The growth and success of green and inclusive business models with high impact potential is central to the challenges many emerging economies are facing.

These enterprises not only spur development and market growth, but also ensure the preservation of the very base of our global economy – environmental and social resources. Thus, these small and medium-sized enterprises (SMEs) may just be the backbone of tomorrow’s global economy.

The considerable political and economic momentum that has been built around social entrepreneurial activity is therefore not surprising. And yet, a lack of access to finance for SMEs - described as “one of the greater challenges” by the World Economic Forum - has not yet been sufficiently addressed.

This financing gap is particularly problematic for social and impact enterprises, as they not only find themselves stuck in the “missing middle” gap of the ‘post start up pre scale up’ phase with other SMEs, but moreover struggle to find an investor equally committed to their social mission.

A hot topic

Impact investing has become a hot topic and is increasingly being explored by the investor community. Numerous calls to action have spurred promising initiatives, but essential challenges remain: Firstly, high transaction costs prevent both investors and impact entrepreneurs from finding fruitful partnerships.

Secondly, even promising new impact investing structures and vehicles still exclude a large group of investors and businesses focusing on early-stage ventures.

Investors often associate impact investing with high risk, unaware that many social/impact enterprises are profitable and have great potential. Moreover, research, due diligence and monitoring costs are high for a single investor.

Even where venture capital could be mobilized, many still fear exiting may be a problem, as potential buyers are hard to find - especially when investing in social/impact enterprises.

Struggle to find deals

Impact investors constantly note that they struggle to identify matching and promising ventures. In this emerging global market with very diverse actors, the likelihood of finding a mission and finance product match through one-on-one pitches is especially low.

Currently huge potential is lost, making the “missing middle” gap and lack of low-scale, globally accessible impact investment structures a considerable drain for growth.

To tackle these issues initiatives for impact investor and entrepreneurial networks are valuable progress.

Forums such as the Global Impact Investing Network, the Aspen Network, the Investors’ Circle and Toniic aggregate expertise, provide space to share knowledge, best practices and potential deals - mostly among investors, and offer valuable tools. Namely, the impact base online directory of investment vehicles, and a global deal flow platform.

Missing voices

Over the past few years, even though much has been done by many to build an impact investing ecosystem, the collective global effort has been focused on:

1. Standard setting
   
   
2. Clarifying definitions
   
   
3. Developing the right kind of investment vehicles, instruments and products
   
   
4. Agreeing on measuring and benchmarking impact methodologies
   
   
5. Establishing policy and enabling frameworks
   
   
6. Structuring funds, etc. in other words, most of the collective effort has focused on the supply side of impact investing.
   
   But there is an absent voice in all these policies, regulation, standardization processes – that of the actual impact enterprise, or stated differently the demand side of impact investing.

In the current global discourse – much is also being said about ‘the lack of investable enterprises’ – or, a pipeline of ready, scalable, innovative and investment ready enterprises that can deliver not only the envisaged impacts but also the elusive and guaranteed returns of impact investments.

We know the challenges that the world is facing are numerous, but are there enough businesses out there that are working to address these issues AND that have the capacity to take on the type of capital that Impact Investors are offering?

Mismatched demand and supply

It is not simple nor easy on a continent like Africa where entrepreneurship is flourishing, but access to capital remains elusive. Investors complain that they have a hard time finding investment ready opportunities, and entrepreneurs complain that impact investors are not willing to take enough risk.

This results in multiple investors chasing after a few star businesses, while multitudes of other businesses stagnate because they cannot find the kind of capital they need to grow.

Even with the exponential growth of innovation hubs, incubators and accelerators, pitching competitions across the continent funded by well-meaning grantmakers, venture philanthropists and corporate social investors, we are not seeing that entrepreneurs who have gone through these supposedly ecosystem and capacity building processes are actually taken up by impact investors at scale. Why is that?

In a paper published by Oxfam on this very issue – the demand side of impact investing was researched. The paper concluded that:

• Impact investing is a growing means of addressing poverty and has become an important topic within the nongovernmental organization (NGO) and philanthropic community.
  
  
• Although impact investing in theory provides a clear opportunity for blending mainstream finance and traditional philanthropy, it is difficult in practice.
  
  
• As a relatively new field, impact investing suffers from a lack of consensus and clarity about its definition, about how impact should be measured, and about choices regarding in whom to invest.
  
  
• In addition, the impact investing sector has not fully examined how it is perceived by those who want to participate but for one reason or another have been excluded.
  
  
• Without the guidance of local entrepreneurs’ experiences, investors may continue to make investment recommendations that follow mainstream investment logic, such as venture capital models, an approach that can yield incomplete decisions and unintended outcomes.
  
  

  Expecting the same scope and scale as venture capital investments, for example, may not be realistic for these entrepreneurs.

This very important research study concludes that two overarching patterns regarding impact investing are emerging:

• First, investor expectations differ based on heterogeneity of investor preferences and priorities: where the investor wants to make an impact (which may or may not address poverty), how the investor values scalability and sustainability, and how the investor evaluates local experience.
  
  
• Second, impact investing is meant to be transformational, but much of the work is transactional. Several factors lead to this outcome: de-coupling ownership of the problem from ownership of the business, and investors and entrepreneurs not working in partnership; lack of accountability to impact measurements leading to a mentality that social impact is a “nice to have” rather than “must have”; and measuring the quantity of investments rather than quality and how the investment serves to drive impact.

The study concludes with three recommendations:

• To build transparency and accountability, investors should define their impact investing goals.
  
  
• To increase knowledge and consensus-building, the investor-entrepreneur relationship should be an inclusive, transparent partnership.
  
  
• To meet market needs, investors are encouraged to consider smaller investments, working with entrepreneurs to find ways to reduce the associated higher transaction costs (for example, by co-investing alongside local investors, embedding third-party local support, or staging investments to focus on impact milestones).

While it is not realistic to ask every impact investor to fundamentally transform his or her current practices, it is important to evaluate how impact investors as a group are developing common practices not typically seen in philanthropy or conventional investing.

A critical piece of this evaluation is determining how the voices and viewpoints of affected communities will be heard. Impact investors can take a first step by conducting an entrepreneur-centric due diligence of their own practices.

According to Beth Sirull - Foundations specifically have at least three critical roles to play in meeting this challenge.

1. First, many potentially investable impact enterprises are too small and/or require a substantially longer investment horizon than investors (especially those looking for market-rate returns) are willing to commit.

   These enterprises need to be nurtured, and foundations are in an ideal position to provide the kind of patient, growth-oriented, and risk-tolerant equity and debt financing that enable such enterprises to take root and flourish.

   Foundations also can provide expertise and access to prospective investors, either directly or through partnerships with programs and organizations whose mission is to build high-impact enterprises.

   Over time, many of these enterprises and perhaps entire new sectors may become viable for impact investments with more conventional financing terms, or even "plain vanilla" market-rate debt and equity. But absent early-stage, catalytic capital from foundations, neither the social impact nor the financial return is likely to be realized.

   By sharing successes, these investments can also provide the additional benefit of “signaling” the market, both in terms of attracting like-minded investors to specific deals and new investors to the impact investing field itself.

2. Second, in some markets, conventional financing will never work due to the underlying economics, population served, regulatory constraints, and/or political risk. Real estate developers, for example, can't generate market-rate returns while providing housing for a senior citizen living on a fixed income of, say, $10,000.
   
   While public subsidies can help make the math work, they often create obstacles of other kinds. As Debra Schwartz of IIX Exchange puts it: "In hard-to-finance markets, large-scale impact investments are made, not found." Foundations can play a role in these markets by providing patient, flexible financial support to mission-driven intermediaries.

   Foundations also can provide the first loss reserves, guarantees, and subordinated investments needed to create innovative, structured finance vehicles tailored to different kinds of impact investors, including those requiring market-rate returns.

   Impact investing is not meant to eclipse traditional grants; both are necessary. The point is to use impact investing dollars where appropriate and to free up more grant dollars for where grants are truly required. As Amy Klement of Omidyar Network says, "Problem first. Tool second. You really need to understand the problem and the need before you decide the best way to address it (grant, equity, debt, etc.)."

3. A third way foundations can support the impact investing field is to use traditional grants to fund learning and policy activities, along with enterprise development and financial innovation.
   
   

   For example, Omidyar Network, along with the Rockefeller, MacArthur, Ford, and Surdna foundations, is funding case studies and other research to inform impact investing policy and practice in the U.S. and abroad. These efforts are also supported by several government agencies and are critical to the long-term development of the field.

In a series of articles by Pioneer Post the following was presented as solutions to overcome the gap between the supply and demand side of impact investing:

Five steps to help tackle the mismatch

While there are undoubtedly challenges in the future of impact investing, there are also tremendous opportunities.

1. Research: As a sector we need to listen more to social purpose organizations and impact enterprises and use more market-based evidence to inform new structures for investing for impact and investing with impact. The opportunity is there for more demand-side research and performance data on which to build a more appropriate spectrum of investment.
   
   
2. Advocacy: To overcome the market gap, we need to promote investing for impact among those (such as trusts, foundations and governments) who are willing and able to accept higher financial risk in seeking to achieve greater lasting social impact.
   
   
3. Governance: There is a need to agree voluntary principles that define the behaviours and approaches differentiating investors for impact from investors with impact, and which also promote incentives rewarding the achievement of both financial and impact targets.
   
   
4. Learning: All investors that have an intention to support solutions to pressing social issues need access to learning opportunities that help them improve the way they operate as investors for impact. This includes knowledge on different financial instruments, skills support and impact measurement and management.
   
   
5. Collaboration: Perhaps the biggest and most concrete challenge for the future is to foster more collaboration between grant funders, investors for impact and investors with impact. Although connected, these communities are not yet working together, and this creates gaps and inefficiencies in the market.

   It is only by recognizing the value of all players and their specificities that we can move towards the co-creation of those solutions that will benefit people and planet. After all, at the end of the day, we are all beneficiaries.

There has been a tremendous growth of impact investing funds, which according to GINN exceeds already 700 billion USD in 2020.

The effectiveness of impact investing depends upon the social and financial success of its investments, which is tied to its investees. During impact investing, the investee impact enterprise is the major instrument through which social and financial returns are generated. The relationship between the impact investor and the investee enterprises forms the major instrument that drives the legitimacy of the impact investing field by creating social and commercial value.

If both the supply and demand side does not work together to create a better world, both sectors may flounder. It is time that the interdependency between the sectors be address more inclusively and collaboratively, if not, both will struggle to become mainstream.

Next Generation is a management consultancy that focuses exclusively on impact management and measurement. Through our proprietary Investment Impact Index™ we aim to assist both impact investors and impact enterprises achieve their intended impact and return on investment. We do this by assisting with the design of impact strategies, developing impact performance frameworks and metrics, as well as communicating, verifying and analyzing impact and return on investment.