselves as “impact investors”; rather, they seek reasonable and somewhat uncorrelated returns. They also recognize that aligned investing provides some protection against the potential financial risk that less socially-minded investment managers can unwittingly create, as when they pursue profit maximization without regard for social, environmental and other standards. 

Integrate Social Impact Metrics into the Investment Screening, Selection and Monitoring Process as Early as Possible

The impact objectives should drive the fund thesis, pipeline generation, investments made and, importantly, incentives of the investment team. The fund management team should be aware of investors’ dual motivations. To demonstrate success, the manager must be able to collect, track and evaluate the data from investments made. Alignment from the beginning makes it much easier to integrate the metrics into the investment process; however, the more specific the targets become, the more difficult it can be to balance the developmental objectives with the financial ones. For example, narrowing the universe of acceptable investments too much may mean that the available investments cannot meet financial objectives. Instead of strengthening the impact, a plethora of very specific and potentially competing metrics can hamper the investment team’s ability to find good investments that meet the criteria. This results in the funding of financially unsustainable investments that meet neither social nor financial objectives.

These caveats are particularly important with investments made in smaller and often less mature markets. In the end, the team must seek opportunities that are sound and sustainable, yet conducive to the social impact that investors desire. 

Ideally, the investment professionals should see that achieving the developmental objectives also factors into their compensation. Unfortunately, this is all too rare for two reasons: first, it is not easy to devise the right balance of incentives; and second, even aligned investors are frequently most comfortable remaining with traditional incentive structures based on financial return. No basis exists to create incentives geared to anything other than financial performance if the fund manager does not develop and deploy metrics for evaluating agreed social and developmental outcomes (e.g. job creation, wage growth or sector-specific metrics related to providing basic services or health outcomes). 

In the end, rigorous impact measurement and evaluation methods can play a significant role in successfully balancing financial and social returns, so long as both are measured and the incentives do not tip the scale too far in one direction. One example is a scale of financial incentives that increases as long as sufficient progress is made in achieving both social and financial returns.

We have also adapted and implemented a stakeholder-benefit methodology that quantifies the net benefit to the local economy of investments made in emerging-market SMEs. We calculate the multiplier effect of investments through in-depth case studies of representative portfolio companies. Using a cash-flow model, the multiplier effect considers the financial return of an investment plus additional external social returns (see Figure 10 and “SEAF – The Economic Rate of Return”).

By gathering more than just deal-specific financial data, we are able to tell the story of the investments and make the case to an increasing number of stakeholders about the positive role that SME investment can play.

Figure 10: SEAF Economic Rate of Return
Source: SEAF

Select Financially Sound Investment Opportunities and Provide Support to Keep Them on Track

Central to SEAF’s investment philosophy is the belief that high developmental impact can only be achieved through financial success of the portfolio company.¹⁶ Given that our vehicle for achieving impact is a private-sector company, the SME must be financially healthy to continue delivering on impact objectives (e.g. creating jobs, increasing wages and skills, paying taxes, procuring supplies of inputs, giving customers better value and more choices, and contributing to the fabric of the local community by a variety of philanthropic activities).¹⁷

We provide technical assistance to portfolio companies’ management teams to improve their financial and cost controls, source new customers and markets, adhere to relevant quality standards, and access industry experts to advise on operations and expansion strategies. 

That said, we monitor and evaluate the portfolio companies to ensure that even the most financially successful investments continue to meet the development priorities of the Fund and provide the social benefits sought through the original investment thesis. This is critical for managing investor expectations given that our investors stipulate ESG norms and development impact in their investment parameters.  

Design and Manage Governance to Make It Easier to Achieve a Fund’s Objectives

As impact investing funds move from the donor world to the investment world, they need to seek appropriate business models and develop strict investment discipline and strong financial controls. Several aspects of governance are critical to achieving double-bottom-line performance. At a high level, the legal structure and governance should protect the mission of the organization. On a day-to-day basis, sound governance practices should ensure clear investment policies and processes. Finally, the importance of full accountability and transparency could not be overestimated in giving confidence to investors.

SEAF is structured as a non-profit with a mission-focused charter and binding investment policies that stipulate the scope and target of investments. SEAF’s board of directors ensures the mission is central to charting the organization’s direction. Besides SEAF’s own board, each individual fund’s board and shareholders provide additional oversight and governance necessary to keep the fund manager on track and aligned – both through financial incentives for risk-adjusted investment returns, and from an investment policy standpoint whereby approval is given only to investments meeting the developmental parameters.

We make it a priority to meet all fiduciary obligations to our investors and have developed strong financial controls and reporting. We perform regular valuation of fund investments and provide investors with quarterly reports on their investment status.

Strong focus on its development mission, strict investment discipline and commitment to transparency has enabled SEAF to attract diverse investor base and grow assets under management. SEAF is a SEC-registered investment adviser, which further signals to investors its commitment to prudently manage capital, and with full understanding of fiduciary obligations.

As assets under management in impact investments grow, more fund managers will become registered and regulated by governmental or industry bodies. Meeting regulatory requirements will in turn lead to the further professionalization of the impact investing sector. It is a virtuous circle that starts with the fund manager ensuring appropriate fund governance practices. This eventually will lead to more capital flowing into impact investing.

Conclusion

While the desire to produce both financial returns and development impact can create occasional tension, the challenges of achieving a healthy balance can indeed be reduced by consciously developing an approach and structure that allows an organization to pursue both goals effectively. First, the importance of working with investors who are aligned with the dual mission and take each aspect of it seriously cannot be understated. Second, the investment team must be able to define, measure and incentivize non-financial success. Third, it should be understood that social and development impact flows from financial success when the impact delivery vehicle is a private sector company. And finally, creating a corporate governance structure conducive to double-bottom-line investing can help tie all activities together.