4.2 Small Average Deal Size

The second challenge that institutional investors face when considering allocation of capital to impact investments involves the size of the transactions. As Figure 18 illustrates, the average direct investment made by impact investment funds into impact enterprises is significantly less than the growth capital deals of traditional private equity firms in 2012.

To overcome the challenge of direct investment, institutional investors can make investments into impact investment private equity funds. However, the challenge is also acutely present for these investments. An anecdotal example helps illustrate this constraint. An impact investment fund manager described an investment meeting with a pension fund in which the investment committee explained that they would not take more than a 5% stake in a private equity fund and would not commit less than US$ 30 million; thus the impact investment fund would need to be at least US$ 600 million to even pass the pension fund’s initial screen. In reality, only 2% of impact investment funds would meet these criteria.⁷⁸ This challenge is further illustrated in Figure 19, which shows the average individual allocation of capital to private equity by all major institutional investor types compared to the average investment sought by impact investment private equity funds.

Because the deal sizes are smaller, the costs of due diligence may be higher for impact investments and the deal economics may look fundamentally different. Sourcing the right deals in the pipeline can be costly, often requiring local country support, especially for deals in frontier markets. Although further work needs to be done to better understand the fundamental economics of impact investment deals, 58% of US-based pension funds surveyed said that impact investing involves a higher cost of due diligence than traditional investing. As one institutional investor explained during an interview, “The due diligence time required for a US$ 10 million investment is the same as the time required for a US$ 100 million investment; our resources are best spent on the larger deal.”

One way that institutional investors have worked around the small deals is by investing in asset classes other than private equity and direct investment. As described in Section 3.4, impact investments in real estate, infrastructure and fixed income typically involve larger deal sizes and thus may be more applicable asset classes for large-scale institutional investors.