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Impact Investing: Instruments, Mechanisms and Actors [2 ed.]
 3031321820, 9783031321825

Table of contents :
Contents
List of Figures
List of Tables
1 Introduction
1.1 Context
1.1.1 Social Enterprises
1.1.2 Societal Challenges and Changes in the Social Sector
1.1.3 Capital Providers
1.2 Impact Investing
1.3 Outline of the Book
Bibliography
2 Social Entrepreneurship
2.1 Social Entrepreneurship at the Core
2.1.1 Introduction
2.1.2 Defining Social Entrepreneurship
Conceptual Challenges
Legal Forms of Social Enterprises
2.1.3 Differentiation from Other Actors
2.1.4 Scaling Strategies
2.2 Social Business Model Innovation
2.2.1 Opportunity Creation
2.2.2 Smart Distribution
2.2.3 Ecosystem Engineering
2.2.4 Cheap Sourcing
2.2.5 Smart Pricing
2.2.6 Inclusive Production
2.3 Thematic Areas for Impact Investing
2.3.1 Introduction
2.3.2 Sustainable Development Goals
2.3.3 Child Labor
Introduction
Definition
Drivers
Bibliography
3 Impact Investing
3.1 Introduction and Definition
3.2 Rationale for Impact Investing
3.3 Investors
3.3.1 Donors
3.3.2 Investors with Reduced Financial Return Expectations
3.3.3 Investors with Market-Oriented Financial Return Expectations
3.4 Impact Investment Theories
3.4.1 Introduction
3.4.2 Trade-Off Considerations Between Social and Financial Return
Introduction
Trade-Off Conflicts
Strategies for the Resolution of the Financing Conflicts
3.4.3 Flexibility Restrictions Driven by Public Authorities
3.4.4 Sustainability Conflicts
3.4.5 Income Streams
3.4.6 Crowding-Out
3.4.7 Conclusion
Bibliography
4 The Impact Investing Market
4.1 Actors
4.1.1 Networks
4.1.2 Social Investment Advisors
4.1.3 Social Venture Capital Funds
4.1.4 Ethical Banks
4.1.5 Crowdfunding Platforms
4.2 The Instruments and Mechanisms
4.2.1 Socially Responsible Investments
Introduction
Investor Profile
Financial Perfofrmance
4.2.2 Outcome-Based Financing Models
4.2.3 Guarantee Schemes
4.2.4 Catalytic Structures
Bibliography
5 Financing Instruments and Transactions
5.1 Introduction
5.2 Financing Instruments
5.2.1 Equity Capital
5.2.2 Debt Capital
5.2.3 Other Forms
Mezzanine Capital
Recoverable Grants
Forgivable Loan
Convertible Grant
Revenue Share Agreement
Grants
5.3 Investments
5.3.1 Structure of the Investments
5.3.2 Exits
5.4 Technical Aspects
5.4.1 Structure of the Fund Industry
5.4.2 Valuation of Social Enterprises
Bibliography
6 Impact Measurement and Management
6.1 Introduction
6.2 Purpose of IMM
6.3 Terminology
6.4 IMM Along the Investment Process
6.4.1 The IMM Process
6.4.2 Pre-investment Analyses
6.4.3 Post-investment Analyses
6.5 Challenges in IMM
Bibliography
7 Assessment Tools and Methodologies
7.1 How to Choose a Method
7.1.1 Introduction
7.1.2 Target Audience of Impact Assessment
7.1.3 Objectives of Impact Measurement and Management
7.1.4 Reporting Determinants
7.1.5 Scope of Impact Measurement and Management
7.2 Existing Impact Measurement and Management Methods
7.2.1 Introduction
7.2.2 Differentiating IMM for Different Financial Instruments
7.2.3 Categorization of  IMM  Methods
7.2.4 Methods for Assessing and Evaluation of Social Impact
7.2.5 Data collection
The Universe of Data Collection Methods
Indicators
Lean Data and the Use of Mobile Technology for Data Collection
7.3 Outlook
Bibliography
Index

Citation preview

PALGRAVE STUDIES IN IMPACT FINANCE

Impact Investing Instruments, Mechanisms and Actors Wolfgang Spiess-Knafl · Barbara Scheck Second Edition

Palgrave Studies in Impact Finance

Series Editor Mario La Torre, Department of Management, Sapienza University of Rome, Rome, Italy

The Palgrave Studies in Impact Finance series provides a valuable scientific ‘hub’ for researchers, professionals and policy makers involved in Impact finance and related topics. It includes studies in the social, political, environmental and ethical impact of finance, exploring all aspects of impact finance and socially responsible investment, including policy issues, financial instruments, markets and clients, standards, regulations and financial management, with a particular focus on impact investments and microfinance. Titles feature the most recent empirical analysis with a theoretical approach, including up to date and innovative studies that cover issues which impact finance and society globally.

Wolfgang Spiess-Knafl · Barbara Scheck

Impact Investing Instruments, Mechanisms and Actors

Second Edition

Wolfgang Spiess-Knafl Munich Business School European Center for Social Finance Munich, Germany

Barbara Scheck Munich Business School Munich, Germany

ISSN 2662-5105 ISSN 2662-5113 (electronic) Palgrave Studies in Impact Finance ISBN 978-3-031-32182-5 ISBN 978-3-031-32183-2 (eBook) https://doi.org/10.1007/978-3-031-32183-2 1st edition : © The Editor(s) (if applicable) and The Author(s) 2017 2nd edition: © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. Cover illustration: VividaPhotoPC/Alamy Stock Photo This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Contents

1

1

Introduction

2

Social Entrepreneurship

13

3

Impact Investing

51

4

The Impact Investing Market

73

5

Financing Instruments and Transactions

97

6

Impact Measurement and Management

117

7

Assessment Tools and Methodologies

137

Index

157

v

List of Figures

Fig. 3.1 Fig. 4.1 Fig. 4.2 Fig. 5.1 Fig. 5.2 Fig. 5.3 Fig. 5.4 Fig. 6.1 Fig. 6.2 Fig. 6.3 Fig. 6.4

Fig. 6.5 Fig. 6.6 Fig. 7.1 Fig. 7.2

Return expectations (Source Based on Spiess-Knafl [2012]) Outcomes-based financing structure (Source Own depiction based on Beetz [2018]) Guarantee scheme (Source Own illustration) Layers in the financing structure of social enterprises (illustrative) (Source Own illustration) Financing instruments (Source Based on Achleitner et al. [2011a]) Fund structure (Source Own illustration) Principles of valuation (Source Own illustration) Impact value chain model OECD-DAC (Source Jackson and Harji [2016]) The results staircase (Source Own depiction based on Phineo gGmbH [2016]) Impact value chain model Clark et al. (Source Own illustration, based on Clark et al. [2004]) Theory of change, planning triangle for a substance abuse initiative (Source Own illustration based on Harries et al. [2014]) IMM along the investment process (Source Own depiction) Levels of evidence in IMM (Source Own illustration based on Harries et al. [2014]) Possible scope of impact assessment (Source Own depiction) Categorization of IMM tools (Source Own depiction)

54 89 91 98 102 112 114 123 123 124

126 128 132 141 143

vii

List of Tables

Table 1.1 Table Table Table Table Table Table Table Table Table Table Table Table Table Table Table Table Table Table Table Table Table Table Table

1.2 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 3.1 3.2 3.3 3.4 3.5 4.1 4.2 4.3 4.4 4.5 4.6 5.1 5.2 5.3

Potential invested capital to fund selected BoP businesses over the next 10 years Forms of creation of social impact Institutional actors Growth strategies Categories of social business model innovation Categories of non-profit organizations Issues along the food value chain Key Performance Indicators to track progress for all SDGs Child labor situations Two schools of thought Legacy and non-legacy capital of foundations Opportunities for the achievement in different asset classes Theories to explain financing decisions Income streams Financing conflicts Actors of the social capital market Selection criteria Selected social venture capital funds Balance sheet data of selected ethical banks Forms of crowdfunding Costs per unit in the social sector (selection) Characteristics of funds Fund index summary Use of financing instruments

6 7 19 22 24 28 37 39 42 42 55 56 58 66 68 74 77 78 82 83 90 98 99 106

ix

x

LIST OF TABLES

Table Table Table Table Table

5.4 5.5 5.6 5.7 6.1

Age distribution of investments Focus groups in different regions Acquisition of ethical brands Acquisition of social enterprises Overview terminology

106 107 109 111 127

CHAPTER 1

Introduction

1.1

Context

Over the last thirty years, we have seen surprising changes in the way societal changes are initiated. These changes were driven by changes in the way public authorities deal with societal challenges, how individuals decide to work for the common good and what has changed for corporations. Take the examples of microfinance, social housing, green tech, or social businesses. While those sectors were either inexistent or unfunded, they are at the moment important sectors and attract significant amounts of capital. Behind this trend is a range of underlying trends. Milton Friedman once famously wrote “The business of business is business” (Friedman 1970). That was long true and shareholder value thinking dominated and still largely dominates capital markets (Hart and Zingales 2017). The end of stock market bubble in the early 2000s, a financial and economic crisis starting in 2008, the increased feeling of economic disparity led to the belief that the world needs new economic thinking. That change came among others in the form of social entrepreneurship. This was combined with the Nobel Peace Prize for Muhammad Yunus and the Grameen Bank as well as success stories of social enterprises which were illustrating that social and financial return are not mutually exclusive. © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 W. Spiess-Knafl and B. Scheck, Impact Investing, Palgrave Studies in Impact Finance, https://doi.org/10.1007/978-3-031-32183-2_1

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A new generation of social entrepreneurs is working on new business models to further a specific social mission. There is the belief that there is a business model for almost every social problem and businesses can be social platforms. This belief is supplemented by the fact that everybody can be a changemaker. Societal challenges are changing and there is an increased understanding that the private sector and the civil society need to be a part of the solution. New arising and persistent challenges are climate change, international migration flows, and economic disparities. Refugees from the Middle East, Afghanistan, or Africa all have different issues, skills, and needs. It is becoming clearer that those challenges can only be addressed by working in broad coalitions. The pressure on public sector budgets was one of the impulses for the commercialization of the social sector and the emerging sector of social enterprises. Those new actors were an attractive alternative for foundations which were searching for more entrepreneurial organizations. Impact investors are also considering impact investments as an attractive alternative. Individuals are also increasingly interested in financial assets which support a social mission. 1.1.1

Social Enterprises

Social entrepreneurship aims to solve social issues and societal problems by applying business techniques. The visible success of the social enterprises supported and promoted by fellowship associations such as the Skoll Foundation, Ashoka, or the Schwab Foundation for Social Entrepreneurship has helped social entrepreneurship to gain a prominent role in policy debates and to become an investment focus for foundations and venture philanthropy funds. Social entrepreneurship is the process from identifying opportunities to exploiting them (Grichnik 2006; Austin et al. 2006), while the social entrepreneur is the person driving this change (Dees 1998; Martin and Osberg 2007). The social enterprise is the organizational form to deliver those services and products (Defourny and Nyssens 2008; Alter 2006). Universities have adapted their curricula to help students better understand the economics and mechanisms of the sector. Incubators and investment-readiness programs help aspiring entrepreneurs start their business.

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3

Often these solutions find their way to the more traditional sectors. Many disruptive innovations have been developed in the social sector and many technologies are diffused with the help of social sector organizations. Social technologies can be understood as methods to organize society. Different development phases of social business models can be observed. The first business models were built around ethical sourcing which included organic agriculture, the pursuit of fair-trade principles, a reduction of harmful behavior in the supply chains, and a focus on the recruitment of disadvantaged groups. Examples can be found in the fair-trade business or ethical fashion. The second group of business models tried to establish a more direct relationship with the target group of beneficiaries. Toms Shoes pioneered the “one for one concept”. Whenever a shoe is sold an additional show is given to an impoverished child in a developing country. The model was even expanded and now includes eyewear, coffee, and bags. Other companies are following this approach and have included this giving policy in their company. The third group of business models attempts to achieve a much more direct social impact and tries to create a business model around the social problem. Landfill sites in developing countries are now the source and inspiration to produce handbags or jewelry. Those concepts are labeled “waste couture” or upcycling. The circular economy also needs those business models (Ellen McArthur Foundation 2013). Blind, autistic, or street children are no longer seen as a burden, but social entrepreneurs developing new social business models increasingly see their special abilities which gives them a superior productivity for certain tasks such as software testing. In the last years we have seen new business models built around new technologies. Social enterprises are integrating artificial intelligence or blockchain technology in their offerings. Examples can be found in agriculture, healthcare, renewable energy, or inclusive finance (Spiess-Knafl 2022). 1.1.2

Societal Challenges and Changes in the Social Sector

At the same time, there was a shift in the societal challenges. Migration flows will continue to dominate headlines and growing ethnic diversity of societies leads to the necessity to develop different and multiple programs.

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Collier (2014) even speculates about an accelerating pace of international migration. At the same time, societies are continuing to age and thus increasing the pressure to develop new elderly care systems. Climate change is also happening and needs new international approaches and also new funding mechanisms. Those are just a few examples of changing societal challenges which also illustrate that not only the government or public agencies can solve them. There needs to be a rather large coalition of actors which can work together. A parallel trend is the pressure on public budgets which leads to budget cuts for social sector organizations and the need to identify new and additional funding sources. Previously, this led to the situation that nonprofit organizations had to identify additional income streams. Museums started to develop museum shops or host events and hospitals started to offer additional services. Weisbrod (2000) covered it as the commercial transformation of the social sector. The pressure was supplemented by a widespread introduction of business techniques and management studies. The public authorities also started to use benchmark studies to better control and regulate price schemes. Although, it is often considered to be controversial (e.g., Weisbrod 2004; Edwards 2008) the impact of new approaches is significant and tangible. Different societal challenges and the commercialization of the social sector were supplemented by a development for hybridization. Thirty years ago, there was a clearer distinction between markets, governments, and the third sector. Each sector was responsible for a certain set of tasks and had a very distinct rationale and way of acting. The development of new approaches which are often referred to as hybrid organizations is one of the more significant changes (e.g., Pache and Santos 2013). Those hybrid organizations are an important organizational form in the emerging field of impact investing. Moreover, mainstream companies feel the need to adopt their business model to follow social objectives. There is pressure from employees, customers as well as the media. That is one of the reasons why companies are buying ethical, fair trade, or social enterprises to protect their business model and help them to innovate.

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Capital Providers

The next years will see significant wealth transfers to a generation often called millennials. They place higher values on corporate social responsibility and are also more interested in impact investing as they are more concerned about societal and environmental issues. Moreover, the tech and finance industry will continue to create self-made billionaires who are interested in applying the same business techniques in financing social causes they support. Historically, social sector organizations were funded through donations. Although they remain a very important currency, new financing techniques have been applied to the social sector. Foundations have found interest in applying the venture capital approach to the funding of social sector organizations. This resulted in the development of a field called venture philanthropy. Instead of providing small grants to many different organizations this approach takes a more active approach funding only selected social sector organization. Individuals have also developed interest in impact investing. Nowadays, negative and positive screening when investing in the public equity and bond market is the main vehicle. Some new platforms are working on ways to open the market for private investments. That also made it interesting for banks as they want to satisfy the customers’ demand for social investments. Additionally, institutional investors such as pension funds or insurance companies are investing and providing capital to impact investment funds. Impact investments can offer attractive returns and the returns are uncorrelated to the equity market. That makes impact investing an alternative once the volumes are increasing. Governments are also increasingly interested in providing funding to social sector organizations (Cohen 2011). Examples are social impact bonds and funding programs for the social capital market of the creation of dedicated offices.

1.2

Impact Investing

Solar energy and primary education in rural Africa or work integration and social infrastructure in Western Europe are all areas where additional funding could facilitate social impact. The big issues are often underfunded.

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Table 1.1 Potential invested capital to fund selected BoP businesses over the next 10 years

Sector

Potential invested capital required in USD bn

Housing: Affordable urban housing Water: Clean water for rural communities Health: Maternal health Education: Primary education Financial Services: Microfinance

$214–$786 $5.4–$13 $0.4–$2 $4.8–$10 $176

Source O’Donohue et al. (2010)

In an early study, O’Donohue et al. (2010) estimated the capital needed to scale Bottom of the Pyramid business models across developing countries. Housing is the largest sector in terms of capital requirements. Housing is usually an attractive sector as cash flows are predictable but depends on the availability of property rights. In this scenario the potential capital requirement ranges between 214 and 786 billion US dollars. Other sectors are water, health, education, and microfinance (Table 1.1). The field of microfinance was developing rapidly over the last years. The Nobel Peace Prize awarded to Muhammad Yunus and the Grameen Bank showed that social and financial targets do not need to be mutually exclusive. The success of microfinance has developed over 30 years. Interestingly, those microfinance institutions are mainstream institutions nowadays but have often started as non-profit organizations. In 2022, these numbers have become much larger. The International Finance Corporation (2022) estimates $5–7 trillion/year of financing is needed to achieve the SDGs. Public and philanthropic sources which are traditional sources of funding are not sufficiently large to cover these investment needs. Impact investing has its roots in the search of foundations to better invest and utilize its capital. While capital was previously allocated to a wide range of projects it was targeted toward projects with potential for social impact. This approach is also interesting to other capital owners. Impact investing also needs to be differentiated from other approaches. In this chapter, we differentiate between social finance, socially responsibly investment, and impact investments which are often complementary.

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Impact investing is the art of investing with an intended social impact while also achieving a positive financial return. Grant giving can be a complementary strategy to impact investing. Grants can be provided to organizations in the start-up stage or in the form of hybrid financing structure. Socially responsible investing (SRI) is focused on public investing and the selection of publicly traded stocks and bonds which are in line with the values of the investor. Impact investing also needs to be differentiated from corporate social responsibility (CSR). Corporate social responsibility are corporate strategies to reduce the negative externalities created by a company or even create positive externalities. Those differences are shown in Table 1.2. There are also the global development goals of the United Nations. They cover, for example, poverty, hunger, food security and nutrition, education, gender equality, access to water and energy, or the conversation of natural ecosystems (United Nations 2015). They show that almost all the 17 development goals can be supported with the use of impact investments. Table 1.2 Forms of creation of social impact Socially responsible Impact investing (SRI) investing

Corporate social responsibility (CSR)

Grant giving

Description

Public investing

Corporate strategies

Form

Selection of publicly traded stocks and bonds

Foundational strategies Grants provided to non-profit organizations

Social impact

Indirect form of social impact through allocation of capital

Source Own illustration

Private investing Funding of companies focused on creating social impact Direct form through the funding of selected companies

Cooperation with actors of the social sector, supporting social initiatives Direct and indirect

Direct form of funding

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1.3

Outline of the Book

The first chapter gave an impression of the context and drivers of impact investing. The book has five different chapters. The second chapter looks at the underlying basics. There are different forms to address societal challenges. Social entrepreneurship is one of the most promising form as it combines social and entrepreneurial thinking. This chapter defines social entrepreneurship and discusses the definitions found in the literature. It also differentiates social entrepreneurship from other forms of providing social services and analyzes different scaling strategies. Those social enterprises can use different social business model innovations and six different strategies are discussed to provide insights into the operations of social enterprises. Social problems are the underlying fields where social enterprises are active. There are different approaches to discuss social problems which are presented. The sustainable development goals (SDGs) are presented as a best practice approach when it comes to classifying social problems. Child labor will be used as a case study for a concrete social problem with 168 million children working globally. It will discuss the drivers, the fields, and possible solutions. The third chapter covers impact investing. It will introduce the topic and discuss the rationales of investors to allocate part of their resources to impact investing. Those rationales are different for the different groups of investors who are contributing to the capital in the impact investing market. There are different theoretical approaches to understand investment decisions. One key consideration is the interplay between financial and social return requirements. Financial performances are easily quantifiable in the form of EBIT, EBITDA, net profits, or revenues. Social goals are another topic and social impact assessment will be covered in the sixth chapter. Both goals are interdependent and trade-offs can occur when capital providers with different return expectations are involved in the financing of a social enterprise. Some aspects of the social sector are also applicable in this field. Public sector funding usually comes with restrictions and has an impact on the financing structure of the organization. Similar restrictions can be observed for the different income streams. Crowding-out occurs when donors and public authorities support an organization.

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The fourth chapter covers the market for impact investing. Interestingly, the market is made up of various actors. The actors are networks, social investment advisors, social venture capital funds, ethical banks, and crowdfunding platforms. Each actor will be described and his role analyzed. This chapter also analyzes the mechanisms available for impact investors. Socially responsible investments are a popular approach for investors in the public equity or bond market. Pay for success models are increasingly rolled out and social impact bonds are the one form that is used extensively. This chapter will also cover guarantee schemes and public subsidies as they are important components in this sector. The fifth chapter takes a look at the financing instruments and transactions in the space for impact investments. This chapter will discuss the various financing instruments available to fund social sector organizations. Equity capital and debt capital are well-known examples. However, in this field there are also transactions based on mezzanine capital, recoverable grants, forgivable loans, convertible grants, revenue share agreements, or grants. There also questions about which social enterprises are being financed. This chapter also takes a closer look at a sample of 342 transactions and shows the transaction sizes and the use of financing instruments. Interestingly, the characteristics of the investee also have an influence on the financing structures. This chapter closes with an analysis of exits and the technical aspects of the fund industry. Investors need to have an exit option for their investments to recover their investment. It will take a look at exits in the ethical products space and also at acquisitions of social enterprises globally. Exit considerations are driven by the structures of the funds and the return requirements of those who provide capital for investing. The sixth chapter covers social impact assessment. Social impact assessment is an inherent part of impact investing, the intentional social change an investment is seeking being a prerequisite for every transaction. The chapter thus introduces the concept of social impact by illustrating the most important terms. Furthermore, the purposes as well as advantages when aiming for determining social impact are being discussed. The seventh chapter explains the process of developing an impact policy and impact guidelines which are necessary to follow a consistent strategy. Assessment tools and methodologies offer a much-needed framework for choosing an adequate evaluation method. Furthermore,

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a summary of the most widely used social impact assessment methods is given as well as an introduction to data collection methods and indicators. The chapter concludes with an outlook on emerging approaches in terms of efficient data collection and the use of mobile technology in impact assessment.

Bibliography Alter, Sutia K. 2006. Social Enterprise Models and Their Mission and Money Relationships. Social Entrepreneurship: New Models of Sustainable Social Change 28: 205–232. Austin, James, Howard Stevenson, and Jane Wei-Skillern. 2006. Social and Commercial Entrepreneurship: Same, Different, or Both? Entrepreneurship Theory and Practice 30 (1): 1–22. Cohen, Ronald. 2011. Harnessing Social Entrepreneurship and Investment to Bridge the Social Divide. EU Conference on the Social Economy, November 18. Collier, Paul. 2014. Exodus: Immigration and Multiculturalism in the 21st Century. London: Penguin. Dees, J. Gregory. 1998. The Meaning of ‘Social Entrepreneurship.’ http://www. redalmarza.cl/ing/pdf/TheMeaningofsocialEntrepreneurship.pdf. Defourny, Jacques, and Marthe Nyssens. 2008. Social Enterprise in Europe: Recent Trends and Developments. Social Enterprise Journal 4 (3): 202–228. Edwards, Michael. 2008. Just Another Emperor? The Myths and Realities of Philanthrocapitalism, 1. Aufl. London (UK): Demos. Ellen McArthur Foundation. 2013. Towards the Circular Economy. Cowes: Ellen MacArthur Foundation. Friedman, Milton. 1970. The Social Responsibility of Business Is to Increase Its Profits. New York Times Magazine, September. Grichnik, Dietmar. 2006. Die Opportunity Map Der Internationalen Entrepreneurshipforschung: Zum Kern Des Interdisziplinären Forschungsprogramms. Zeitschrift Für Betriebswirtschaft 76 (12): 1303–1333. Hart, Oliver, and Luigi Zingales. 2017. Companies Should Maximize Shareholder Welfare Not Market Value. ECGI-Finance Working Paper, No. 521. International Finance Corporation. 2022. Impact Investing at IFC. https:// www.ifc.org/wps/wcm/connect/Topics_Ext_Content/IFC_External_Cor porate_Site/Development+Impact/Principles/Impact-investing. Martin, Roger L., and Sally Osberg. 2007. Social Entrepreneurship: The Case for Definition. Stanford Social Innovation Review 5 (2): 28–39.

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O’Donohue, N., C. Leijonhufvud, Y. Saltuk, A. Bugg-Levine, and M. Brandenburg. 2010. Impact Investments: An Emerging Asset Class. New York: JP Morgan. Pache, Anne-Claire, and Filipe Santos. 2013. Inside the Hybrid Organization: Selective Coupling as a Response to Competing Institutional Logics. Academy of Management Journal 56 (4): 972–1001. Spiess-Knafl, Wolfgang. 2022. Artificial Intelligence and Blockchain for Social Impact: Social Business Models and Impact Finance. New York, NY: Taylor & Francis Ltd. United Nations. 2015. Sustainable Development Goals. http://www.un.org/sus tainabledevelopment/sustainable-development-goals/. Weisbrod, Burton A. 2000. To Profit or Not to Profit: The Commercial Transformation of the Nonprofit Sector. Cambridge: Cambridge University Press. ———. 2004. The Pitfalls of Profits. http://papers.ssrn.com/sol3/papers.cfm? abstract_id=1850719.

CHAPTER 2

Social Entrepreneurship

Impact investing is the process of funding social innovations. This process needs investees to absorb the capital. These investees are often social enterprises or social businesses. These terms are often used interchangeably but social enterprises are usually younger companies led by a social entrepreneur whereas a social business is more established and led by managers. The concept of social entrepreneurship has been used in scientific research since the late 1980s. At that time, a retreat of the state from financing social services was observed and brought non-profit organizations under pressure to consider new revenue opportunities and business models. This also explains the development of social entrepreneurship through the pursuit of non-profit organizations for additional sources of income. In Western Europe, the time was also marked by high unemployment. For this reason, work integration initiatives were the starting point for social enterprises in Europe (Hoogendoorn et al. 2010).

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 W. Spiess-Knafl and B. Scheck, Impact Investing, Palgrave Studies in Impact Finance, https://doi.org/10.1007/978-3-031-32183-2_2

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2.1

Social Entrepreneurship at the Core 2.1.1

Introduction

Social entrepreneurship is an old phenomenon. In a European context, reference is often made to Friedrich Wilhelm Raiffeisen as an early social entrepreneur. Raiffeisen created favorable financing options for farmers and is considered to be the founder of the cooperative movement. He is also regarded as an inspirational model for the development of modern microfinancing institutions. Another prominent example is Florence Nightingale who was a driving force behind the changes in how to care for patients. There are many factors which contributed to the growth of social entrepreneurship. Some authors point to globalization, individual wealth accumulation, or more transparency when it comes to the understanding of social problems (e.g., Beckmann 2011). The concept of social entrepreneurship was characterized in particular by Bill Drayton, the founder of the fellowship organization Ashoka (Drayton and MacDonald 1993). There have been long debates on the definitions of social entrepreneurship (Danko et al. 2011). What they all have in common is the recognition that social enterprises pursue the goal of solving or alleviating social problems, using entrepreneurial means. However, both conceptual components “social” and “entrepreneurial” which describe the core elements of this specific company form are complex to define. Social is often used in a self-referential manner and entrepreneurial is a process which is complicated to operationalize. There are basically two different schools of thought for social entrepreneurship (Dees and Anderson 2006). One school of thought is termed the Social Innovation School and the other one the Social Enterprise School. As the name suggests, the first school of thought focuses on the social innovation while the second school of thought is building its thinking on the income generation of the social enterprise. In practice, every income generation model needs some form of innovation while innovation is hardly sustainable without any form of income generation. The Social Enterprise School was conceived in the 1980s. It was driven by the fact that nonprofit organizations had to identify additional sources of income supplementing donations and declining public funds. Nonprofit organizations were especially looking for revenue from businesses that were not directly related to the primary social objective. Examples

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such as fitness centers operated by hospitals, the renting of museum space for company events, or the sale of advertising products in independent trade journals were discussed in the literature.1 Within the social innovation school, it is often stressed that social enterprises are the experimental laboratory of society and they develop important innovations for the benefit of society. A task that is regularly attributed to social enterprises is the identification of social problems and the development of viable solutions. In this school of thought social enterprises focus more on the strengths of the target group in an empowerment approach. These two schools of thought, however, have their limitations and the boundaries between these two schools of thought are blurring. At this intersection new challenges arise due to requirements, expectations, and different logics of action (Battilana et al. 2012). 2.1.2

Defining Social Entrepreneurship

Conceptual Challenges It is obvious that the definition of social entrepreneurship is difficult. Social enterprises cover a wide range of topics. Some try to protect rainforests, some tackle homelessness while still others try to reduce inequality. Additionally, social enterprises are not restricted by legal forms, as opposed to non-profit organizations. This makes the definition and understanding of the work of social enterprises more difficult. However, there are a couple of definitions which are increasingly being accepted. The aspects of social innovation and the establishment of a business model with income generation characterize the scientific debate. In the scientific discussion, there is also a consensus to accept social enterprises which rely mainly on donations as they have no access to government funds or serve a target group without sufficient financial resources. These include social enterprises that raise awareness of a social problem in the public sphere and cannot resort to any income model. Social innovation is a recurring theme in this area. Social innovations can be clustered in several categories. Rüede and Lurtz (2012) identify

1 Defourny and Nyssens (2010) about the “Earned Income School of Thought” because it uses the term “social enterprise” exclusively for social enterprises with income generation.

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seven categories. They are focused on (1) human well-being in societies, (2) social practices, (3) human-centered community development, (4) work organization, (5) non-technological aspects of innovation, (6) social work provision, and (7) innovations in a digital world setting. Social enterprises are usually working on a combination of those trying to achieve very different aims. They combine digital business models with the general human well-being. In the following some definitions will be discussed. G. J. Dees (1998) defines social entrepreneurs in an idealized definition as change agents by creating social value, always exploiting new business opportunities, engaging in a continuous process of innovation while acting boldly without being restricted by the currently existing resources. Additionally, they exhibit a high degree of accountability toward their stakeholders. Accountability is a criticism often heard in the non-profit sector. Nonprofit organizations receive funding from public authorities and donors but often lack the necessary transparency (e.g., Greenlee et al. 2007). Most definitions, however, impose more stringent conditions on social enterprises, since not only the goal, but also the path of goal-fulfillment should be social. This includes fair pay, efficient management structures, and transparent governance structures. Often it can be difficult to reconcile with the breaking up of social structures.2 An interesting aspect of a definition is formulated by Leadbeater (1997). Social entrepreneurs are understood as people who use underutilized resources such as buildings, equipment, or human resources to solve social problems. Austin et al. (2006) define social entrepreneurship as an innovative activity that creates social value and can take place in the non-profit sector, for-profit sector, or the public sector. With this relatively broad definition they reflect the fact that not the private benefit but the social value added is a crucial element of the definition. Another definition is provided by Zahra et al. (2009). They argue that social entrepreneurship includes the entrepreneurial process from the discovery to the exploitation of an opportunity to create social wealth. New companies can either be created or the processes of existing organizations can be changed. Total wealth is the sum of economic and social wealth.

2 Interestingly, prominent social leaders often have to face criminal charges as they challenge the status quo.

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Rather unsurprisingly, those definitions are often hard to operationalize and one of the more practical definitions was developed by the European Commission within their funding programs for social enterprises (Official Journal of the European Union 2013). It states that social enterprises have a primary objective of achieving measurable and positive social impact by providing goods or services which generate a social return or employing a method of production which meets the social objective. Additionally, the definition states that the profits are used primarily for the social goal and the organization is managed in an entrepreneurial, accountable, and transparent way. Legal Forms of Social Enterprises Every legal form is suitable to create social impact. Social enterprises can choose non-profit and for-profit legal forms or combinations thereof. Globally, there are a few legal structures which incorporate the dual mission of social enterprises. Social enterprises follow a social mission but need to consider financial returns as well. Those legal forms aim at helping to safeguard the company’s mission in the long term and give certainty to the company’s directors when it comes to the integration of non-financial criteria in decision-making processes. Community interest companies (CIC) are popular in the United Kingdom. They are designed for enterprises which have a social goal as primary objective and reinvest the surpluses they generate in the business or the community. Many countries have introduced legal structures or labels for social enterprises (Borzaga et al. 2020). Examples include benefit corporations in the United States, Verified Social Enterprise in Austria, or the Société Coopérative d’Intérêt Collectif in France, among others. In practice, social enterprises often use a system where a non-profit entity owns the for-profit entity or where a non-profit entity and the forprofit entity follow similar goals. In recent years there was a trend toward associations and cooperatives as they are suitable legal forms. 2.1.3

Differentiation from Other Actors

Social services and goods are provided by different actors which all have a different role. Santos (2012) proposed a classification according to the distinct role in the economic system, the dominant institutional goal, and the dominant logic of action.

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The actors are governments, businesses, charities, commercial enterprises, social activists, and social enterprises and they follow different goals. One important aspect of the economic system is negative externalities. Negative externalities arise when others must cope with the results of a specific action. In most cases, negative externalities are dealt with by the government. They can regulate, mandate, or tax. Examples where the government is taking a role include pollution, drug use, or waste recycling. Social activists also play a leading role in reducing negative externalities. The shaming strategy of social activists often works well and is often exemplified by Greenpeace or Attac. Companies targeted by social activists include Nestle, Wal-Mart, Timberland, or Neumann. It is often focused on labor-related issues in the supply chain such as sweat shops in South-East Asia in the fashion industry.3 There is also the question of who creates positive externalities. In a positive theory of social entrepreneurship (Santos 2012) sees social enterprises as those actors who are working on the creation of positive externalities. The difference between social and commercial entrepreneurship lies in the role of value appropriation and value creation. While commercial enterprises focus on the creation of financial returns, social enterprises focus more on the creation of social return. Both see opportunities and build business models around it. Charities are more redistributing organizations with their focus on grant-based strategies. Table 2.1 shows the distinct role, the dominant institutional goal, and the dominant logic of action. Some actors can take a double role. Social entrepreneurship can be combined with social activism and can also often be observed in the field. Corporate Social Responsibility (CSR) is another form of creating social impact.4 The reduction of negative externalities is often seen as the purpose of corporate social responsibility initiatives. Corporate social responsibility departments are trying to reduce damaging effects for

3 Interestingly, family firms were also found to pollute less than their peers (Berrone et al. 2010). 4 There are different streams. Collective Impact was first discussed by Kania and Mark R. Kramer (2011) and Shared Value by Porter and Kramer (2011).

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Table 2.1 Institutional actors Actors

Distinct role in economic system

Dominant institutional goal

Dominant logic of action

Governments

Centralized mechanism through which the infrastructure of the economic system is created and enforced Distributed mechanism through which society’s resources and skills are allocated to the most valued activities Distributed mechanism through which economic outcomes are made more equitable despite uneven resource endowments Distributed mechanism through which neglected opportunities for profits are explored Distributed mechanism through which behaviors that bring negative externalities are selected out Distributed mechanism through which neglected positive externalities are internalized in the economic system

Defend Public interest

Regulation

Create sustainable advantage

Control

Support disadvantaged populations

Goodwill

Business

Charity

Commercial entrepreneurship

Social activism

Social entrepreneurship

Appropriate value Innovation for stakeholders

Change social system

Political action

Deliver sustainable solution

Empowerment

Source Santos (2012)

instance by improving working conditions and environmental protection systems to reduce itself. There are three principles of corporate social responsibility formulated by Wood (1991). The principle of legitimacy states that society grants legitimacy and power to business. Those companies who do not use this principle responsibly will lose it. There is also the principle of public responsibility which states that companies are responsible for the results of their activities. The third principle focuses on managerial discretions. Managers are more actors and they have flexibility to

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exercise discretionary measures to take decisions in the service of their responsibility. The ownership structure is yet another distinguishing criterion. The ownership structure can also have an influence on the decisions taken by the company. Family companies pollute less than comparable companies which is probably driven by the desires of the owning family (Berrone et al. 2010). Non-profit organizations have no owners and the organizations are usually controlled by the management or a board of directors. In the case of for-profit companies, the owners are much more aware of their control and voting rights. Social enterprises often have an ownership and governance structure and are increasingly viewed as being accountable to their stakeholders (Achleitner et al. 2012). Another difference between for-profit companies and non-profit organizations lies in a different type of competition. For-profit companies often compete on price or product characteristics. Non-profit organizations often compete on criteria such as reputation, quality of service, or the ability to meet the needs of the target group. For non-profit organizations, it is often about the quality of the service or the access to traditional media and social media in order to propagate their own mission accordingly (Tuckman 1998). Some authors also focus on market failure to explain the role of non-profit organizations (Steinberg 2003). Another difference lies in the form of the services provided. Basic social services are usually regulated by public authorities in developed countries. This regulation includes the amount of remuneration as well as quality levels. Examples include hospitals, nursing homes, or emergency services.5 Additionally, non-profit organizations carry out tasks for alleviating social problems which can be explained by their religious or social roots. Another area of activity could be the change of social conventions or codified rules perceive is another activity that social enterprises and social activists. In this context, the extended rights of homosexuals or the change of ideas about life of blind persons can be mentioned.

5 Over time the conditions for profit-oriented companies may become attractive.

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Scaling Strategies

Most services of social enterprises are based on the provision of services. The development of technology-intensive products is not yet widespread among social enterprises. Scaling strategies are therefore difficult to implement. Moreover, brands are usually not well-known and products are rarely patentable. The number of large non-profit organizations can be taken as an evidence. Although more than 200,000 non-profit organizations have been established in the United States since 1970, only 144 of these non-profit organizations have achieved more than $50 million in annual revenue (Foster and Fine 2007). The focus on low-technology and personnel-intensive services also explains the difficulty of realizing productivity gains. Productivity gains are generated by additional capital or additional equipment per employee, improved technologies, improved employee skills, better management, and scale effects. In areas such as the elderly or youth work, where human contact is a big part of the service, productivity gains are difficult to accomplish (e.g., Heilbrun 2003). Nevertheless, there are areas in which non-profit organizations need a larger organizational size. International disaster relief organizations need a correspondingly dimensioned infrastructure to be able to react promptly in case of need. In general, social enterprises are not as focused on scaling as traditional enterprises. Some social enterprises focus more on the scaling of their impact than on the scaling of the organization itself (Heinecke and Mayer 2012). Surprisingly, only a few bankruptcies are known to the authors. This is probably driven by low external financing volumes and the associated low risk of over-indebtedness. In addition, it should be possible to continue the social mission on a reduced scale with volunteers. The growth strategies differ according to the degree of control over the business model and the speed of the scaling. Table 2.2 shows different growth strategies based on the speed of scaling and the degree of control of the business model. The four different categories are (1) Networkers, (2) Blueprinters, (3) Localizers, and (4) Scalers. Networkers can either use closed or open structures. Closed structures are social franchise strategies. Social franchise models are comparable to those models developed by fast food chains and give partners a consistent set of criteria to reach (Tracey and Jarvis 2007). Open structures are open

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Table 2.2 Growth strategies Speed of scaling

Control of the business model

Low High

Low

High

Networker Localizers

Blueprinters Scalers

Source Spiess-Knafl and Jansen (2014)

access models where the idea is provided without any costs and partners can decide on how to adapt the idea. There are many concepts which cannot be protected such as new ways to work with disabled persons or. Those models are cost-effective as it involves other organizations to reach more people. Depending on the structure of the network they have differing degrees of control over the business model. The open access limits the available cash flows while social franchise models with regular payments are attractive for investors. Developers show the effectiveness of a concept at a location and pass on their best practice example to interested imitators. These development solutions can also be called “blueprint”. They can only control their business model to a small extent, but they enable a higher spreading speed. Through the open source approach, developers will be more dependent on philanthropic contributions such as donations or contributions to foundations. Localizers use a different approach than developers. They bring existing concepts into their local environment and make use of existing contacts and infrastructure for the dissemination of social services. They thus remain in control of the business model, but can only implement it locally. As a result, all possibilities for financing as well as possible internal cross-financing are available to localizers. Social enterprises are often selling their products and services in solidarity markets. They are effectively intermediaries who mobilize and distribute resources under solidarity. These solidarity markets work best in a local environment and may be difficult to scale. Scalers have developed a business model that enables them to scale their business model with high speed and a high degree of control over the business model. Digital components, which significantly reduce the marginal costs of the service provision, are particularly supportive. In

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general, digital social business models are characterized by the fact that the respective platform can be used for any number of activities. Due to the high degree of control over the business model, this growth strategy is also attractive for investors with a yield claim.

2.2

Social Business Model Innovation

The business model can be labeled as the operating system of a social enterprise. Business models are a system of activities and relationships to offer products and services (Chesbrough and Rosenbloom 2002). It describes the way firms do business and involves revenue and cost structures, value propositions, customer segments, and target markets (Spiess-Knafl et al. 2015). Those business models have been under increasing pressure to innovate themselves. Digitalization, automatization, new technological advances, and political pressures have led to the need to think about business model innovation. It can thus be seen as a reaction to changes in the company’s environment (Demil and Lecocq 2010). Examples are widespread. Consumers are more aware of failures in the supply chain, disintermediation disrupts many industries and digitalization creates new markets. Digital business models are increasingly being found among social enterprises. They have some attractive components and can be used to organize resources more efficiently.6 Digital goods are nonrival, infinitely expansible, discrete, aspatial, and recombinant (Quah 2002). Ushahidi is one example how digital technology can be used for the common good. The company is offering crowd-based election monitoring, crisis response after crisis collecting reports through SMS, email, web app, and Twitter. The company also reports on critical human rights situations. Berlin-based Abgeordnetenwatch is a platform which tracks and monitors representatives in parliaments. Finance is another area where the customers can benefit from the digitalization. London-based Fair Finance is one example. They publish data and maps on all loans made and are especially an alternative to payday or cash lenders.

6 There are many applications where digital business models can contribute to the solution. The allocation of food, volunteering time, or donations are examples.

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Table 2.3 Categories of social business model innovation Type of innovation

Description

Opportunity creation

Creation of new entrepreneurial opportunities for the target group Development of distribution channels to reach customers Combination of initiatives to change an existing ecosystem or create a new ecosystem Identification of underutilized resources to support the provision of the service Use of pricing innovations to facilitate the consumption of the services Inclusion of disabled persons or persons with special skills in the production process

Smart distribution Ecosystem engineering Cheap sourcing Smart pricing Inclusive production

Source Spiess-Knafl et al. (2015)

Six different types of social business model innovation can be classified (Spiess-Knafl et al. 2015). An overview of these categories is provided in Table 2.3. 2.2.1

Opportunity Creation

The first category focuses on the opportunity creation through business models which enable the target group to become entrepreneurial themselves. Some social enterprises are creating additional sales channels for African artisanal designers and thereby giving them additional income opportunities. Other examples are water or sanitary business models in developing countries which provide different micro-entrepreneurial opportunities including maintenance, repair, and distribution. Various crowd-based platforms are also giving micro-tasks to individuals. 2.2.2

Smart Distribution

One of the problems social enterprises are often facing is that the target group is often hard to reach and thus increasing transaction costs. Examples are farmers in rural Africa, homeless in North America, or microcredit borrowers in Bangladesh. Especially, in developing countries the infrastructure is often lacking (Mair et al. 2012). Social enterprises in this category have created a business model which succeeded in overcoming the costs of distributing the products and goods. One well-known and

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interesting example for an intersectoral partnership is colafife which uses the infrastructure of a beverage company to transport pharmaceutical products. 2.2.3

Ecosystem Engineering

Ski resorts or sports leagues are interesting examples for ecosystems as all participants benefit from the success of others. There are many other ecosystems which profit from common initiatives and social enterprises are valuable organizations to orchestrate the development of these ecosystems. Examples are rainforest initiatives which bring together hotels, tour operators, and biodiversity conservation projects. In general, agricultural projects often need the interplay of various organizations to be successful and orchestrating organizations which are trustworthy to the partners. Problems can occur in the distribution of profits and how strategic decisions are taken. 2.2.4

Cheap Sourcing

The customers are often not able to pay the full price for the services and goods provided. One way to reduce the costs of the business is to develop cost-effective sourcing strategies. Social enterprises are often able to access in-kind contributions, donations, or other philanthropic capital which might help to reduce the costs. Leadbeater (1997) sees it even as one strength of social entrepreneurs in the ability to identify underutilized resources. Volunteering is another form to help in the provision of social services and can be substantial (Linardi and McConnell 2011; Preston 2007). These business models are summarized as cheap sourcing. Examples are social enterprises which target highly qualified volunteers to do work on data-related issues or use waste materials to produce bags or jewelry. 2.2.5

Smart Pricing

Another way to reduce the costs for the target group is the use of smartpricing strategies. Social sector organizations often have the challenge to find allocation models to distribute their services. Some are price-based mechanisms while others are based on waiting lists or selection criteria.

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The basis for the trust in the internal decision-making processes of social enterprises as they are more trusted to work for the common good. Social enterprises can use different models such as the pay-per-use model which benefits those who use it only in a limited way or the paywhat-you-want model which relies on the honesty of the customers. It can often be observed in cultural events. Social control also contributes to the functioning of those models. Social enterprises also use cross-subsidization models in which one group pays higher prices to support the consumption of another group. 2.2.6

Inclusive Production

The last category is inclusive production. Social enterprises often employ a form of production which is social through the inclusion of disadvantaged people (Arora and Ali Kazmi 2012). Some organizations employ disabled or long-term unemployed persons and build a production and marketing strategy around it. Those business models often command premium prices. Specialisterne coordinates the work of people with autism to work in IT companies. Blind people are often employed in specific jobs. Those concepts also need special working conditions as the target group has specific needs.

2.3

Thematic Areas for Impact Investing 2.3.1

Introduction

The overall objective of impact investing is to solve social problems. Social problems are complex and some are solved by good policies, some are solved through volunteering work, and some are solved by grants from traditions and donors. Some of the key problems to work against include youth employment and long-term unemployment, poverty and social exclusion, inequality between women and men, inadequate and decent social protection, and discrimination based on sex, racial or ethnic origin, religion or belief, disability, age, or sexual orientation. There are also other ways to think about social problems. The first perspective is from a development point of view as social problems

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develop over time. A small group of people start noticing social problems and then academics or niche media publications will start to cover it. Afterwards, it reaches mass media and political actors will get involved (e.g., Hilgartner and Bosk 1988; Schetsche 1996). This chronological approach helps to understand the process behind certain social problems. In the case of the deforestation of the rain forest, HIV, or child labor the awareness was often created by activists. Greenpeace is an important example which illustrates the importance of raising awareness at the beginning. After the public is aware of the problem, other actors can become active and build business models around the solution of the social problem. It can become mainstream. Another view is from a social sector perspective which helps to gather sector-specific knowledge. The International Classification of Nonprofit Organization is a valuable starting point. Another perspective is from a social problem perspective. Table 2.4 shows the two potential perspectives. 2.3.2

Sustainable Development Goals

Building upon the experience and lessons learned from the previous eight Millennium Development Goals (MDG) which expired at the end of 2015, the United Nations have set up 17 so-called Sustainable Development Goals (SDG). The SDGs constitute a global action plan consisting of goals, targets as well as indicators, focused on eliminating extreme poverty and hunger, fighting inequality, tackling climate change, and achieving sustainable development for everyone (Sachs 2012). The plan promotes a people-centered development agenda understanding that human prosperity, both social and economic, need to go hand-in-hand with protecting the planet. The SDGs constitute a complementary normative framework to the tools of international law, such as global treaties or conventions (Sustainable Development Solutions Network 2015). There are four underlying key principles of the SDGs that can be viewed as transformational in the way they perceive society could work on future development: The first principle is that these goals are universal, meaning they apply to all countries regardless of location, cultural background, or economic prosperity. The second principle is the integration of all aspects of sustainability, social, environmental as well as economic taking into account also their interlinkages. The third key pillar is inclusion, meaning that these goals should leave no one behind due to race,

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Table 2.4 Categories of non-profit organizations International classification of nonprofit organization

Social problems

Culture and recreation

Permanent or temporary physical disability Permanent or temporary psychological disability Poor housing situation/homelessness Severe threat to life/emergency aid Missing or insufficient mobility Language and linguistic skills Insufficient educational opportunities Insufficient opportunities for self-realization and realization of life plans Insufficient access to information and participation opportunities Insufficient structural access to art, natural experiences, positive interpersonal relationships Insufficient financial strength

Education and research Health Social services Environment Development and housing Law, advocacy and politics Philanthropic intermediaries and voluntarism promotion International Religion

Business and professional associations, unions Other

Insufficient ecological consciousness Isolation and insufficient sense of belonging Insufficient integration with the work environment Insufficient knowledge of civil rights

Source Salamon and Anheier (1996) and Scheuerle et al. (2015)

gender, physical ability, socio-economic status, religion, or location. The final principle relies on the participation of all, both on a national and global scale, and in the public, private, and third sectors (Sachs 2012; Sustainable Development Solutions Network 2015). This comprehensive collection of goals and their set-up is ambitious and at the same time comparatively well implementable. However, it also has some drawbacks. For example, the goals cannot, and should not be considered separately. Rather, the 17 SDGs are highly interconnected, there are synergies as well as trade-offs between different goals. Synergies are understood as the positive statistical relationship (correlation) between individual SDGs. Here, progress in one target promotes the achievement of other targets. Trade-offs are negative statistical correlations. In this

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case, progress in one target hinders the achievement of another target. There is still a lack of valid data regarding the relationship between some of the SDGs, but first statistical analyses on synergies and trade-offs within each SDG suggest that the number of synergies outweighs the trade-offs. However, it was also found that there are also significant negative correlations between different SDGs. Synergies can be identified, for example, for SDGs 1 (end poverty) and 3 (Ensure healthy lives and promote well-being). Achievement of targets in the area of these SDGs has a positive impact on almost all other SDGs. In contrast to these positive relationships, SDGs 8 (Promote inclusive and sustainable economic growth, employment, and decent work for all) and 9 (Build resilient infrastructure, promote sustainable industrialization, and foster innovation) are characterized by their high number of negative correlations. The achievement of these targets, as executed to date, has resulted in negative impacts on the achievement of other targets (Kroll et al. 2019). In addition, a certain hierarchy is inherent within the SDGs (Stockholm Resilience Centre 2017): Environmental SDGs and the biosphere represent the foundation for global sustainability and are considered foundational to all other goals (SDGs 6, 13, 14, 15) followed by the societal goals (SDGs 1, 2, 3, 4, 5, 11, 16) and lastly, the economic goals (SDGs 8, 9, 10, 12) all of jointly contributing to SDG 17 (“Revitalize the global partnership for sustainable development”). The SDGs are about to become a widely used framework for thinking about and categorizing social and environmental issues and can serve as a starting point for impact investing considerations (Global Impact Investing Network [GIIN] 2016). Goal 1: End poverty in all its forms everywhere Although the global poverty rate has been halved since 2000, the numbers are still alarming: an estimated 767 million people still lived below the international poverty line of $1.90 a day in 2013 and 18,000 children still die each day from poverty-related causes (United Nations 2017c). Poverty influences human decisions in a number of ways and often leads to seemingly irrational decisions (e.g., Banerjee and Duflo 2012). Poverty is a multi-faceted topic. Official statistics usually rely on income-oriented measures which are often declared to be incomplete or arbitrary, not taking into account relative poverty (e.g., Hagenaars and De

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Vos 1988). There are other more individual-based approaches, e.g., calculated on consumption, daily calories, or housing. The so-called capability approach, developed in the 1980s by Amartya Sen understands poverty as a deprivation of individuals’ capabilities in achieving the kind of lives they have reason to value (Nussbaum and Sen 1993; Sen 2005). However, income-oriented measures remain the most reliable and easiest to measure criteria. There are several solutions which impact investments could help to achieve. On the product side, for example, in the area of microfinance: Besides the more widely known microcredit products, micro-savings are an important topic: Karlan et al. (2014) see the following five factors which hinder the usage of savings products: (1) transaction costs, (2) lack of trust and regulatory barriers, (3) information and knowledge gaps, (4) social constraints as well as (5) behavioral biases. Those are all barriers which could be addressed by impact investments. Unsurprisingly, microfinance is a large area and there are many institutions which are ready to manage investments. Micro-insurance is another closely related field which could have similar effects on the clients. Besides health and life insurance, there are increasingly products for low-income farmers protecting them against loss of or damage to crops or livestock. Other investment possibilities are represented by projects that aim to change behavior patterns, e.g., better family planning or reducing expensive customary practices associated with weddings and funerals. The concept of addressing the market at the so-called bottom of the pyramid (BOP, Prahalad, 2006, 2012) focuses on addressing the poorest socio-economic group, i.e., the 2.7 billion people who live on less than $2.50 a day, with products or services that enable them to escape poverty. Not without critic, especially concerning the idea of perceiving beneficiaries as consumers, the concept provides large opportunity for impact investments created by BOP markets as a new source of radical innovation. Goal 2: End hunger, achieve food security and improved nutrition and promote sustainable agriculture According to figures from the United Nations (2017b), almost 800 million people worldwide are undernourished. Undernourishment leads to stunted growth which affects one in four of the world’s children. Being

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hungry also affects the capacity to pursue a job and earn a living. In order to be able to feed all human beings, the agriculture sector is a key player. As we will see in the following chapters, agriculture is one of the major investment topics for impact investors (Spiess-Knafl and Aschari-Lincoln 2015). Agriculture offers many investment opportunities and also offers the possibility to invest larger sizes in one transaction. The agriculture sector also employs 40% of today’s global population and accounts for 30% of greenhouse gas emissions. Impact investments in the agriculture sector address the following issues (Lang et al. 2017): – Sustainable production: • Crops, livestock, fisheries • animal welfare • timber and wood products – Sustainable consumption: • • • •

nutrition and healthy foods food safety Genetically modified crops Food waste

– Agricultural technology: • • • • •

Smart irrigation Biowaste Software and big data Green chemistry Digital precision

– Conservation and climate change • • • • •

Climate change mitigation and adaptation Deforestation Land care and soil health Water use Biodiversity

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– Social equity and sustainable livelihoods • • • • •

Fair trade Land grabs Workers’ rights and child labor Women farmers Food sovereignty.

Major investments aim to address the sector’s immense carbon footprint by focusing on an increase in efficiency of input factors such as water, energy, fertilizers, or pesticides or by aiming at decreasing wastage. Another field of significant social innovation is driven by the fact that farmers in rural areas of developing countries often lack access to data including information on crop yields, economic variables, or environmental data such as weather forecasts (Burwood-Taylor 2016). Goal 3: Ensure healthy lives and promote well-being for all at all ages The world has seen tremendous advances in the health sector over the last decades and medical advances have saved million lives. However, according to figures from the United Nations (2017a), more than six million children still die before their fifth birthday, maternal mortality ratio is 14 times higher in developing than in developed regions and HIV/AIDS, malaria, and other diseases remain widespread. Given the costs of healthcare it is one of the more challenging social problems to address. Vaccination, pharmaceutical products and research, medical personnel, and medical equipment are cost-intensive. Thus, a variety of social entrepreneurs have developed market-based solutions to health problems in emerging economies (Bafford and Gelfand 2016). Health-focused impact investments can be made in – Health care: prevention and health care services, such as health centers, training, or pharma. – Health coverage: payment vehicles such as niche health insurance companies.

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– Health community: reducing the need for health care, for example, with providers of physical activities, healthy delivery systems (Grantmakers in Health 2011)

Goal 4: Ensure inclusive and quality education for all and promote lifelong learning Education is the basis for economic development. Although access to education has increased dramatically over the past decade, globally, still 57 million children remain out of school and even when they go to school, poor quality education leads to the fact that 103 million youth lack basic literacy skills (United Nations 2015). However, providing quality education is a good field for impact investors. There is a willingness to pay for the education and the customers are easily identifiable. Opportunities for impact investors have proven to be successful when scaling successful models, tapping into the potential of edtech, investing in student financing. In terms of market-place building, the field can also be segmented in investment opportunities addressing – Infrastructure: mostly school buildings – People: loan programs, vocational training, teacher training – Technology: education software, back-office support for school chains – Ecosystem: strengthening the education sector, e.g., with rating programs (D. Capital Partners 2013).

Goal 5: Achieve gender equality and empower all women and girls Gender inequality remains an issue globally depriving women and girls of their basic rights and opportunities: at least 20% of women have experienced physical or sexual abuse in their life, child marriages still persist as well as female genital mutilation. Gender equality also affects differences in compensation, representation in national parliaments, and enrollment in schools. However, women’s empowerment is a prerequisite

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for building prosperous societies and it could be one of the transformative economic trends of our time (“Goal 5: Sustainable Development Knowledge Platform,” n.d., 5). Specific impact investments in this sector are still limited, the issue is usually addressed as a side effect in other areas (e.g., education). However, due to the huge potential social leverage, investors should consider the following areas of opportunity (LaRue 2017): – Microfinance institutions empowering women in developing countries, – Female networking organizations, – Women’s investing networks and organizations, – Funds focused on women-led startups.

Goal 6: Ensure access to water and sanitation for all There is enough fresh water available for every person. However, bad economics or poor infrastructure negatively impact water accessibility. Universal access to basic sanitation and ending the unsafe practice of open defecation are prerequisites to ensure health and access to freshwater for everyone. In addition, clean, plentiful water is essential for all other forms of life, too. Impact investments in this field either focus on the provision and distribution of clean water (“doing good”) or on preventing harm to water by addressing issues of pollution, land grab, or irresponsible extraction. For financial-first impact investors, companies that provide the operations, equipment, chemicals, and services that make water available for municipal, industrial, and agricultural markets worldwide could be interesting, e.g., in the area of water waste and utilities, infrastructure, or technology. Furthermore, a wide variety of organizational levels can be found in the sector, ranging from the seed to the maturation stage, even including publicly traded companies (Falci and Emerson, n.d.; Impax Asset Management 2013).

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Goal 7: Ensure access to affordable, reliable, sustainable and modern energy for all Access to affordable, reliable, sustainable, and modern energy is still not available for one in five people globally. And although there is already a range of alternative and sustainable energy forms available, almost 3 billion people still use wood, coal, charcoal, or animal fuel for cooking and heating which has severe health consequences. In addition, fossil fuels further global warming and thus climate change. Energy is a good source for impact investments. They enable a business model based on the consumption which can be monitored efficiently. The business model can also take advantage of cost savings for the user. Investments can be categorized as either taking place in the field of innovation of energy technologies or the deployment of clean energy solutions (Kearney et al. 2014). Goal 8: Promote inclusive and sustainable economic growth, employment, and decent work for all This SDG addresses the issue of labor productivity, unemployment, especially for young people, and access to financial services and benefits for all. For example, global unemployment amounted to 202 million as of 2012 while employment still does not guarantee an income above poverty levels. Impact investments are a good tool to address these issues as they aim to provide job opportunities with decent working conditions. Social enterprises in this field mostly either ensure employability or provide training or employment (Petrick 2013). Goal 9: Build resilient infrastructure, promote sustainable industrialization and foster innovation Globally, there is still a lack of functioning basic infrastructure such as roads, information and communication technologies, electricity grids, or sanitation. Basic sanitation and electricity have already been covered but up to 1.5 billion people still lack reliable phone services. However, quality infrastructure is necessary to achieve sustainable growth. Impact investments can tackle these challenges by, e.g., fostering the use and spread of information and communication technologies (ICT), especially mobile phones which have proven to significantly impact economic growth (Piatkowski 2006; Vu 2005).

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Goal 10: Reduce inequality within and among countries Inequality remains an issue within countries but also among countries. According to figures from the United Nations (2015) income equality increased by 11% between 1990 and 2010. While some inequality is inevitable, inequality harms economic growth beyond certain thresholds. The possibility to address these issues with impact investments are very limited—they are rather a positive side effect when addressing other challenges such as goals 4, 7, or 8. Goal 11: Make cities inclusive, safe, resilient and sustainable Half of the global population is living in urban areas. In cities, major sustainability issues converge, such as urbanization, a rising middle class, and population growth. Cities are a hub for innovation, culture, and development. However, urbanization is putting pressure on water supplies, infrastructure, and public health. Impact investments can help to make cities more inclusive, safe, resilient, and sustainable, for example, with investments in the area of building energy efficiency, energy recovery from municipal waste, pollution issues (air, water, noise), transportation, or infrastructure (Global Environment Facility, n.d.; D. Wood, n.d.). Goal 12: Ensure sustainable consumption and production patterns One-third of all food produced is going to waste. Water is in many places around the world not managed sustainably. The world is also facing declining soil fertility or overfished seas. The field can be categorized into four sub-sectors where impact investments can add value (Deloitte 2013; Pons et al. 2013): production, processing, distribution, and consumption, drivers in the field are access to food, waste of food as well as the reduction of the carbon footprint of food production (see also SDG 2) (Table 2.5). Goal 13: Take urgent action to combat climate change and its impacts Climate change is one of the bigger risks the world is currently facing. From 1880 to 2012 the average global temperature increased by 0.85 °C and has reduced grain yield, led to the rise of sea levels, and possibly led to more volatile weather. The world’s governments largely agree that global warming must be limited to no more than 2 °C (3.6 °F) above the average

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Table 2.5 Issues along the food value chain Sub-sector

Production

Processing

Distribution

Consumption

Details

Research & development Framing Ranching Trading Management capabilities Strategy Access to capital

Harvesting Butchering Manufacturing Marketing & Sales

Distribution Logistics Retailing

Shopping Consumption

Strategy Achieving scale Supply chain strategy

Distribution strategy

Food prices Food security Food safety Health and wellness

Key issues

Source Own illustration based on Deloitte (2013)

global temperature experienced before the Industrial Revolution (USSIF 2013). The increase in temperature observed during the last decades has been caused largely by human activities, especially by the use of fossil fuels such as coal, oil, or gas adding to the concentration of carbon dioxide and other greenhouse gases in the atmosphere hindering the heat from the sun to escape. The International Energy Agency (IEA) estimates that $1 trillion per year in investment is needed to achieve this goal and impact investments are very popular in addressing this challenge (also through addressing other SDGs). Investments are possible across all asset classes, for example, in innovative technologies, improving energy efficiency, or developing infrastructure. Goal 14: Conserve and sustainably use the oceans, seas and marine resources Oceans contain 97% of the earth’s water. Three billion people depend on the coastal biodiversity for their livelihoods. That may explain that the value of those marine and coastal resources and industries is estimated at $3 trillion per year. Impact investments can create value by investing, e.g., in sustainable global fishery on a small scale (in order to protect and restore fish stocks or support fisher livelihoods), on an industrial scale (e.g., larger fisheries in order to restore depleted fish stocks and feed more people), or on

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a national scale (e.g., fishery-wide data collection and port infrastructure). However, examples of successful marine impact investments are very rare—existing investments are either in fisheries finance or marine eco-tourism. Goal 15: Sustainably manage forests, combat desertification, halt and reverse land degradation, halt biodiversity loss The Sustainable Development Goal 15 covers forests, desertification, and biodiversity. Forests are responsible for the livelihood of 1.6 billion worldwide. They are also home to 80% of all terrestrial species of animals, plants, and insects. Desertification is another issue which needs to be tackled globally. Drought and desertification lead to the loss of arable land in the amount of 12 million hectares each year. As forestry resources are being demanded in large quantities at the moment, sustainable forestry provides many opportunities for achieving a financial return while addressing environmental issues. Problem-solving mechanisms include, for example, reforestation, the establishment of cooperatives, a focus on marketable native species or the use of organic fertilizers. However, due to a lack of metrics and a very intransparent market, forestry is still underrepresented as an asset class in large investment portfolios (Glauner et al. 2013). Goal 16: Promote just, peaceful and inclusive societies Goal 16 covers just, peaceful, and inclusive societies. Corruption, bribery, theft, and tax evasion are undermining societies. Tackling those issues is hard for impact investments as they are hard to identify and there is rarely a business model around it. However, impact investors can follow good business practices and comply with all legal requirements. Goal 17: Revitalize the global partnership for sustainable development The last goal is more about the ways to achieve these goals in an intersectoral manner. It is also concerned about the best use of development assistance, the reduction of debt distress and new partnerships, and the ease of the debt burden for developing countries.

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The World Business Council for Sustainable Development, the Global Reporting Initiative as well as the Global Compact have already drafted a first set of Key Performance Indicators to track progress for all SDGs (Table 2.6).

Table 2.6 Key Performance Indicators to track progress for all SDGs Goal

Key performance indicators

1

Poverty headcount ratio at $1.90 a day (2011 PPP; % of population) Poverty headcount ratio at national poverty lines (% of population) Prevalence of undernourishment (% of population) Prevalence of obesity, BMI ≥ 30 (% of adult population) Cereal yield per hectare Mortality rate, under-5 (per 1,000 live births) Life expectancy at birth, total (years) Lower secondary completion rate (% of relevant age group) PISA score Proportion of seats held by women in national parliaments (%) School enrollment, secondary (gross), gender parity index (GPI) Improved water source (% of population with access) Water Stress Score Access to electricity (% of population) Alternative and nuclear energy (% of total energy use) Share of youth not in education, employment or training, total (% of youth population) Average annual per capita GDP over the past 5 years Mobile broadband subscriptions per 100 inhabitants Research and development expenditure (% of GDP) Palma ratio Gini index Percentage of urban population living in slums or informal settlements Mean annual concentration of PM2.5 in urban areas Municipal solid waste generation (kg per capita) CO2 emissions per capita Losses from natural disasters (% GNI) Share of marine areas that are protected Fraction of fish stocks overexploited and collapsed (by exclusive economic zone)

2

3 4 5 6 7 8

9 10 11 12 13 14

(continued)

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Table 2.6 (continued) Goal

Key performance indicators

15

Red List Index Annual change in forest area Homicides per 100,000 population Corruption Perception Index For high-income and upper-middle-income countries: International concessional public finance, including official development assistance (% GNI) For low- and lower-middle-income countries: Government revenues (% GNI) Subjective Wellbeing (average ladder score)

16 17

Source Sustainable Development Solutions Network (2015)

2.3.3

Child Labor

Introduction Child labor is one issue which is interesting for impact investing. Child labor is also a topic which helps to understand the drivers behind certain social problems. A few hundred companies have so far signed the Responsible Sourcing Network’s cotton pledge. They have committed to not source Uzbek cotton until forced and child labor are eliminated in the country. According to Responsible Sourcing Network (2015) over one million children are forced to pick cotton by the Government of Uzbekistan and children who fail to pick their quota face fines, physical punishment, or expulsion from school. While Western consumers and fashion labels are quick to condemn child labor sociologists, employers and NGOs have different thoughts. Employers believe that child workers become used to being productive and laborious which can be beneficial in their later life. Labor also keeps them away from mischief and it increases the income of the children’s families (Kumar 2013). Academics study poverty, income inequality, lack of education, the break-up of family structures, and traditions. It might be rather surprising that it can be beneficial for mothers when they can bring their children to the factory. Experts see that child labor is both an economic necessity and a widespread phenomenon. With 168 million children working globally it seems to be wishful thinking that you just ban child labor.

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Definition The International Labour Organization (2015) which is the most relevant international organization covering child labor defines it as work that: – is mentally, physically, socially, or morally dangerous and harmful to children; and – interferes with their schooling by: – depriving them of the opportunity to attend school; – obliging them to leave school prematurely; or – requiring them to attempt to combine school attendance with excessively long and heavy work. It has a focus on negative effects on their health and the interference with school requirements. A priority is the elimination of the worst forms of child labor which is driven by slave-like conditions and/or activities which are either illicit (e.g., drug trafficking or prostitution) or work which is likely to harm the health of children. Drivers Child labor can also be found in a number of situations. It can be either visible or invisible or concentrated or dispersed (Table 2.7). Bachmann (2000) estimates that only 5% of all child laborers are working in the formal economy. That may explain why children are less well paid when they are working. In Ghana, the (International Labour Organization 1996) found that the average monthly earning for around 75% of the child laborers was roughly $1.25 while the national average was at $7.70. There are basically two schools of thought when dealing with child labor and the right approaches (Table 2.8). Most of the research is focused on the drivers of the supply side (Hilowitz 2004). Family context, economic shocks, influence of society, and the dynamics of poverty all play a role in understanding why families are deciding to forego an investment in education and let their children work. The demand-driven school of thought says that children are better workers as they are cheaper, less likely to unionize, or just have the right size to pick fruits or manufacture specific items.

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Table 2.7 Child labor situations Child labor situation

Concentrated

Dispersed

Visible

Invisible

Child labor which is concentrated and visible includes children who work in one place, are easily observed, and can be approached from the outside • Seamstresses, tailors, soccer ball stitchers, • Service workers in congested areas, e.g., shoe shiners, car washers, • Plantation workers (sugar cane, coffee, vegetables) These children work alone and are, or may appear to be, self-employed • Delivery boys, messengers, • Professional beggars • Herders and those engaged in livestock care

Children in these situations work together or near each other, but cannot be seen or are inaccessible to outsiders • Brick kiln workers, quarry workers • Carpenters, helpers, and carriers at construction sites • Miners of coal and minerals These are the children most unknown and hardest to reach; they work in remote areas, isolated and powerless • Domestic servants • Children working in family-based industries, such as craftwork • Children held under conditions of slavery or bondage

Source Illustration based on ILO (2002)

Table 2.8 Two schools of thought Supply-driven Main motive

Benefits for children Long-term effects Solution

Demand-driven

Child is part of the family as an Factory owners search for cheap labor economic unit and is supposed and replace adult workers through to contribute to family income children laborers with less rights Children learn skills and are None introduced to the adult life Low level of education and impact on national human capital Creating economic opportunities for families, improve family planning

Source Own illustration

Sanctions, creation of fair-trade certificates

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Examples of how such a complex social problem could possibly be solved will be discussed later in this book. New Zealand-based Child Labour Free is offering a certification of a supply chain free of child labor. Nobel Peace Prize recipient Kailash Satyarthi established GoodWeave International which was a pioneer in monitoring and certifying rugs manufactured in South Asia. Ethical fashion is a way to achieve this goal. The US-based Cordes Foundation has invested in ethical fashion companies which connect artisans with international department stores (“How and Why Stephanie Cordes Pursues Her Passion for Ethical Fashion Through Impact Investing—Cordes Foundation,” n.d.). Bain Capital has invested in TOMs (Stock 2014).

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CHAPTER 3

Impact Investing

3.1

Introduction and Definition

The concept of using investments to enable social change is not new. The entire field of impact investments already spans a wide range of efforts in building a global industry striving for investments with a positive social and environmental impact. Efforts to build a formal impact investing market have substantially increased in the second decade of the twentyfirst century and the disparate and uncoordinated innovation in the field has transformed into a distinct field of public and academic discourse. The term “impact investing” first appeared in 2007 at an event organized by the Rockefeller Foundation for leaders in finance, philanthropy, and development. On a very general level, it describes investments that are made with the explicit intention to generate societal or ecological benefits. However, it means that the financial return is not the only objective but that also social and environmental impact is considered. The idea to use investing to achieve social outcomes is not a new idea. O’Donohue et al. (2010) mention the Commonwealth Development Corporation in the United Kingdom or the World Bank’s International Finance Corporations for this approach. Höchstädter and Scheck (2015) see three different levels to discuss the meaning of impact investing which are definitional, terminological, and strategic. The definition is around the two core elements which are © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 W. Spiess-Knafl and B. Scheck, Impact Investing, Palgrave Studies in Impact Finance, https://doi.org/10.1007/978-3-031-32183-2_3

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the pursuit of a financial return and some additional non-financial impact. The Global Impact Investing Network (2016) defines impact investing as Impact investments are investments made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return.

The financial return is understood to be at least the return of the principal while others expect at least the rate of inflation or even normal or above market-rate returns. There is no agreement on whether the financial or the non-financial return requirements should be weighted higher: So-called financial-first investors favor the pursuit of the financial returns, while the impact-first investors strive for the pursuit of a social impact first. The social goal is sometimes substituted or understood more broadly including environmental, developmental, economic, or governance aspects. It is not tied to a specific legal form. Impact investments can be made in non-profit organizations as well as for-profit companies. As it is common in the social entrepreneurship area, the term social is usually rather vaguely defined. However, the social impact cannot be an incidental side effect (Brown and Swersky 2012). There is a range of companies who created an enormous social impact over their life cycle but were not doing it as a planned output. Additionally, the social impact should be measured and quantifiable.1 On a terminological level social (impact) investment is often used as a synonym for impact investment and vice versa. Overall, the use of words is confusing and the level of interactions is changing. In general, social investments are more common in Europe than in the United States. Social investments and social finance are often understood to also include grants. Socially responsible investing and impact investing share very similar definitions. However, most practitioners and academics share the view that both forms are rather distinct. Socially responsible investing targets investments in publicly traded bonds or stocks while impact investing is focused on private equity and debt. SRI investors also want to achieve close to market-rate returns. 1 The different tools and methods to assess the social impact are presented in later chapters of this book.

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Socially responsible investment funds have basically three different forms of investment strategy. They follow a negative selection where they exclude companies from specific segments such as tobacco, weapons, or gaming industry which are often referred to as “sin stocks”. They can also follow a positive selection strategy where they invest in companies which outperform their peers in certain benchmarks (best-in-class) or invest in specific sectors such as renewable energy, water management, or energy efficiency. The third strategy is based on engaging with the companies’ management to make them aware of potential improvements in terms of ecological, social, or governance issues. Looking at the foundations globally, one can recognize why impact investing is a relevant approach. According to numbers from Global Philanthropy Report there are more than 260,000 foundations in 39 countries. Their assets exceed USD 1.5 trillion (Johnson 2018).

3.2

Rationale for Impact Investing

Andreoni (2015) sees three different motives why people are getting involved in charitable activities. People might like the services the charity is producing, they might get a benefit or have some kind of internal motivation which is often referred to as “warm glow” (e.g., Andreoni 1990; Harbaugh 1998). In practice, it might mean better quality of media someone is consuming, better seats at the opera, or a positive feeling when providing money to a charity. Traditionally, there was a clear separation between investing and donations and they were considered and managed separately. The development of the impact investment market is a response to the financing needs of projects, enterprises, and organizations creating social impact which were not met previously. Impact investing has arrived in the mainstream although it might not be always labeled as such. Crowdfunding platforms are a favorite financing source for social impact companies and there are also socially responsible investment funds which have a large investment base. The investors can be classified according to the net present value of their investment decisions. The net present value is zero if the returns are equivalent to market rates. If investors are only willing to invest when the net present value is zero or slightly positive they are aiming at market-rate returns. If they are willing to have a negative net present value but a positive return in absolute numbers they are supporting the social mission

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Fig. 3.1 Return expectations (Source Based on Spiess-Knafl [2012])

with a reduced social mission. There are also other investors who are willing to have a negative financial return or no financial return at all. Those different approaches are shown in Fig. 3.1.

3.3

Investors

There are different group of investors and they can be classified according to their return preferences. 3.3.1

Donors

Investors who exclusively support the social goal without a financial return expectation are the first group of investors. In this case, no financial return on investment is equivalent to a complete transfer of funds without any repayment or interest. These investors are donors or charitable foundations. Although they might not invest in impact investments it is important to understand their motives as they are often involved in the financing of social enterprises.

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Table 3.1 Legacy and non-legacy capital of foundations Legacy fund

Non-legacy capital

Description

Identity-creating assets that are held and not sold

Typical examples

Large company shareholdings, real estate, rights, and other intangible assets

Investment in the traditional capital market to achieve market-rate returns Stock market holding, investment funds, bonds

Source Own illustration

Andreoni (2000) speaks of three possible explanation strands. They might demand that more of a public good is produced. This public good can be the national public radio or the integration of refugees. The second rationale might be a direct benefit drawn from the donation. Benefits can include tax savings, material benefits like lottery tickets, free entry or special access to art exhibitions for a donation, or increased visibility for the donor.2 The third motive might be the so-called “warm glow effect”. Andreoni (1990) sees the warm-glow effect as another motivation to donate. Warm glow means that even the pure act of donation gives the donor a certain benefit (Crumpler and Grossman 2008). The personal benefit from the warm-glow effect is independent of the expected future output of the organization. Apart from donors, foundations are important institutions with differing rationales. The capital of foundations is usually divided into legacy capital and non-legacy capital. Large company shareholdings, real estates, rights, and other intangible assets are often identity-creating assets for a foundation. They might derive their name from a company or the family firm and they might not be willing to sell those assets. Non-legacy capital are public equity or debt holdings or fund investments. They are held to achieve market-rate returns which are then used to provide grants to social sector organizations (Table 3.1). Interestingly, when foundations want to achieve social impact within their existing use of capital they have different opportunities. In the 2 The motives of foundations and donors are also regularly criticized. Large foundations can influence entire fields and occasionally even control them and there are concerns about democratic legitimacy and governance issues.

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Table 3.2 Opportunities for the achievement in different asset classes Approach Aim

Cash

Stock market

Real estate

Non-tradeable Grant shares in giving companies

Environmental Use of Protection ethical-social banks that lend to ecological company

Use of new environmental protection technologies

Use of new environmental protection technologies in factories

Promotion of ecological projects

Costs

Cost neutral over time

Cost neutral over time

Traditional distribution

Use of SRI strategies, avoiding companies in the fossil energy sector Cost neutral Cost over time neutral over time

Source Own illustration

following table it is shown for the environmental protection. They can use social-ethical banks, use socially responsible investment strategies or implement new energy saving technologies in their real estate. They might also engage with their privately held companies to consider new technologies. The traditional form of achieving this goal would be through traditional grant giving (Table 3.2). 3.3.2

Investors with Reduced Financial Return Expectations

Investors seeking a reduced financial return are the second group of investors. These investors expect a low positive return but would also accept a slightly negative financial return in favor of the social purpose. These investors want to support a social purpose, but assume that it is to be implemented optimally and sustainably with entrepreneurial financing instruments. The simultaneous pursuit of social and financial returns is also called blended value proposition (Emerson 2003).

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It is often considered that the origins of this approach lie in the 1990s when wealthy entrepreneurs have started thinking about new ways to act philanthropically. This group will try to solve problems of a specific group of a company with concrete concepts and provide capital for them. 3.3.3

Investors with Market-Oriented Financial Return Expectations

Investors who seek a market-oriented financial return but which do not necessarily consider financial or social and ecological criteria in the investment decisions represent the third group of investors. Although there is a trade-off between social and financial returns there is the possibility to achieve market-rate returns. Impact investment funds with an emphasis on venture capital in developing countries expect an average return of 12.0% to 14.9% and in industrialized countries 15.0% to 19.9%. The investment areas are primarily energy, telecommunications solutions, and fair trade (O’Donohue et al. 2010). The origins of the approach of ethically conscious dealings, especially with investments in the general stock market, lie in the 1960s driven by a change of the political climate (e.g., Williams 2007).3

3.4

Impact Investment Theories 3.4.1

Introduction

The traditional finance theories are not applicable without adjustments to the field of social investment. There are many differences between traditional and impact investments. First, there is an additional return requirement in the form of social return.4 Those considerations are described in the form of trade-off considerations in this chapter. The theories can be based on the return expectations of the investors. Investors can have different return expectation and this can result in conflicts as part of the trade-off considerations. Second, social enterprises are operating in segments with their own logic. Public authorities have different rules when they are providing 3 Investor profiles can be found in Chapter 4. 4 Similar considerations are known for family firms which focus on socio-emotional

issues when considering decisions (Berrone et al. 2012).

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Table 3.3 Theories to explain financing decisions Return expectation of the investors Spectrum

Criteria

Financing instrument

– No financial return expectation – Equity capital – Reduced financial return expectation – Market-return expectation – Debt capital – Hybrid capital – Mezzanine capital – Grants Agency theory Pecking order

Income streams – Public income streams – Private income streams

Contract restrictions

Source Based on Spiess-Knafl (2012)

contracts or supporting social enterprises. The same is true for the income streams social enterprises can access. Those conflicts are described in the following sections. Third, the financing instruments can be explained by using the pecking order for traditional companies. Those considerations are explained in the subsequent chapter. Additionally, the use of different financing instruments can lead to pecking order issues. However, it is more complicated as there is no clear pecking order for social enterprises. Those different views are shown in Table 3.3. Social enterprises have a dual mission. They need to achieve a financial return but also pursue a social mission and create social value. In certain cases, it might be possible to increase social and financial returns simultaneously. This is the so-called lockstep model. Grabenwarter and Liechtenstein (2012) even state that social and financial returns are always positively correlated. In other cases, there is a trade-off function between social and financial return requirements means that every increase in one dimension leads to a reduction of the other dimension. These trade-off preferences are different for each investor. While foundations might be content with negative financial returns, traditional banks might only focus on financial returns. Traditional investors have thus a steep preference curve, where a reduction in financial returns must be balanced with a significant increase in

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social returns. On the other hand, foundations and donors have a flatter yield curve. This means that they are willing to offset a small increase in social return with a higher financial loss. 3.4.2

Trade-Off Considerations Between Social and Financial Return

Introduction The conflicts which are caused by the involvement of several investors with different expectations of return can be analyzed with the help of the agency theory. The social entrepreneurs may be perceived as an agent, whereas the external investors are the principals.5 The agency costs are relevant to the theoretical consideration of the relationship between social enterprises and capital providers. Jensen and Meckling (1976) define agency costs as the sum of monitoring costs, signaling costs, and the residual loss. Agency costs may occur both in monetary and non-monetary terms and arise if the interests of the principal and agent are not aligned. The monitoring of a social enterprise is more complicated than for other companies.6 Investors in the for-profit sector can rely on market mechanisms that prefer better products and efficient trading companies. Market mechanisms are less distinctive as the recipient of the product or service often pays only a fraction of the costs and has thus less incentives to refuse a service or a product. Hansmann (1980) speaks in this context of the separation between the buyer and recipient of the service. Even if the beneficiary takes over the entire cost of the service evaluation may be difficult. Elderly care or childcare facilities are examples. Social enterprises have to make an effort to signal to the investor that the right measures are taken. These expenses are combined under the term signaling costs. Decisions by social enterprises are difficult to communicate since the impact of measures can have a variety of causes. In addition, in the decision-making process a variety of stakeholders as well as a balance between social and financial goals must be considered.

5 Donors and lenders without a claim to a return can also have a great influence on the orientation of the organization. In this case, they can be understood as principals. 6 The chapter on social impact assessment discusses the methodologies to monitor the performance of social enterprises.

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Fama and Jensen (1983) argue that the legal form of a non-profit organization acts as a sign of confidence because this legal form prevents access to residual cash flows. It is also possible with a for-profit legal form to adapt the articles of association accordingly. However, the distribution restriction for non-profit organizations is much more firmly anchored and widely understood. The residual loss is the equivalent of the loss of welfare suffered by the principal based on the decisions of the agent, which do not coincide with his interests. Donors will mainly consider the social return and consider deviations from the maximum social return as loss of welfare. Trade-Off Conflicts The use of different financing instruments does not lead to conflicts.7 It is rather the return requirements by the investors. The conflicts arise because of the simultaneous inclusion of investors with different expectations of return. A social enterprise might simultaneously receive donations and repay a loan to a bank. A donor might dislike the lender’s access to the cash flows and special rights in case of insolvency or liquidation. Additionally, part of the current income is used for interest payments and the repayment and not for the pursuit of the social objective. The lender might not understand the specifics of social business models which are partly funded by donations. The stability of donations for the assessment of repayability is also difficult to estimate. With a well-defined use, donations reduce the organization’s costs for service delivery and increase output accordingly. The unearmarked donation to organizations, however, is associated with significant agency costs, which are due to the wide-ranging freedom of action for the social entrepreneurs. Conflicts might arise over the governance of the social enterprise and the management of conflicts. Traditional investors will ask for maximization of the financial return while donors and foundations will ask for a maximization of the social return. These differences in return expectations between financial and social returns mean that agency costs increase if the business model does not match the expectations and interests of external investors. The agency

7 Conflicts are all those situations in which the interests are aligned.

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costs depends on the sum of the monitoring costs, signaling costs, and the residual loss. These conflicts can occur in the growth phase or at any time when the investor base changes with refinancing. There are different strategies to resolve these financing conflicts. Strategies for the Resolution of the Financing Conflicts The four strategies available to resolve these conflicts are (1) focus, (2) creation of a satellite model, (3) creation of a hybrid model, or (4) lifecycle financing. Strategy 1: Focus This strategy implies that the social enterprises focus on the most promising financing source. This reduction in the diversification of capital sources and the associated agency costs also means that the investor base is shifting. The consequence is that investors’ aggregate return expectations change as one of the investor groups no longer needs to be considered. The social enterprise has to consider the changed combination of yield expectations on the capital side. Interestingly, the strategy of social enterprises often follows the financing options, whereas it is different in the for-profit area. Strategy 2: Satellite model A strategy to reduce the financing conflicts can be to split the social enterprise into a non-profit and a for-profit part. The non-profit unit becomes the owner of the for-profit unit and thus the beneficiary of future profits. An example is a consulting business in the profit-oriented unit and operation of the core business in the non-profit unit. Examples are hospitals, nursing homes, or educational programs in which a non-profit company has one or multiple for-profit units. The structure can be used if the splitting is useful for legal or financial reasons. However, this does not include models in which the for-profit sector is solely responsible for financing the non-profit organization. One example would be the operation of a bakery to finance a well construction company in Africa. This is referred to as a profit generator model. Strategy 3: Hybrid model Many social enterprises continue to face the challenge that the provision of social services requires grants and donations and they cannot split the company into a non-profit and for-profit sector. Within the framework the social enterprise uses basic funding of foundations or public authorities

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institutions and can leverage capital from private investors with a marketoriented financial return expectation. The financing structure of the social enterprise is comparable to the layers of a cake (Milligan and Schöning 2011). Large foundations and public institutions are increasingly using this approach as it helps them to mobilize additional private capital to solve the social problem. Strategy 4: Financing lifecycle Especially for social enterprises, a financing life cycle could be a viable alternative. This means that foundations, donors, or the public sector take over innovation financing in the first part of the lifecycle, while investors with a positive return expectation are providing more commercial funding for scaling and expansion. This approach seems attractive, since it already reflects today’s financing practice. Foundations are more focused on supporting innovation and are not focused on further follow-up financing. At the same time, there are investors with a positive financial return expectation that is not interested in the risk of innovation financing. In this model, however, it remains unclear how to deal with the profits in the later phase.8 It would also be an innovation-friendly financing structure as debt is often considered to be inhibiting innovation while donations are not putting pressure on the business model. 3.4.3

Flexibility Restrictions Driven by Public Authorities

Capital cost restrictions are another issue often encountered in the field. In some cases public authorities reimburse on a cost basis and exclude for reimbursement any capital costs for interest. This specific restriction makes the use of mezzanine or debt capital more difficult. Any capital costs would then have to be paid either through donations or income from other branches of business. A similar problem arises if the costs are paid in equal installments during the project runtime. A considerable part of the investment costs

8 Compartamos Banco’s and SKS’s initial public offerings have caused considerable criticism as part of the start-up financing has been provided through public funds and the profits have been distributed to private actors.

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is incurred at the beginning of the project period but they are only reimbursed with a certain delay. In addition, assets acquired through public funds can often not be used as collateral. These restrictions are particularly relevant to social enterprises wishing to finance capital-intensive assets or real estate with borrowed capital. Social enterprises receiving guaranteed future payments from a national or international institution face similar problems. This promise of future payments can also not be used to securitize the payments and thus to have the capital available at an early stage. The restriction is that the interest component of a possible securitization cannot be paid. These interest costs should then be covered by donations or other means. However, this leads to other possible conflicts. 3.4.4

Sustainability Conflicts

Many researchers assume that non-profit organizations do not prefer commercial activities but prefer to rely on donations as a source of income. Commercial activities are therefore only undertaken when the donation volume is not sufficient. James (1998) explains the conflicts that exist between donors and managers. Managers are likely to be interested in sales, while at the same time fearing that donors will no longer consider supporting them because of the possible impact of a market-oriented economy and thereby reduce donations. Segal and Weisbrod (1998) found in a sample of US non-profit organizations a negative relationship between donations and sales that either arise in the context of activity such as entrance fees or non-related businesses. The results vary depending on the topic field and in some areas of the topic, this connection is also not demonstrable. This relationship is not fully valid for social enterprises. Many donation-based venture philanthropy funds will support these sales-based models. They are interested in the ways sustainability can be achieved. For single donors, however, these revenues will significantly reduce the appearance of the need for a donation. In this case, it is possible to speak of a sustainability conflict even if a donation would help the social enterprise.

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3.4.5

Income Streams

Social enterprises have a business model and different groups of beneficiaries. Private beneficiaries are patients or homeless persons who are identifiable. They can receive a service and there is usually a way to charge for the services either directly or indirectly. Public beneficiaries are the public or a larger population group that benefits from the service. For those beneficiaries, it is harder to establish a business model which relies on the charging of a fee. Mixed beneficiaries have both features with identifiable individuals but also a public benefit. Fischer et al. (2011) analyzed the beneficiary nature of more than 45,000 non-profits. They find that 59% have mixed, 28% private, and 13% public beneficiaries. Each business model has corresponding income streams. Results show that a higher diversification of income sources leads to a low volatility of the total income. However, non-profit organizations also show a clear concentration of income sources. Carroll and Stater (2009) investigate all US non-profit organizations with an annual budget of more than $25,000 on the diversification of income streams. They consider the revenue from donations, commercial income, and investment income from the accumulated capital. Both greater diversification and growth relative to total expenditure lead to lower volatility in revenues. These results are, however, to take with caution, as the three income streams require in an investigation for social enterprises a more detailed subdivision. There are also conflicts between the different income streams. When choosing the income structure, social enterprises must focus on income sources and thus create a stable and sustainable structure of internal financing. Studies for the non-profit sector show that most non-profit organizations have a rather one-sided or concentrated revenue structure despite the supposed advantages of diversification. Foster and Fine (2007) analyze the 144 US non-profit organizations with an annual budget of over $50 million. Although they represent less than 0.1% of all US non-profit organizations, they are interesting to study to understand the implications of the size. The authors show that these non-profit organizations base their financing model almost exclusively on a single source of funding and adjust the organizational structure to meet the needs of the investors, even if there are adjustments to the program design.

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Table 3.4 shows the income streams of German social enterprises which can be found in similar proportions in all Western countries. On average, the income structure is quite diverse and social enterprises access different income streams. However, individual social enterprises have 3 different income streams with one primary income stream accounting for most of total income. Weisbrod (1998) found that there are interdependencies between the various income streams. For example, an increase in commercial activities in non-profit organizations will have a negative impact on the donation. A cut in public funding will lead to the non-profit organization having to cover the income with new income strategies. Weisbrod (1998) also argues that the choice of source of income has an impact on the output of the organization, and the output of the organization in turn affects the sources of income. Obviously, diversification across different income streams can be an important support of risk minimization (Light 2009). The conflicts between the various income streams are especially driven by the special contract design of public authorities. The restrictive provisions which exist from the side of the public sector can be explained by the fact that monitoring capacities are limited and therefore the provisions against possible misuse or incorrect use of funds are restrictive.9 Van Slyke (2007) identified four potential problems that may occur in the awarding of public contracts and grants to non-profit organizations. First, there is incomplete competition in certain areas which makes the efficient allocation of orders more difficult. Second, there is a lack of administrative capacities in the public agencies to check the performance. Third, there is a lack of coordination between the different levels of government and divergent political opinions. Fourth, misplaced incentives found in contracts may eventually lead to a dependency on public funds.

9 The public authorities acts in the interests of the target group and ensures equivalent access to the service. Examples include school visits where parents’ contributions are deducted from the public contributions. The same applies in shelters where the homeless cannot contribute monetarily to the service. All additional revenues would be deducted from the public payments.

16.8 36.9 14.1 7.9 38.3 21.0

20.7 24.2

24.9

27.7 8.3

20.8

Source Based on Spiess-Knafl (2012)

Education Work integration Social inclusion Social services Regional development Total

Fees (public) (%)

Income (‘000e)

Earned income (%)

Income streams

Table 3.4

15.4

20.0 6.0

17.7

14.7 15.8

Subsidies (public) (%)

10.3

10.8 18.8

5.4

9.8 2.3

Donations (%)

7.1

10.7 3.3

9.1

10.7 0.7

Foundations (%)

8.0

10.5 0.8

1.6

16.8 0.3

Sponsor-ship (%)

5.0

3.7 0.2

9.6

2.9 0.1

Member-ship fees (%)

12.6

8.7 24.2

17.8

7.6 19.6

Other (%)

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Crowding-Out

Crowding-out occurs when the public sector and donors finance a non-profit organization. Empirical studies show that an increase in taxfinanced public funding leads to a decrease in donations. One of the main arguments is that donors see the increase in public funding as a substitute for their own donation. However, Andreoni and Payne (2011) show that reduced fundraising activities to increase public posts explain this effect mainly. Non-profit organizations have less incentives to maintain their fundraising activities to the same extent after increasing public funding. In a sample of 8,062 non-profit organizations, they show that the crowding-out effect is significant and can be explained by the so-called “fundraising crowdingout”. Crowding-out reduces thus the net effectiveness of public financing. For this reason, some innovative financing concepts require so-called matching grants which requires private investors to provide donations at a proportional rate. As a result, these opposing effects can be avoided by means of reduced fundraising activities. 3.4.7

Conclusion

This chapter has shown that there exists a range of interdependencies between the different stakeholders. Between the capital providers it is mostly trade-off situations. Between capital providers and public funds or the target group there can be sustainability conflict, problems arising due to the interest payment restrictions, and crowding-out. Those interdependencies are shown in Table 3.5.

Interest payment restrictions

Interest payment restrictions (No conflict)

Trade-Off

Trade-Off

Sustainability conflict



Trade-Off

Source Achleitner et al. (2014)

Target group & beneficiaries

Trade-Off

Investors with reduced financial return expectations



Investors with market-rate return expectations

Financing conflicts

Investors with market-rate return expectations Investors with reduced financial return expectations Investors without financial return expectations Public funds

Table 3.5

(No conflict)

Crowding-Out



Trade-Off

Trade-Off

Investors without financial return expectations

Tight contractual terms



Crowding-Out

Interest payment restrictions

Interest payment restrictions

Public funds

Tight contractual terms –

(No conflict)

(No conflict)

Sustainability conflict

Target group & beneficiaries

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Grabenwarter, Uli, and Heinrich Liechtenstein. 2012. In Search of Gamma. An Unconventional Perspective on Impact Investing. IESE Business School. Hansmann, Henry B. 1980. The Role of Nonprofit Enterprise. The Yale Law Journal 89 (5): 835–901. Harbaugh, William T. 1998. What Do Donations Buy?: A Model of Philanthropy Based on Prestige and Warm Glow. Journal of Public Economics 67 (2): 269– 284. Höchstädter, Anna Katharina, and Barbara Scheck. 2015. What’s in a Name: An Analysis of Impact Investing Understandings by Academics and Practitioners. Journal of Business Ethics 132 (2): 449–475. James, Estelle. 1998. Commercialism Among Nonprofits: Objectives, Opportunities, and Constraints. In To Profit or Not to Profit: The Commercial Transformation of the Nonprofit Sector, ed. B.A. Weisbrod, 271–286. New York: Cambridge University Press. Jensen, Michael C., and William H. Meckling. 1976. Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics 3 (4): 305–360. Johnson, Paula D. 2018. Global Philanthropy Report: Perspectives on the Global Foundation Sector. Cambridge: Harvard Kennedy School. Light, Paul C. 2009. The Search for Social Entrepreneurship. Washington, DC: Brookings Institution Press. Milligan, Katherine, and Mirjam Schöning. 2011. Taking a Realistic Approach to Impact Investing: Observations from the World Economic Forum’s Global Agenda Council on Social Innovation. Innovations 6 (3): 155–166. O’Donohue, N., C. Leijonhufvud, Y. Saltuk, A. Bugg-Levine, and M. Brandenburg. 2010. Impact Investments: An Emerging Asset Class. New York: JP Morgan. Segal, Lewis, and Burton A. Weisbrod. 1998. Interdependence of Commercial and Donative Revenues. In To Profit or not to Profit: The Commercial Transformation of the Nonprofit Sector, ed. Burton A. Weisbrod, 105–127. Cambridge: Cambridge University Press. Spiess-Knafl, Wolfgang. 2012. Finanzierung von Sozialunternehmen: Eine Theoretische Und Empirische Analyse. München, Technische Universität München, Diss. http://d-nb.info/102496406X/34. Van Slyke, David M. 2007. Agents or Stewards: Using Theory to Understand the Government-Nonprofit Social Service Contracting Relationship. Journal of Public Administration Research and Theory 17 (2): 157–187. Weisbrod, Burton A. 1998. Modeling the Nonprofit Organization as a Multiproduct Firm: A Framework for Choice. In To Profit or Not to Profit: The Commercial Transformation of the Nonprofit Sector, 47–64. New York: Cambridge University Press.

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Williams, Geoffrey. 2007. Some Determinants of the Socially Responsible Investment Decision: A Cross-Country Study. The Journal of Behavioral Finance 8 (1): 43–57.

CHAPTER 4

The Impact Investing Market

The market for impact investments has started to gain momentum in the second decade of the twenty-first century. There is significant interest from investors, the sector has professionalized its practices and there is a lively investment activity. However there is still a weak secondary market for equity investments which leads to a preference for debt capital. There are also difficulties in bringing together the supply and demand side of the market. Incubators or intermediaries delivering investment-readiness programs are trying to address those issues. Moreover, there is little cooperation between the actors of the market (Spiess-Knafl and Scheck 2019). In the following the different actors of the social investment market are portrayed and discussed.

4.1

Actors

Over the last years a market for social investment developed. Every actor of the traditional sector was replicated in the social finance sector (Table 4.1).

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 W. Spiess-Knafl and B. Scheck, Impact Investing, Palgrave Studies in Impact Finance, https://doi.org/10.1007/978-3-031-32183-2_4

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Invest Europe, National Venture Capital Association (NVCA)

Goldman Sachs, Morgan Stanley Sequoia Capital, Kleiner Perkins Caufield & Byers HSBC, Bank of America, Deutsche Bank CircleUp, AngelList, Early Shares

Networks

Investment bank

Crowdfunding platforms

Commercial banks

Venture capital funds

Examples

Actors of the social capital market

Actors in the traditional capital markets

Table 4.1

Social impact crowdfunding platforms

Ethical banks

Social investment advisor Social venture capital funds

Networks

Actors in the social market

BetterPlace, Green Rocket, Indiegogo Equity, Kiva

Triodos, First GREEN Bank, Vancity, GLS Bank

European Venture Philanthropy Association (EVPA), Aspen Network of Development Entrepreneurs (ANDE), Schwab Foundation for Social Entrepreneurship, Global Impact Investing Network (GIIN) ClearlySo, Big Society Capital, Financing Agency for Social Entrepreneurship (FASE) Bridges Ventures, BonVenture, PhiTrust

Examples

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Networks

Networks try to connect actors working on the supply and demand side of the social capital market. The social capital market suffers from very high transaction costs. This can be explained by small investment sizes and high costs for due diligence and the identification of targets. Both financial and social criteria must be analyzed and evaluated. Search costs arise in the identification of attractive investment targets in a fragmented and complex market. Moreover, cooperation between the players in the social capital market is not well established. There are some conferences that bring together stakeholders, but there is almost no co-operation between philanthropic and yield-oriented investors. Networks can fill this role as an intermediary between supply and demand and enable access to expertise. If necessary, social innovations can be made visible and synergy effects can be used within the network. There are some networks that are positioned in this area. They can therefore be defined according to the role of their networking activities. There are networks that act exclusively on the supply or demand side, and others that try to network supply and demand. The aim of the European Venture Philanthropy Association (EVPA) is to link European venture philanthropy funds and to contribute to an exchange. In addition to regular studies and workshops, the annual conference is an important contact for the sector. There are also organizations working on the potential deal flow (“pipeline”) and making it available to several investors. The Asian Venture Philanthropy Network offers similar services for the Asian market. There are also networks for banks. FEBEA is the European Federation of Ethical and Alternative Banks and Financiers. The Global Alliance for Banking on Values (GABV) has a global approach and includes banks which finance projects with a social or environmental focus. The association of social enterprises is established by the Schwab Foundation for Social Entrepreneurship, Ashoka, and the Skoll Forum for Social Entrepreneurship. Every year, a certain number of social entrepreneurs are selected as fellows and are also made visible by this award. Within the framework of a fellowship program, they gain access to networks, events, and pro bono services.

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4.1.2

Social Investment Advisors

Investment banks are the key actors when it comes to match supply and demand. The equivalent of traditional investment banks are social investment advisors. Big Society Capital was founded with 600 million GBP of funding from dormant bank accounts and is trying to connect investors with charities and social enterprises. Since their start in 2011, it has committed 820 million GBP to reach more than 2,000 organizations. It is interesting to note how a commercial approach enables a financial intermediary to give out loans more than once and thus multiply its impact. Besides Big Society Capital, there are other social investment advisors. The Financing Agency for Social Entrepreneurship (FASE) is consulting social enterprises in their fundraising process and connecting them with investors. From the start they have helped social enterprises raise more than 50 million Euros and have set up their own investment fund as well. 4.1.3

Social Venture Capital Funds

Social venture capital funds apply the concepts of venture capital to the social sector. It was first discussed by Letts et al. (1997) about the promise of using the concept of venture capital for philanthropy. It is thus also known as venture philanthropy. Those funds follow some rules. They provide their portfolio company with access to their network, provide non-financial support in the form of advice, support capacity building, and measure the performance (John 2006). Social venture capital funds also apply multi-stage selection processes and apply a number of selection criteria. For this reason, investors make a detailed analysis before investing to use capital as efficiently as possible. Table 4.2 lists some selection criteria that investors make. The concept is concerned with aspects that relate to the specific service provision. Like traditional investors, they also examine innovations and strategies. There are also specific factors such as the intended system change, which can be reflected in the change in the living conditions of the target group or in new social patterns of thought. The motivation is analyzed for entrepreneurs who are facing a social problem. There are also the classical criteria, such as creativity and the

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Table 4.2 Selection criteria Concept

Entrepreneur

Market

Social

Financials

Innovation

Creativity

Social problem

Social return

Strategy

Communications capability Social motivation

Market development Competition

Reach

Business model Legal due diligence Financing needs

System change

Transferability

Source Based on Heister (2010)

ability to communicate but also the social motivation often resulting from the entrepreneur’s biography. Markets of social enterprises are analyzed according to criteria other than traditional markets. The question is whether it is a social problem at all and which target group benefits from the concept. There is also the question of how the market will develop and how many people are affected. For the investor, there is always the question of the competitors present in this market and how the social enterprise differs from the other approaches. In the case of investors who also pursue a social objective the social return is of great interest. It concerns the value created for society and involves the range and size of the social problem. Another difference concerns the transferability of the concept. An easy transferability increases the attractiveness of the concept since other social enterprises could adopt the concept. Table 4.3 gives an overview of European social venture capital funds. It describes the fund, the amount of capital they’ve raised, and portrays selected investments. 4.1.4

Ethical Banks

Another actor of the social capital market are ethical banks. They focus on a growing niche of the financial sector which integrates cultural, social, local, and ecological criteria in their decision-making. They also refuse to participate in speculative asset classes and usually provide their clients with transparent processes. There are even experiments to create democratic decision-making processes.

Description

BonVenture funds companies and organizations with a social purpose in German-speaking countries. The fund seeks projects that are innovative with a strong social impact, are led by motivated and committed social entrepreneurs, and will be financially self-sustaining in the long term in the areas of social businesses, ecological impact, and societal improvement

BonVenture Germany

Selected social venture capital funds

Venture philanthropy fun

Table 4.3

Parlamentwatch

Kinderzentren Kunterbunt Wald 21

Rock your life!

Ilses weite Welt

Name of investment

Selected investments

Holistic interactive concept for dealing with senile dementia in everyday life University students coaching problematic junior-high pupils Responsible day care centers with proximity to the workplace Ecologically responsible tree nurseries for high grade wood Monitoring of the political activities of the representatives in the German Parliament

Short description

Not publicly disclosed Not publicly disclosed Not publicly disclosed Not publicly disclosed

Not publicly disclosed

Amount & instrument

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Description

Bridges Ventures is a sustainable growth investor whose commercial expertise is used to deliver both financial returns and social and environmental benefits. They believe that market forces and entrepreneurship can be harnessed to do well by doing good. They currently have three types of funds under management

The Noaber Foundation aims to initiate and support the acceleration of innovations in the civil society where “noabership” (neighbourship) is key. These innovations are related to health and care, education, and community building. To reach its aims, the foundation acts as an “entrepreneurial philanthropist”

Venture philanthropy fun

Bridges Ventures United Kingdom

Noaber Foundation Netherlands

Loco Tender B.V. Mentalshare

Carefarm’t Paradijs

Autest

Abakus B.V.

Hackney Community Transport HCT Historic Futures

Care and Share associates cloud.IQ

Auto 22

Name of investment

Selected investments

Employment and social inclusion of the disadvantaged and community development Supply chain adjustment to assure it complies with corporate governance goals, reduces emissions and waste Elaborated digital doctor–patient consulting system Employment of autists as software testers Agricultural farming project, which lets visitors participate in the farming business Specialized schooling system for children with learning disabilities Provision of e-mental health services for effective prevention and treatment of mental disorders

Car service garage with preferable employment of young people, reinvesting in new job opportunities Employee-owned homecare franchises for elder people Apps and technical backend provision for firms of all kinds

Short description

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(continued)

Not publicly disclosed Not publicly disclosed

GBP 200,000 Debt Capital GBP 2,000,000 Equity GBP 2,000,000 Debt Capital GBP 1,600,000 Equity Not publicly disclosed Not publicly disclosed Not publicly disclosed

Not publicly disclosed

Amount & instrument

4

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PhiTrust France

Oltre Venture is the first Italian Social Venture Capital company, supporting the growth of enterprises which are able to match social value and economic sustainability. Such enterprises appeal to the grey area of invisible hardship and to fragile social-economic problems such as housing discomfort, unemployment, solitude, and marginalization

Oltre Venture Italy

Ambulatorio Dentistico Boccaleone Sri Centro Medico Santagostino

Name of investment

Selected investments Amount & instrument

High level of all kinds of specialized medicine, available to all

Offers access to high-end dental care EUR 115,000 to the economically weak Equity

Short description

EUR 1,500,000 Equity Concordia Spa Housing for elderly with special care EUR 300,000 facilities Equity Fraterniti Sistema Cooperative specializing in services EUR 300,000 for public administrations such as Equity tax plannings and collection of those Personal Energy Planning and installation of EUR 570,000 photovoltaic systems Equity (100% stake) PhiTrust Partenaires is dedicated to Association Cooperative, providing excluded EUR 50,000 funding and mentoring companies in Chênelet people with an accomodation, job Equity the fields of social business through and healthcare paired with quality of its foundation and social investment living funds. Phitrust focuses its investments both at a European and a worldwide level. PhiTrust Partenaires can be seen as the social division of the PhiTrust Asset Management Group

Description

(continued)

Venture philanthropy fun

Table 4.3

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Description

Refurbishment of computer technology by mentally impaired people Development and management of office space for non-profits in high-environmental quality (HEQ) buildings Social housing project with support from companies providing sustainable building materials

Ecodair

Ethical Property

Groupe la Varappe

EUR 3,000 Equity, EUR 150,000 Debt Capital EUR 65,000 Equity, EUR 200,000 Debt Capital EUR 530,000 Equity

Amount & instrument

EUR 150,000 Equity, EUR 100,000 Debt Capital Social reintegration through EUR 400,000 employment in construction, waste Equity, EUR treatment, maintenance of green 52,000 Debt spaces and installation of solar panels Capital

Disabled people guide through exhibitions in which visitors explore the life of blind people

Dialogue social enterprise

Foncière Chênelet

Short description

Name of investment

Selected investments

Source Own research, EVPA, Company information (Spiess-Knafl and Jansen 2013)

Venture philanthropy fun

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Table 4.4 Balance sheet data of selected ethical banks

GLS Bank Loans Deposits Alternative Bank Schweiz Loans Deposits Triodos Bank Loans Deposits Merkur Cooperative Bank Loans Deposits Southern Bancorop Loans Deposits

2020

2015

2010

4,828 7,555

2,323 3,946

1,142 2,102

1,631 2,020

1,077 1,477

801 995

10,457 13,415

5,689 7,943

2,820 4,027

251 539

209 336

194 247

1,136 1,378

768 1,009

605 939

Source Global Alliance for Banking on Values (n.d.); company data; numbers in million USD

Some of the larger ethical banks are globally organized within the Global Alliance for Banking on Values (Global Alliance for Banking on Values, n.d.). The development of the loans and deposits are shown in the following table. They have all posted impressive growth figures over the last years (Table 4.4). 4.1.5

Crowdfunding Platforms

The last actors are crowdfunding platforms. Crowdfunding is a major trend in the financing of social innovations and an attractive source of financing for social enterprises (Lehner 2013). There are four different types of crowdfunding depending on the type of funding provided. The different types are equity, debt, donation, or reward-based. In some cases it might be an equity investment which is structured like a debt instrument. The different types are illustrated in Table 4.5. The total numbers are hard to estimate but go into the billions each year with thousands of projects posted online. For social enterprises, crowdfunding is an interesting alternative. The large number of individuals supporting the social enterprise increases the

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Table 4.5 Forms of crowdfunding Form

Description

Equity-based Crowdfunding Reward-based Crowdfunding Donation-based Crowdfunding

Individuals purchase equity issued by a company

Debt-based Crowdfunding

Backers provide funding to individuals, projects, or companies in exchange for non-monetary rewards or products Donors provide funding to individuals, projects, or companies based on philanthropic or civic motivations with no expectation of monetary or material return Individuals provide a loan to the company

Source Own illustration based on Ziegler et al. (n.d.)

legitimacy and can also act as multipliers for the social mission. The large number of backers and investors also pose certain problems. It is complex to manage the stakeholder relationship and there might not be enough resources to engage with the investors on an ongoing basis. Moreover, we have already discussed the benefits of principals and engaged shareholders. They have control and voting rights and act as an important counterpart for the management of the social enterprise. Given that the individual investor has only invested limited amounts of money there is less incentive to control and advise the company’s management. Crowdfunding has a certain preference for lifestyle segments or those brands which are easier to communicate with potential investors. That also explains why social media activities are integral to most crowdfunding campaigns. Investments are also rather illiquid and it might take a while to sell an investment once it is needed. Given that there are thousands of campaigns at any given time those platforms can be interesting platforms to analyze what is happening next. It could thus be an innovation radar. In some cases, there was a first round of investing by the crowd which was later supplemented by institutional investors. In those cases, it is necessary to work on good mechanisms to have good governance structures. In the early days of crowdfunding there were some cases in which each shareholder of the crowd had to support and agree to certain actions of the company.

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4.2

The Instruments and Mechanisms 4.2.1

Socially Responsible Investments

Introduction Social responsible investments are the method to achieve social good in the public capital markets. Some date the origins of socially responsible investing date it back to the Quakers but the more recent origins can in be found in the 1960s. Williams (2007) identifies different movements in different countries. In Germany, those initiatives were influenced by environment and peace movements during the 1970. In the United Kingdom, it dates to Victorian social concerns. The first ethical bank was created in 1974 and the first ethical investment fund started its operations in 1984. In the United States, socially responsible investments have started traction in the political climate of the 1960s and 1970s. Nowadays, it has become a mainstream approach which has been widely adopted. Basically, there are different strategies to invest in the industry which are (1) exclusion of stocks from the investment universe in the form of negative screening, (2) positive screening and selection of best-in-class investments, and (3) shareholder activism and engagement approaches. Negative selection excludes investments in certain sectors, such as the tobacco, weapons, or gambling industry. In the case of a positive selection, investments are made in the companies with the most environmentally friendly production processes or the best working conditions in a benchmark process. However, it may also consist of a combination of the two methods. These approaches, however, almost exclusively involve investments in publicly traded shares and bonds. The third approach can also be connected with the other two approaches which is based on engagement and activism. This can happen through voting but also public actions such as writing of reports, meeting the management or voting at the annual general meeting. Investor Profile In the early days of this investment style studies found socio-demographic differences between conventional and socially responsible investors. Socially responsible investors were thus found to be younger and better educated (McLachlan and Gardner 2004; Williams 2007). Rosen et al. (1991) show that socially responsible investors are younger and better educated than conventional investors. Beal and Goyen

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(1998) asked the shareholders of the Australian environmental protection company Earth Sanctuaries Limited (ESL) why they have invested. Most were focused on non-financial criteria which is shown with the responses: (1) conservation of endangered animals, (2) help to save endangered ecosystems, (3) conservation of endangered plants, (4) provision of sanctuaries, (5) help protect ecosystems, (6) provision of educational services, (7) financial stability of ESL, (8) provision of recreational services, (9) share price (capital) growth, (10) portfolio diversification, and (11) dividends. Investors were also found to be more female and better educated. Lewis and Mackenzie (2000) show in a sample of 1,146 British investors of ethical investment funds that they are often middle-aged and middle-income and have an active role in political parties, non-profit organization, or religious groups. Socially responsible investors can also be segmented into various groups. According to Nilsson (2009) the largest segment can be classified as socially responsible and return driven. They believe that one person can make a difference toward solving social and environmental issues. The second group is primarily concerned about profit and believes that SRI funds could be a good financial decision. The third group is primarily concerned about social responsibility by allocating a part of their overall portfolio to SRI funds. McLachlan and Gardner (2004) compare 54 ethical investors against 55 conventional investors. Investors differed in terms of age, education, income, and pro-social orientation. However, Williams (2007) shows in an international sample that demographic factors do not play a prominent role. This would mean that social selection criteria in the mainstream of investment decisions arrived. Financial Perfofrmance The financial performance of SRI funds depends on the study, the timeframe, and the selected universe. Early research focused on the relationship between corporate social performance and corporate financial performance at the company level (e.g., Orlitzky et al. 2003; Waddock and Graves 1997). Corporate social performance can be defined as “a business organization’s configuration of principles of social responsibility, processes of social responsiveness, and policies, programs, and observable outcomes as they relate to the firm’s societal relationships” (Wood 1991).

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The reasons for this causality and the factors driving this relationship are still debated but it seems that being good is also an attractive strategy. In recent years there has been research on the financial performance of mutual funds following a SRI strategy. Capelle-Blancard and Monjon (2014) find that industrial screens decrease financial performance but that the following international agreements such as UN Global Compact Principles or ILO regulations have no impact. Industrial screens reduce the diversification of a portfolio more than a screen for compliance with international regulations. Nofsinger and Varma (2014) find that socially responsible mutual funds outperform traditional mutual whenever market crises occur. They tend to underperform in non-crisis periods. In a meta-analysis of investments in the public capital markets (Revelli and Viviani 2015) find that the consideration of CSR is neither a weakness nor a strength compared with traditional investment decision criteria. 4.2.2

Outcome-Based Financing Models

Scarce financial resources restrict the ability of many social services and companies to innovate. This applies to companies and initiatives both within and outside traditional welfare organizations. In order to make funding more accessible, efficient, and effective, outcome-based financing models have become increasingly popular. These models are built around a payment structure that is dependent on the success of the underlying programs as opposed to the actual costs or outputs they occur. Different terms are used to describe outcome-based schemes, such as social outcomes contracting (SOC), payment by results (PbR), social impact bonds (SIB), development impact bonds (DIB), pay for success (P4S or PFS), results-based financing (RBF), or performance-based financing (PBF). These terms are often used interchangeably or differ depending on the geographic region in which they are used (European Commission et al. 2021). Different financing structures have been developed around this notion, varying according to which stakeholder (1) provides working capital, (2) funds the outcome premium, and (3) takes on the investment risk.

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Depending on the actual model, an outcomes-based financing instrument usually involves some or all of the following stakeholders: ● Outcome funder: A public entity or any other outcome funder(s) (for example, a foundation, an international donor) is responsible for paying back the principal and/or interest if the pre-determined outcomes are achieved; ● Intermediary: Receives the loan from the investor(s) and coordinates all project activities (such as distribution of funds, outcome assessment, monitoring, etc.) ● Investor(s): Provides working capital upfront. Investors include foundations, investment funds, banks, private sector CSR programs, or individuals; ● Service provider(s): Government entity, NGO, or private enterprise that executes the interventions required to achieve the desired outcomes. ● Evaluator: Entity that validates the achievement of the outcomes. ● Beneficiaries: Population that benefits from the project. Different combinations of stakeholders, funding streams, and risk allocation have led to the emergence of various funding structures: Social Impact Bonds (SIB) are the most widely known and were first launched in 2010 in the United Kingdom addressing high recidivism rates among young offenders (Bolton and Savell 2010). Within the structure of an SIB, the government as outcome payer reimburses private investors who have provided upfront capital plus an additional premium in case of success. The reimbursement and the payout of a potential return only take place if evidence shows that a certain, pre-agreed minimum success has been achieved. In general, the more successful the intervention, the greater the return to investors. In some cases, the interest rate is capped, however. If the agreed-upon social objectives have not been reached, investors lose their capital partly or entirely depending on the contractual agreement. An SIB thus enables effective partnerships between various stakeholders from different sectors, i.e., public administration, private investors, and social organizations. Sometimes, this model and the ensuing partnership are structured by an intermediary, a special purpose entity taking on legal, financing as well as operational tasks. However,

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there are also examples of social impact bonds which operate without such an intermediary (in this case, the social service providers receive, for example, capital directly from the private investors) or mixed forms. The name of the financing vehicle, “bond” is misleading, though: an SIB is not a financial instrument with a fixed interest rate, nor are SIBs legally structured as traditional bonds. Rather, the financial return that can be generated by an SIB is variable, since it depends on the achieved social impact, in some constructs, even the nominal capital is not necessarily hedged. Thus an SIB can rather be considered a public–private partnership, that some authors associate with an equity-like character due to the involved risk, while others compare it with derivatives, and more specifically digital options, considering the complex contractual relationships as well as the time-lag between the actual investment and the decision about the payback. The structure and objectives of an SIB have also been transferred to other areas. In the context of development, they are implemented as so-called Development Impact Bonds (DIBs; The Center of Global Development & Social Finance, 2013). This financing mechanism intends to improve the efficiency of development assistance by improving the quality as well as the local accountability of development funding. The outcome funders in this case are also government bodies, primarily public sector agencies from developing or donor countries who pay for achieved outcomes as local administrations often lack the capital for such interventions. As of January 1, 2022, there were 221 social and development impact bonds in 37 countries around the world, including 21 in low- and middleincome countries (LMIC). The leading sectors globally continue to be social welfare (75) and employment (68), while in LMICs employment (8) and health (6) prevail (Osborne 2022). Often, they are implemented for preventative interventions leading to cost savings at a later stage. SIBs are therefore an interesting alternative for budget-constrained governments. In the context of ecologically oriented investments, the first Environmental Impact Bond (EIB) has been launched in 2016 in Washington, DC to fund the construction of infrastructure to manage storm water runoff and improve the local water quality (Glazier 2016). The construction cost will be paid for by the public administration, but the performance risk of the infrastructure is shared among government and private

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Fig. 4.1 Outcomes-based financing structure (Source Own depiction based on Beetz [2018])

investors. Consequently, payments on the bond may vary based upon the success of the environmental intervention. Another outcomes-based structure that has emerged is the so-called Social Success Note. In such a model, the service provider is contracting directly with the investor for the funding. The investor is incentivized by an outcome payer to provide this funding by an additional outcome payment. A Social Impact Incentive combines the same stakeholders, but in this case, it is the social service provider that takes out a loan and receives the outcome premium upon successful implementation (Fig. 4.1). In a recent development, fund solutions have emerged for these outcomes-based models. Rather than developing and funding outcomesbased models one at a time, outcomes funds allow for designing and/or implementing several projects simultaneously thus lowering transaction costs through greater standardization and synergies as well as mounting outcomes-based models on a larger scale. All outcome-based models need strong underlying data to calculate the costs and potential savings through various interventions. In order to provide this data, the UK government has initiated a unit cost database which collects cost estimates in a single place. Those cost estimates make it easier for social sector organization to build and develop business plans (Table 4.6). The literature on outcome-based models mentions several advantages for the involved stakeholders: Public institutions must reimburse the cost of such an investment only if the project is successful. Thus, limited financial resources can be used more efficiently and social purposes can be promoted with orientation

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Table 4.6 Costs per unit in the social sector (selection) Detail

Unit

Fiscal value

Child taken into care—average fiscal cost across different types of care setting Average cost of a fire in a domestic building Offender, Prison Male Category B prison including central costs (costs per prisoner per annum) Temporary accommodation—average weekly cost of housing a homeless household in temporary accommodation using stock belonging to a private landlord Not in Employment Education or Training (NEET)

Per year

£52.676

Per incident Per person per year

£51.129 £34.398

Per week

£177

Per year

£4.637

Source New Economy (n.d.)

toward impact. This leads to efficiency gains. Since the financial risk is taken on by private investors or the social service providers, government agencies can experiment with new innovative interventions for complex problems addressing beneficiaries that are not well-known, difficult to reach, or emerging (effectiveness gains). Moreover, through their financing structure, outcome-based models are very well suited to endorse preventive measures that could often not be funded in the past due to difficulties in proving results. Private investors can channel their funds into the social sector and thus combine financial investment with the solution of social problems. In addition, outcome-based models offer the possibility to further diversify impact investing portfolios according to individual risk-return criteria. Social organizations are enabled to focus on their core work with the beneficiaries rather than continuously fundraising through a secure financing base. In addition, the pre-defined project budget gives them a certain degree of flexibility in the administration of the funds. However, a number of challenges have also been identified that may occur during the implementation of such an instrument: There is a high complexity involved and significant transaction costs might occur. Those transactions costs can probably be reduced once a certain level of standardization is introduced. Moreover, it might be complex to determine the remuneration reflecting a risk-adjusted interest rate. Given that the remuneration is linked to the achieved social change there needs to be a professional assessment.

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Guarantee Schemes

Guarantees enable the social enterprise to take on additional debt capital. They are thus credit-enhancing and a way to leverage additional capital. The guarantor takes on the risk of the repayment and therefore enables the investee to get debt capital at preferential interest rates as the credit rating of the guarantor is used to calculate the loan terms. Governments are the traditional providers of guarantees. They give guarantees to financial institutions which leads to lower credit default costs. Once a loan is defaulting the guarantee covers these losses which leads to lower overall costs for the bank (Fig. 4.2). Potential cases are loans for housing in undervalued neighborhoods, operating loans for companies or loans for energy efficiency improvements (Schiff and Dithrich 2017). This shows that guarantees are a good financing mechanism to leverage additional capital and enable financing structures. It can either be combined with other financing provided at the same time such as equity or there can be a fee on the provision of the guarantee.

Fig. 4.2 Guarantee scheme (Source Own illustration)

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4.2.4

Catalytic Structures

Although impact investing is about investments which are repayable public subsidies and grant financing are an important component of the market for impact investments. Catalytic investments can initiate large changes through additional funding. Catalytic investments focus on initiating social change, economic development, and creating social value by attracting additional private capital. They can include a range of financing instruments as the private capital can be levered through signaling effects, risk mitigation, or capacity building which is also often referred to as investment-readiness programs. As diverse as the aims and the financing instruments are also the capital providers of catalytic solutions. They can be either institutions of the public sphere or strategic philanthropists. Ultimately, they can make high-performing social value creating enterprises investable and scalable. The main tool to achieve these targets is by attracting private capital and unlocking larger amount of capital for investments into business models with strong evidence for generating social impact. Examples of sectors that where were established by catalytic investments especially in their early stages are microfinance or renewable energy. Various instruments used have shown how to attract significant amounts of private capital while at the same time generating social and environmental value. One example is Gavi Alliance which was previously known as Global Alliance for Vaccines and Immunisation is building such a model. It pools the demand from the world’s poorest countries and signals thus that there is a large and viable market. It combines this pooled demand with support from governments and donors. One interesting financing mechanism is the International Finance Facility for Immunisation (IFFIm). It raises funds by issuing bonds which are based on legally binding commitments from donors. It thus makes the long-term commitments immediately available for programs. Convertible grants have already been discussed as an attractive financing instrument. Convertible Grants are one way to link financing in these two phases of the cycle. Donations are converted into equity in case of success. For foundations, it might be an interesting approach in a slightly modified form. As part of a funding agreement it could be determined that the foundation takes a certain share of the equity in a subsequent capital increase at a specified price and thus can secure a share of a company’s positive development.

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An optimal life cycle funding would also provide for debt in the early stage to promote innovation donations and in the later phase scaling equity when there is a viable business model. There are some investors who participate in this financing in two phases. Acumen Fund and LGT Venture Philanthropy, for example, have in some cases awarded first a donation and later a loan.

Bibliography Beal, Diana, and Michelle Goyen. 1998. Putting Your Money Where Your Mouth Is? A Profile of Ethical Investors. Financial Services Review 7 (2): 129. Beetz, Peter. 2018. Social Impact Incentives/Social Success Note. Bolton, Emily, and Louise Savell. 2010. Towards a New Social Economy: Blended Value Creation Through Social Impact Bonds. London, UK: Social Finance. Capelle-Blancard, Gunther, and Stéphanie. Monjon. 2014. The Performance of Socially Responsible Funds: Does the Screening Process Matter? European Financial Management 20 (3): 494–520. European Commission, Social Affairs and Inclusion Directorate-General for Employment, L. Klimaviˇci¯ ute, ˙ V. Chiodo, B. De Pieri, and V. Gineikyte. ˙ 2021. Study on the Benefits of Using Social Outcome Contracting in the Provision of Social Services and Interventions: A Cross-Country Comparative Assessment of Evolving Good Practice in Cross-Sectoral Partnerships for Public Value Creation: Annexes. Publications Office. https://doi.org/10.2767/412285. Glazier, Kyle. 2016. DC Water Closes Historic Deal. The Bond Buyer. http:/ /www.bondbuyer.com/news/washington-infrastructure/dc-water-closes-his toric-deal-1114647-1.html. Global Alliance for Banking on Values. n.d. Thinking People Before Profit. Global Alliance—For Banking on Values. Accessed November 2, 2016. http:/ /www.gabv.org/. Heister, Peter. 2010. Finanzierung von Social Entrepreneurship Durch Venture Philanthropy Und Social Venture Capital. Springer. https://doi.org/10. 1007/978-3-8349-6309-3.pdf. John, Rob. 2006. Venture Philanthropy: The Evolution of High Engagement Philanthropy in Europe. Oxford: Skoll Centre for Social Entrepreneurship. Lehner, Othmar M. 2013. Crowdfunding Social Ventures: A Model and Research Agenda. Venture Capital 15 (4): 289–311. Letts, Christine W., William Ryan, and Allen Grossman. 1997. Virtuous Capital: What Foundations Can Learn from Venture Capitalists. Harvard Business Review 75: 36–50. Lewis, Alan, and Craig Mackenzie. 2000. Morals, Money, Ethical Investing and Economic Psychology. Human Relations 53 (2): 179–191.

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McLachlan, Jonathan, and John Gardner. 2004. A Comparison of Socially Responsible and Conventional Investors. Journal of Business Ethics 52 (1): 11–25. New Economy. n.d. Unit Cost Database. New Economy. Accessed October 28, 2016. http://neweconomymanchester.com/our-work/research-evalua tion-cost-benefit-analysis/cost-benefit-analysis/unit-cost-database. Nilsson, Jonas. 2009. Segmenting Socially Responsible Mutual Fund Investors: The Influence of Financial Return and Social Responsibility. International Journal of Bank Marketing 27 (1): 5–31. https://doi.org/10.1108/026523 20910928218. Nofsinger, John, and Abhishek Varma. 2014. Socially Responsible Funds and Market Crises. Journal of Banking & Finance 48: 180–193. Orlitzky, Marc, Frank L. Schmidt, and Sara L. Rynes. 2003. Corporate Social and Financial Performance: A Meta-Analysis. Organization Studies 24 (3): 403–441. https://doi.org/10.1177/0170840603024003910. Osborne, Sarah, and Emily Gustafsson-Wright. 2022. A Review of the Global Impact Bonds Market in 2021 and What to Expect in 2022. Brookings (blog), January 6. https://www.brookings.edu/blog/education-plus-develo pment/2022/01/06/a-review-of-the-global-impact-bonds-market-in-2021and-what-to-expect-in-2022/. Revelli, Christophe, and Jean-Laurent. Viviani. 2015. Financial Performance of Socially Responsible Investing (SRI): What Have We Learned? A MetaAnalysis. Business Ethics: A European Review 24 (2): 158–185. Rosen, Barry N., Dennis M. Sandler, and David Shani. 1991. Social Issues and Socially Responsible Investment Behavior: A Preliminary Empirical Investigation. Journal of Consumer Affairs 25 (2): 221–234. Schiff, Hannah, and Hannah Dithrich. 2017. Scaling the Use of Guarantees in U.S. Community Investing. Global Impact Investing Network. https://the giin.org/assets/GIIN_Issue_Brief_Guarantees_final%20for%20web.pdf. Spiess-Knafl, Wolfgang, and Stephan A. Jansen. 2013. Imperfections in the Social Investment Market and Options on How to Address Them. Ex-Ante Evaluation for the European Commission. Germany: Zeppelin University. Spiess-Knafl, Wolfgang, and Barbara Scheck. 2019. Social Enterprise Finance Market Analysis and Recommendations for Delivery Options. Luxembourg: Publications Office of the European Union. Waddock, Sandra A., and Samuel B. Graves. 1997. The Corporate Social Performance-Financial Performance Link. Strategic Management Journal 18 (4): 303–319. Williams, Geoffrey. 2007. Some Determinants of the Socially Responsible Investment Decision: A Cross-Country Study. The Journal of Behavioral Finance 8 (1): 43–57.

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Wood, Donna J. 1991. Corporate Social Performance Revisited. The Academy of Management Review 16 (4): 691. https://doi.org/10.2307/258977. Ziegler, Tania, E.J. Reedy, Annie Le, Randall S. Kroszner, Bryan Zhang, and Garvey Kleran. n.d. Hitting Stride: The 2017 Americas Alternative Finance Industry Report. Accessed June 28, 2017. http://polsky.uchicago.edu/sites/ polsky.uchicago.edu/files/uploads/05242017_AltFin_V5%5B1%5D.pdf.

CHAPTER 5

Financing Instruments and Transactions

5.1

Introduction

Impact investing is different to other investment fields as investment professionals not only consider risk and return but also the impact dimension. The impact dimension is incorporated in different layers. Figure 5.1 shows illustratively the layers for the capital structure, the operating structure, and the revenue structure. At the core of the impact investing arena is the dealflow pipeline of deals. Investors can rely on different sources to find their deals. Some investors have the opportunity for social enterprises to apply directly. There is usually an option on the website where social enterprise can submit their business plan or a concept paper. Some investors also actively search for deals. Good sources are competitions, incubator programs, or reports in newspapers or magazines. There is also the possibility that other organizations refer deals. Other investors might be interested in having a co-investor. Social investment advisors might propose deals and foundations might have provided seed funding for social enterprises and then help them to find commercial investments afterward. It is also interesting to see how investments are performing financially. Performance measurements in impact investing are always restricted by small sample sizes, a survivorship bias, and self-selection problems.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 W. Spiess-Knafl and B. Scheck, Impact Investing, Palgrave Studies in Impact Finance, https://doi.org/10.1007/978-3-031-32183-2_5

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Fig. 5.1 Layers in the financing structure of social enterprises (illustrative) (Source Own illustration)

Table 5.1 Characteristics of funds

Vintage year

Number of funds

Fund size

Number of funds

1998–2001 2002–2004

6 5

6 14

2005–2007

15

2008–2010

17

2011–2014

25

2015–2019

20

$1–10 MM $10–25 MM $25–50 MM $50–100 MM $100–200 MM >$200 MM

11 22 20 15

Source Cambridge Associates (2020)

Cambridge Associates (2020) measures the performance of 88 funds which invest with an intent to generate social impact and a total volume of $14.5 billion. A large of their investments is in the United States (54.1%), followed by investments in Africa (28.0%). Most of the remaining funds are invested in global emerging markets (12.9%). Most of the funds are invested in multiple industries (84.0%) and with information technology as the most relevant single sector (9.4%).

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Table 5.2 Fund index summary 1-quarter 1-year Cambridge Associates PE/CV Impact Investing Index Bloomberg Barclays Capital Government/Credit Bond Index MSCI World ex US Index (net) MSCI World Index (net) MSCI Emerging Markets Index (gross) Russell 1000 Index Russell 2000 Index S&P 500 Index

3-year

5-year 10-year 15-year

−5.88

−0.13

5.14

4.96

5.86

5.34

3.37

9.82

5.17

3.54

4.15

4.49

−23.26 −21.05 −23.57

−14.89 −2.07 −0.76 −10.39 1.92 3.25 −17.36 −1.25 0.01

2.43 6.57 1.04

3.06 5.33 5.8

−20.22 −30.61 −19.6

−8.03 4.64 6.22 −23.99 −4.64 −0.25 −6.98 5.1 6.73

10.39 6.9 10.53

7.63 5.71 7.58

Source Cambridge Associates (2020)

Table 5.1 shows the funds classified with vintage year and fund size. Analyzing the performance of those 63 funds it is interesting to compare the performance with other funds. On a 15-year horizon they have an annual return of 5.34% which compares favorably to other asset classes (Table 5.2).

5.2

Financing Instruments

There is little research on why certain financing instruments are used. There are many factors which need to be taken into account. Entrepreneurial flexibility and agency topics remain other factors which need to be taken into account. Debt capital requires a mature business model and stable cash flows. Equity capital gives the investor control and voting rights and might give rise to agency conflicts. Grants or financing instruments with a grant component might limit the entrepreneurial flexibility of social enterprises. A typical case in the social sector is that a donor demands the opening of a new branch or office in his local home town although it might not be in the best interest of the social enterprise.1 1 In the non-profit literature, there is a research strand which deals with the capital structure and the financing instruments of non-profit organizations. Financing of nonprofit organizations different from for-profit companies through the equity limit. Being limited to non-profit legal forms, non-profit organizations cannot rely on external equity funds for financing.

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In the choice of the financing instrument, there are two classical theoretical approaches which are based either on the agency theory or considerations of information asymmetries. In the theories that are based on the agency theory, debt plays a central role. It revolves around tradeoff considerations which is why they are also known as trade-off theories (Harris and Raviv 1991). A major advantage of borrowed capital is the tax deductibility of interest. Through this tax benefit the company value can be maximized to a certain degree of debt. In the case of conflicts between capital providers and management borrowed capital brings advantages in resolving agency conflicts. As Fedele and Miniaci (2010) conduct a study of 504 Italian companies in the field of social housing and the use of leverage. They show that the leverage of the for-profit companies in this area is 6% higher than for nonprofit companies and name two possible effects. The commitment of the non-profit entrepreneur reduces the risk of moral hazard compared to a for-profit entrepreneur and the profit distribution restriction increases the company’s equity and reduces leverage through retained earnings. There are, however, also trade-off considerations between the shareholders and lenders. From the equity point of view, it would be attractive if the lender provided the entire capital but received only a portion of the operating profits in the form of interest payments. For these reasons lenders fear that the management is pursuing particularly risky projects. However, this theory is not directly applicable to the choice of financial instruments for social enterprises. Although it would be conceivable that there would be an optimal capital structure for a financially viable financial return expectation, this theory considers the multidimensional returns expectations of the investors only to a small extent. While a borrower is also keen to invest in safe investment projects, it is difficult to determine social return expectations in this context. In addition, it is not unusual for the same investors to provide equity and equity at the same time. The second classical theory from the for-profit sector in addition to trade-off theory is the so-called pecking order theory (Myers 1984). It relates to information asymmetries between investors and management. Basically, the management of a company is much more informed about planned investment projects than external investors. For example, new shareholders demand a higher return because they have less information about possible investments than the management and therefore take a higher risk. In this context, one can speak of a clear preference order of financing options. The financing options are internal financing through

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capital reserves or operating cash flows, external borrowed capital, and external new equity as the least preferred option. In the case of social enterprises, this theory approach is not directly applicable to possible information asymmetries and proportional return requirements. It is driven by the fact that there is no corresponding link between the risk and the return on the financing of a social enterprise. Thus, depending on the investor’s expectation of return, the return on an equity instrument can be very low, negative, or at market levels. However, an extension of the existing pecking order theory, taking account of control, could contribute to a better understanding of the decision-making criteria in the choice of financing instruments. Control is another variable which has to be considered in this area. In the case of donations, it can be assumed that a social enterprise is limited in its entrepreneurial flexibility. The social enterprise must usually meet the expectations of the donor. Donations can usually only be used for specific purposes and mostly for project expenditures. In the case of equity, the investor receives voting rights and will usually only provide equity for a growth strategy. Although debt increases the financial pressure on the social enterprises, the participation rights of lenders are usually rather low. Social enterprises in the choice of financing instruments must consider a possible trade-off between growth financing and company accountability. The course of the beam indicates how pronounced the respective dimension is. The flexibility in the use of funds for donations is low, for example, while flexibility in the use of funds with repayable debt is very high. The different financing instruments are suited for different forms of investments. Financing instruments are equity capital, debt capital, mezzanine capital, hybrid capital, and donations. They can be described according to the repayment requirements and the interest-bearing characteristics. For impact investors, all instruments except for donations are of interest (Fig. 5.2). 5.2.1

Equity Capital

Equity capital is the most suited financing instrument to finance longterm investments, start-up costs or to cover short-term losses. Contrary to other forms equity capital is not repayable and the capital provider has several benefits. The capital provider gets a proportional part of the profits

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Fig. 5.2 Financing instruments (Source Based on Achleitner et al. [2011a])

and has voting and control rights. The right to sell the shares or the stake in the company is often restricted by the company and depends on the clauses of the contract (Ben-Ner and Jones 1995; Brown 2006). Impact investors need to consider legal restrictions. Many social enterprises use a non-profit form which do not allow the use of equity capital as there is a profit distribution constraint. Often, there is a hybrid structure in which a non-profit entity owns a for-profit entity. Those entities can be used for equity investments. Equity capital is the form most often used by business angels, social venture capital funds. At the beginning, there are also often investments by friends or family (Mac an Bhaird and Lucey 2010). Equity capital is the riskiest form of investments and therefore has another range of investors. Within equity capital, there are further differences which are driven by the return expectations of the investors. Patient capital refers to equity capital which is provided without the expectation of any profit distributions. Normal equity capital is used by traditional investor which expects a return on the investment. The return can be realized when the shares are sold or when the company pays a part of their profits as profit distribution to the shareholders. Among social enterprises the use of equity capital is not well established. There is often the fear of a mission drift which refers to the fact that an investor might push the enterprise to focus on the financial instead of the social goals (Achleitner et al. 2013; Brown and Murphy 2003).

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5.2.2

103

Debt Capital

Debt capital is a form of financing used for long-term projects with stable and predictable cash flows. Debt capital is most often provided by banks but also by investors who search for safer investments than equity capital. It therefore requires a low-risk financial model. Debt capital is repayable at the end of the period and the investee has to pay an interest payment in certain pre-defined time intervals. It is also possible that the interest payment is paid in the form of a balloon or bullet payment at the end of the period. Debt capital providers are preferred in case of an insolvency and have the first right to any liquidation payments. Compared to equity capital debt capital has a fixed exit mechanism but requires a more stable business model. Looking at the use of debt capital among non-profit organizations there are interesting figures. 60% of the US-based non-profit organizations use a form of debt capital (Yetman 2007). The pricing of the debt capital is often not linked to the risk but to the affordability. It may be that individuals donate the interests earned in so-called linked deposits (Varga and Hayday 2016). Debt capital can be unsecured or secured. They also have different ranks in the financial structure and it can be junior or senior. Debt capital can also come as mortgage, working capital, bonds in the capital market, or simple overdrafts. For debt capital (Fedele and Miniaci 2010) find that for-profit companies have a higher leverage than social enterprises. They argue that there is a reduced moral hazard problem with social entrepreneurs which would potentially allow for more leverage. On the other side, the nondistribution constraint reduces the leverage.

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5.2.3

Other Forms

Other forms include mezzanine capital, recoverable grants, forgivable loans, convertible grants, revenue share agreements, and two financing instruments which can be used as additional or supplementary tools (Achleitner et al. 2011a, b). Mezzanine Capital Mezzanine capital combines the benefits of equity and debt capital. It has a repayment and interest component but can also benefit from a positive equity valuation of the company. It is a relatively popular financing instrument as it gives structuring flexibility to build the financing around the needs of the investee. Recoverable Grants Recoverable grants are grants which are repayable if certain milestones are reached. The investor carries the total risk of the investment and it might create unattractive incentive structures. Forgivable Loan Forgivable loan is debt capital which is reduced when the investee reaches certain milestones. It is well-known from the employee funding where the employee needs to return for a certain time period after the company paid for an executive education. It can be used to prevent a mission drift as the investee has to follow the social mission. Convertible Grant Convertible grants are a financing instrument which are only converted into equity capital if the company is successful. This might be attractive for industries which are in their early stages but have the potential to be attractive. Industries which might serve as an example are the renewable energy sectors. Revenue Share Agreement Revenue share agreements are another attractive financing instrument. The investor is providing a certain amount of capital and receives his repayment in the form of a pre-defined proportion of the overall revenues. This gives the social enterprise a flexible cost structure.

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Grants Grants are rather used as supplementary and additional financing instruments. Grants are the most widely used financing instrument in the social sector and especially popular among foundations. Grants are not repayable and carry no interests or dividends. They are therefore not part of the impact investing universe but investors can use them to provide grants for capacity building or for a certain social project.

5.3 5.3.1

Investments

Structure of the Investments

One of the early studies on the structures of deals was done by SpiessKnafl and Aschari-Lincoln (2015). This study was based on the analysis of 342 social investments. They were done in a rather narrow field which excludes microfinance, social banking loans, or clean tech. The investments were done by Aavishkkaar, Acumen, African Agricultural Capital, Bamboo Finance, Beyond Capital Fund, BonVenture, Big Issue Invest, Bridges Venture, CAN Breakthrough, Core Innovation Capital, d.o.b. Foundation, E+Co, Equitas, Ferd Social Entrepreneurs, Good Capital, Grassroots Business Fund, Gray Ghost Ventures, Impetus, Ignia, LGT Venture Philanthropy, New Profit, Noaber Foundation, Oltre Venture, Phi Trust, Private Equity Foundation, REDF, Social Venture Fund, Tony Elumelu Foundation, Venture Some, and Willow Tree (Table 5.3). It shows that grants are still important. Grants are the backbone of many social enterprises and help them develop the business model and fund the program. More than 76% was commercial capital. Equity was the most important financing instrument which was used in 58.9% of the investments. Given the difficulties in selling shares in a company, there is also a high degree of debt capital in the industry. 19.6% are pure debt capital and another 12.6% were combinations of equity and debt capital. 8.6% of all commercial investments were structured with other financial instruments such as revenue share agreements or similar other financing instruments. Interestingly, 47.5% of all financial transactions are less than $500,000 while financial transactions exceeding $1,000,000 compose 31.1%.

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Table 5.3 Use of financing instruments

Financial instrument

Number of deals

Relative proportion (%)

Median investment size

Philanthropic Capital Commercial Capital Thereof: Equity Debt Equity and Debt Other

80

23.4

768,000

262

76.6

500,000

96 32 21

58.9 19.6 12.9

600,000 335,385 580,796

14

8.6

624,543

Source Based on Spiess-Knafl and Aschari-Lincoln (2015)

Table 5.4 Age distribution of investments

Age (years)

Observations

Share (%)

Median investment size

0–2 3–5 6–8 9–14 15–19 20–29 30+ Total

134 72 44 50 12 10 5 327

41.0 22.0 13.5 15.3 3.7 3.1 1.5 100

467,677 600,000 397,562 734,000 702,359 200,185 217,905

Source Based on Spiess-Knafl and Aschari-Lincoln (2015)

Another interesting distribution is the age structure of the investments. 41% of all financial transactions involved social enterprises which were between 0–2 years. The remaining investments were distributed among the other age groups. Analyzing the probabilities of receiving commercial or philanthropic capital it was interesting to note that the odds of a social enterprise aged 5 years or older obtaining grant financing are three times higher than the odds of such an enterprise receiving commercial capital. Possible reasons may include self-selection or reputational considerations. That means that a foundation is more willing to invest in older social enterprises with a proven track record (Table 5.4).

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Table 5.5 Focus groups in different regions Focus groups

Western countries

Farmers + rural Disabled + sick, disadvantaged, children + youth + young adults

Non-Western countries

Observations

Share Observations (%)

Share (%)

2 152

1.1 82.2

72.8 25.2

110 38

Source Based on Spiess-Knafl and Aschari-Lincoln (2015)

There is also an interesting pattern when the investments in Western and Non-Western countries are compared. In Western countries, there is a focus on specific and identifiable target groups whereas in NonWestern countries there is a focus on more general population groups. This relationship is shown in Table 5.5. 5.3.2

Exits

There are basically three different exit options depending on the form of the investment. Equity investments necessitate a form of transaction. In the case of a management buy-out (MBO) the management buys the stake usually by taking on a loan provided by banks. It is also possible that another fund is paying the stake or that a strategic partner is willing to take over the stake. The strategic partner is usually an industrial partner who is interested in taking over the brand, technologies, or customer base. Debt investments are easier to handle as the two financing streams are easy to manage. The interest payment has to be made every year and the principal needs to be repaid at the end of the financing period. There is also the possibility that the loan is refinanced which implies that the loan is not repaid but turned over. Mezzanine capital combines the benefits of both instruments. It is repayable as debt capital and therefore relatively certain to plan and it adds some return potential due to some participation of the profit development. Especially, equity investments put some pressure on the capital provider. Private equity investments are illiquid. Funds need to exit their

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investments given their limited lifetime and the requirement by investors to repay the money invested. There are only a few funds which do not need to repay their investments. This is also an advantage for family offices or business angels who are able to hold an investment for longer periods of time. That means that investors need to think about exit scenarios for their investments. One analogy can be found in the sector for organic products. Ben & Jerry’s was founded in 1978 in Vermont and has made its name for ethical behavior. In April 2000, Ben & Jerry’s was taken over by Unilever for $326 million. Unilever has decided to leave the foundation and to pay $5 million to the Foundation and its staff at the same time (The New York Times 2000). It is not clear which impact the acquisition had on the company but it is often considered as a valuable starting point for the sustainability strategy of the company. This acquisition also illustrates why those brands are attractive. Customer’s willingness to pay a premium for these products is higher. It is also likely that social enterprises have more loyal customers and a younger generation of customers and employees demand a more society-centered approach to doing business. Additionally, some authors talk about a moralization of markets (Stehr 2008). Customer campaigns in products such as palm oil, cotton, coffee, furniture, toys, or leather are an example for a shift in the consumer markets. Another point is that many innovations are increasingly coming from the social sector. Peer-based concepts in the sharing economy were first established by social enterprises. There is a focus on companies with a strong brand and customer narrative. Potential targets could be ethical fashion brands, social tourism providers, social finance intermediaries, supply chain technologies providers, or urban mobility concepts. One of the trends which will be there over the coming years is the acquisition of social enterprises by mainstream companies. We see various shifts. Consumers are increasingly willing to pay for products with an added social value (Engelke et al. 2014). There are also public procurement directives which enable the purchase of products and services of social enterprises. Students and graduates are increasingly looking for job opportunities with companies following a social mission. Other logics arise against the backdrop of steady consumer pressure with a view to the production conditions for coffee, tea, palm oil, cotton

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and textiles, electronics, toys, furniture, and the social impact of tourism or financial services. All those changes in the consumer motivate companies to consider their positioning. One way can be the acquisition of social enterprises. Acquisitions are mostly seen in the context of sales-enhancing purchases, especially with regard to new market access. However, such transactions also play an essential role, for example, when certain skills are acquired (Neely et al. 2015). An interesting industry is the microfinancing industry. Many for-profit banks have a background as an NGO. Additionally, profitable companies have purchased non-profit organizations. The acquisition of a social enterprise usually involves the transfer of equity in the form of company shares or shares. This possibility exists also for social enterprises, which use a profit-oriented company form. Otherwise, there might be other possibilities like asset deals. The transactions of ethical brands can be a good indicator (Table 5.6). These were the acquisitions which took place in the space for ethical brands. It is thus an emerging trend and only a few examples exit so far. In addition, social enterprises build loyal customer bases, which are interesting for many other companies, not just because they are more willing to pay. In addition, up to an expertise in areas such as social tech or healthcare that are interesting additions. Transactions are conceivable in many areas. Tourism, banking, or consumer goods are future possible investment targets. Table 5.6 Acquisition of ethical brands Target

Industry

Buyer

Purchase price, year of acquisition

Seeds of Change Cascadian Farm Ben & Jerry’s Kashi Lightlife Foods

Organic Food

Mars

Not publicly disclosed, 1997

Organic Food

General Mills

Not publicly disclosed, 1999

Social Unilever Consciousness Organic Food Kellogg’s Vegetarian food ConAgra

326 million USD, 2000 $33 million, 2000 Not publicly disclosed, 2000

(continued)

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Table 5.6 (continued) Target

Industry

Buyer

Purchase price, year of acquisition

Odwalla Stonyfield Farm

Organic Food Organic Products

Coca-Cola Danone

Green & Black Tom’s of Maine Body Shop

Organic Food

Cadbury

181 million USD, 2001 Not publicly disclosed, 2004, sold in 2017 to Lactalis for 875 million USD 20 million GBP, 2005

Organic Products Organic Products Organic Products Organic Products Organic Food

Colgate-Palmolive

$100 million, 2006

L’Oreal

GBP 652 million, 2006

Clorox

925 million USD, 2007

Coca-Cola

Total sum unknown, 76 million GBP for 38%, 2009, 2010, 2013 Na, 2009, 2012

Burt’s Bees Innocent Bionade

Radeberger (Oetker Group)

Source Jansen and Spiess-Knafl (in press)

Table 5.7 shows an overview of social enterprises which were acquired in recent years. Singapore-based Start Now was created in the Enterprise Social Venture Lab and creates software solutions for social sector organizations. UK-based Roadio develops online tools for people interested in learning how to drive. Another UK-based social enterprise is Slivers of Time. The social enterprise recruits, places, and evaluates volunteers. It as acquired by Brookfield Rose which can take advantage of these skills in the management of temporary employment relationships. Charles Printing was a small company employing 8 people with intellectual disabilities. The acquirer promised to keep the social mission of the company for at least one year. In 2014 Bain Capital acquired 50% of the shares in Toms Shoes. The company was valued at a valuation of 625 million USD. HessNatur was founded in 1978 and is a pioneer of the fair-trade industry. Neckermann took over the majority in 2001 and sold the company in 2012 in a secondary deal to Swiss financial investor Capvis. Hess Natur has annual revenues of 73 million euros and a customer base of one million customers.

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Table 5.7 Acquisition of social enterprises Target

Industry

Buyer

Value

Start Now (Singapore) Roadio (UK) Slivers of Time (UK) Charles Printing (Canada) Toms Shoes

Software for social contractors Software Recruitment

Goodtizens Technologies a2om Brookfield Rose

381,000 USD

Print services

Groupe convex

Not publicly disclosed

Shoes

Bain Capital

Hess Natur

Fair Trade Trade

JustGiving

Charity Crowdfunding Platform

Neckermann (2001) Capvis (2012) Blackbaud

50% stake at a company valuation of 625 million USD Not publicly disclosed

Not publicly disclosed Not publicly disclosed

95 million GBP

Source Own research, Jansen and Spiess-Knafl (in press)

An interesting case is JustGiving which was acquired in 2017 by Blackbaud for 95 million GBP. JustGiving is a leader in the crowdbased fundraising for charities. Since 2001 they have helped charities and individuals raise 4.5 billion USD. The acquirer is a company providing software solutions to non-profit and social sector organizations. There are different motivations for those transactions. Social enterprises have a loyal customer base which are willing to pay higher prices. There might be some conflicts once the transaction becomes public and could possibly damage the brand. Social enterprises also have a different skill set managing a diverse set of stakeholders. They are also better in being a purpose brand and being attractive for employers. Especially, the younger generation is looking for ways to engage with the social mission of a company. The microfinance sector has seen some institutions. These institutions include Compartamos (Mexico), Equitas Micro Finance India (India), Equity Bank (Kenya), Janalakshmi Financial Services (India), MiBanco (Peru), and SKS Microfinance (India). Those institutions provided at least 5× or greater returns to their investors (Bannick et al. 2015).

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5.4 5.4.1

Technical Aspects Structure of the Fund Industry

The fund industry is mostly following the same model. A team of investment managers set up a management company which is referred to as General Partner (GP). The GP is raising funds from insurances, banks, family offices, or wealthy individuals which are called Limited Partners (LP). The investment managers are then investing the capital of the LPs often across different funds in target companies. A new management company usually starts with a small first fund which is often in the range of $10–20 million. Over time, the management company builds a track record and is able to attract additional investors and thus increase the fund size. A second fund might already be in the range of $20–40 million, and a third fund might again be larger than the first two funds as shown in the illustration. Increased fund sizes are important as the investment managers charge fees which are usually in the range of 2% of the committed, respectively the invested capital. Smaller funds are thus not sustainable in the long term as they barely cover the operating expenses (Fig. 5.3). The creation of a new fund is rather costly with many uncertainties. The fundraising process takes 18–24 months as the investment team might have to speak with hundreds of investors. Potential investors expect detailed information about aspects such as the management team, the investment strategy, the track record, the target market, expected returns, and terms. The preparation of these documents takes time.

Fig. 5.3 Fund structure (Source Own illustration)

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In addition, legal advisory is needed to set up the entities and contracts which govern the investment process and the distribution of cash flows between fund management company and the limited partners. A typical fund might use the following description for the management fee: 2.00% of committed capital during the investment period, 1.75% of invested capital for two following years, thereafter the greater of 90% of the annual management fee for the immediately preceding year and 0.25% p.a. of aggregate Invested Capital.

Most investment funds have an impact component to determine the performance fee. The performance fees are usually covered in the following way: First, 100% to Limited Partners until they receive their Realized Capital and Costs and an 8% per annum cumulative annually compounded internal rate of return on their Realized Capital and Costs. Then, 100% to the General Partner until the General Partner “catches up” to an overall 20% Carried Interest, followed by 20% to the General Partner and 80% to Limited Partners.

It is also clear that some LPs have higher financial return expectations, while others have lower return expectations. In practice, we see a range of 5% to 15%. These financial return expectations also impact the investment strategy as there is a trade-off between social and financial objectives. 5.4.2

Valuation of Social Enterprises

The valuation of a social enterprise is a key element of the investment process. A high valuation might negatively impact the fund return and the long-term sustainability of the fund. A low valuation could cause social enterprises to reject the investment proposal and look for alternative sources of capital. There are many different ways to value companies (Koller et al. 2020). In principle, the valuation only depends on the underlying financials such as revenues, costs, profitability, and projected cash flows. These cash flows are then discounted to calculate a net present value as shown in Fig. 5.4.

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Fig. 5.4 Principles of valuation (Source Own illustration)

Impact considerations impact the valuation on two levels. The first level is the structure and sustainability of the financials, and the second level is the cost of capital which is used to value a social enterprise. Impact considerations can influence the underlying financials of the social enterprises. Social enterprises might have customers with a higher willingness to pay or might have lower operating costs as they are able to mobilize third-party resources. Customers are also considered to be more loyal. There are many examples to illustrate this tendency. Sustainably sourced minerals or food can be sold for higher prices, while there might be lower risks for corporate scandals. The impact considerations also reduce the cost of capital. Investors are willing to reduce their risk-adjusted return of capital to support the impact of the company. It means that different investors have different return expectations which obviously has an impact on the valuation. These considerations are also at the core of the social enterprise itself in the form of trade-offs. For fair-trade companies lower sourcing prices mean higher margins but less income for the local communities. Microfinance companies might charge higher interest rates but would reduce the available capital for the clients at the same time. Theaters and museums

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might offer inclusive pricing options such as open Tuesdays which reduce the total revenue they can generate.2

Bibliography Achleitner, A.K., A. Heinecke, A. Noble, M. Schöning, and W. Spiess-Knafl. 2011a. Unlocking the Mystery: An Introduction to Social Investment. Innovations 6 (3): 145–154. https://doi.org/10.1162/INOV_a_00090. Achleitner, Ann-Kristin, Andreas Heinecke, Abigail Noble, Mirjam Schöning, and Wolfgang Spiess-Knafl. 2011b. Unlocking the Mystery: An Introduction to Social Investment. Innovations 6 (3): 145–154. Achleitner, Ann-Kristin, Eva Lutz, Judith Mayer, and Wolfgang SpiessKnafl. 2013. Disentangling Gut Feeling: Assessing the Integrity of Social Entrepreneurs. VOLUNTAS: International Journal of Voluntary and Nonprofit Organizations 24 (1): 93–124. https://doi.org/10.1007/s11266012-9264-2. Bannick, Matt, Paula Goldman, and Michael Kubzansky. 2015. Frontier Capital—Early Stage Investing for Financial Returns and Social Impact in Emerging Markets. https://www.omidyar.com/sites/default/files/file_arch ive/insights/Frontier%20Capital%20Report%202015/ON_Frontier_Capital_ Report_complete_FINAL_single_pp_100515.pdf. Ben-Ner, Avner, and Derek C. Jones. 1995. Employee Participation, Ownership, and Productivity: A Theoretical Framework. Industrial Relations: A Journal of Economy and Society 34 (4): 532–554. Brown, Jim. 2006. Equity Finance for Social Enterprises. Social Enterprise Journal 2 (1): 73–81. Brown, Hilary, and Emma Murphy. 2003. The Financing of Social Enterprises: A Special Report by the Bank of England. London: Bank of England Domestic Finance Division. Cambridge Associates. 2020. Private Equity & Venture Capital Impact Investing. Engelke, Henning, Stefanie Mauksch, Inga-Lena Darkow, and Heiko von der Gracht. 2014. Heading Toward a More Social Future? Scenarios for Social Enterprises in Germany. Business & Society. https://doi.org/10.1177/000 7650314523096. Fedele, Alessandro, and Raffaele Miniaci. 2010. Do Social Enterprises Finance Their Investments Differently from For-Profit Firms? The Case of Social Residential Services in Italy. Journal of Social Entrepreneurship 1 (2): 174–189.

2 Some are referring to the “lockstep model” which postulates that impact and returns are increasing at the same time. This might be true for growing companies but is hard to imagine for stable businesses.

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Harris, Milton, and Artur Raviv. 1991. The Theory of Capital Structure. The Journal of Finance 46 (1): 297–355. Koller, T., Marc Goedhart, and D. Wessels. 2020. Valuation: Measuring and Managing the Value of Companies. McKinsey & Company. Mac an Bhaird, Ciarán, and Brian Lucey. 2010. Determinants of Capital Structure in Irish SMEs. Small Business Economics 35 (3): 357–375. https://doi. org/10.1007/s11187-008-9162-6. Myers, Stewart C. 1984. The Capital Structure Puzzle. The Journal of Finance 39 (3): 574–592. Neely, J., John Jullens, and Joerg Krings. 2015. Deals That Win. http://www. strategy-business.com/article/00346?gko=47f36. Spiess-Knafl, Wolfgang, and Jessica Aschari-Lincoln. 2015. Understanding Mechanisms in the Social Investment Market: What Are Venture Philanthropy Funds Financing and How? Journal of Sustainable Finance & Investment 5 (3): 103–120. Stehr, Nico. 2008. The Moralization of the Markets in Europe. Society 45 (1): 62–67. The New York Times. 2000. Ben & Jerry’s to Unilever, with Attitude. The New York Times, April 13. http://www.nytimes.com/2000/04/13/business/benjerry-s-to-unilever-with-attitude.html?_r=0. Varga, Eva, and Malcolm Hayday. 2016. A Recipe Book for Social Finance— A Practical Guide on Designing and Implementing Initiatives to Develop Social Finance Instruments and Markets. Luxembourg: Publications Office of the European Union. http://ec.europa.eu/social/main.jsp?catId=738&lan gId=en&pubId=7878. Yetman, R.J. 2007. Borrowing and Debt. In Financing Nonprofits, ed. D.R. Young, 243–268. Lanham, MD: AltaMira Press.

CHAPTER 6

Impact Measurement and Management

6.1

Introduction

In the final section of this book, we would like to address the crucial topic of assessing impact as well as the various tools used to measure and manage the impact of the investing strategy. Impact measurement and management (IMM) is paramount for impact investors to ensure that they are indeed delivering on their claim to generate a positive impact with their investments. In general, any investment can be said to have a social impact; different from other forms of socially responsible investment, the most prominent feature of impact investing is a focus on demonstrating the social or environmental return that it generates. Hence, IMM is fundamental for the entire concept of impact investing. Furthermore, IMM helps impact investors mitigate the risk of mission drift—that is, the possibility that investees will prioritize financial objectives over social ones—and exploitation, which are legitimate concerns with regard to impact investing. It is therefore not surprising that IMM is regularly mentioned as a focal element of impact investing definitions. However, traditional performance measurement involving the mere gathering of financial indicators is insufficient in the case of social enterprises. The possibility of generating income at all depends on which social problem the organization is tackling (Dees 1998; Foster and Bradach © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 W. Spiess-Knafl and B. Scheck, Impact Investing, Palgrave Studies in Impact Finance, https://doi.org/10.1007/978-3-031-32183-2_6

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2005); Furthermore, reaching financial goals is only of secondary importance for social entrepreneurs (Brinckerhoff 2000; Kramer 2005; Nicholls 2005). However, demonstrating impact is complex and impeded by methodological difficulties, such as the measurement of often intangible effects or the collection of field data. As a result, IMM so far has often remained largely focused on costs and outputs (i.e., direct measurable results, such as the number of lives touched by a program). Assessing the social and/or environmental effects of business activities has been subject of wide discussions in the corporate world: Analyzing the relationship between corporate social performance (CSP) and corporate financial performance (CFP) is a major research topic in the area of corporate social responsibility and is reflected in concepts such as shared or blended value. And although the empirical results clearly point toward a highly significant, positive, robust, and bilateral correlation between CFP and CSP (see Busch and Friede 2018), traditional businesses focus on financial performance first. Social enterprises, however, primarily aim at achieving a social return and thus need to focus even more on assessing the effects their actions have. A variety of frameworks and tools to capture social value creation has been developed over several decades. But although the non-profit sector has made significant progress in developing metrics and is becoming increasingly data rich, the status quo of evaluation practices can still be described as extremely fragmented as well as limited in scope and scale, with no mandatory requirements or standardized scientific concepts, methods, or objective criteria for social impact evaluation and reporting. This chapter will therefore demonstrate the relevance of and necessity for IMM and will then illustrate various methods that have been applied in order to determine the effects of impact investing.

6.2

Purpose of IMM

For investors as well as investees in impact investing, IMM provides various benefits.

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Investors and fund managers: ● Improving impact performance: Impact investors make financial investments foremost to create social impact and secondly to generate a financial return. Thus, assessing the social impact of the investments is fundamental and constituent to this investment strategy. Better evidence on results can help ensure that scarce resources are allocated where they can have the most impact. ● Making more informed investment decisions: Integrating IMM before the investment, already in the screening and due diligence stage, enables a better allocation decision, channeling resources toward the most (socially) promising organizations. During the investment, IMM supports investment managers in their collaboration with the investee. Furthermore, some investors use impact-related data to determine the conditions under which tranches of capital will be released. At the end of the investment cycle, IMM can inform the exit decision in terms of identifying possible and appropriate exit channels as well as potential buyers. ● Improving financial performance of the portfolio: By better understanding the beneficiaries of the funded social organization (e.g., social context, socioeconomic status, access to services, preferences), revenue growth can be optimized, for example, by developing more effective marketing, accessing new market segments, developing/ refining products and services, or better informing the product and pricing strategy. Practical examples can be found at the website of the Global Impact Investing Network (GIIN 2016). ● Benchmarking of investments: IMM across portfolios enables investors to establish benchmarks, either for certain organizations against each other or for investments over time. Besides a more effective portfolio management and better prospective

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investment decisions, this would contribute to more transparency in the impact investing field and, hopefully to the mobilization of additional capital. ● Avoiding mission drift: It is possible that social organizations develop in a way where they are confronted with a trade-off between increasing financial returns versus achieving additional social change. Opting for the former is termed a mission drift and would contradict in most cases the investment objectives of impact investors. IMM can thus ensure that the venture remains accountable to its social mission. Social Enterprises: ● Enabling strategic alignment and risk mitigation: For social enterprises, pursuing impact is at the core of their operations and constitutes their reason for existing. Thus, assessing the progress toward these objectives helps ensure that the operations are aligned with the strategy of the organization. Likewise, a deviation from this course can be detected earlier and more easily when consistently assessing the social progress achieved and allows for spotting early warnings. ● Increasing operational effectiveness and efficiency: Besides strategic value, IMM also contributes to enhancing operational potential: Determining the most effective form of solving the addressed issue, identifying what works and what doesn’t as well as detecting areas of improvement can strengthen business operations in terms of effectiveness as well as efficiency. ● Complying to external requirements: IMM has gained importance recently due to an increased external demand for demonstrating results. IMM thus enables the social enterprise to fulfill

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its contractual obligations toward stakeholders such as funders or public authorities to assess social and/or environmental performance. ● Supporting communication and marketing: Demonstrating the benefits an organization has achieved can be a differentiating factor from other players when marketing the social organization toward investors, funders or volunteers. Showing good impact information can help building a positive reputation, and by going beyond telling positive stories, trust and goodwill with key stakeholders, e.g., local authorities or communities, can be earned. A trustful relationship then often leads to less transaction costs and fewer conflicts.

6.3

Terminology

While the word “impact” is ubiquitous in the impact investing field, not everyone understands or uses it similarly: The terminology on the subject is very heterogeneous as a variety of terms (such as social performance, outcome, or blended value) is being used interchangeably by different stakeholders to describe the intended positive societal change. One of the most accepted and widely used definitions has been coined by the Development Assistance Committee (DAC) of the Organization for Economic Co-operation and Development (abbreviated with the acronym OECD/ DAC [Organisation for Economic Cooperation and Development/The Development Assistance Committee (OECD/DAC) 2000]). The Development Assistance Committee is an international forum of many of the largest funders of aid and has the mandate to promote among others the development of cooperation and policies for sustainable development. The focus on impact and the evaluation of interventions has a long tradition in the field of development cooperation and since its establishment, OECD/DAC has sought to clarify concepts, terms, and definitions. According to the OCED/DAC understanding of impact, the social effect an organization has achieved can be illustrated by the so-called impact

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value or results chain which comprises the following element (Organisation for Economic Cooperation and Development/The Development Assistance Committee [OECD/DAC] 2000): ● Inputs: These comprise all types of resources an organization employs in order to bring about social change. They can be categorized as monetary inputs, in-kind support, and time invested by volunteers. ● Activities: These are the actions, programs, or projects the organization carries out. ● Outputs: These are the direct and immediate consequences or results of the activities. They are often clustered into number of lives touched, number of activities conducted, and number of institutions where the organization is active. ● Outcomes: These are the short- and medium-term changes the organization achieves at the beneficiary level. Outcomes thus coincide with the objectives of the organization and can causally and quantitatively be attributed to the intervention. ● Impacts: These are the long-term effects that occur during or after the intervention. Impacts go beyond the primary group of beneficiaries aiming at the institutional and societal macro level. The logical flow and the connection of these terms is often illustrated by means of a so-called impact value chain (Fig. 6.1). In other words, the long-term effects of interventions that go beyond the primary beneficiaries and reach additional target groups such as communities and families or that lead to changes on an institutional level are termed impacts. In this context, the terms “non-financial returns” and “social and environmental returns (SER)” are often used simultaneously or interchangeably. In being consistent with the above definition of impacts and outcomes, these terms can best be compared to impacts denominating benefits accruing to beneficiaries without direct link to the primary target group and/or the investment (Reeder and Colantonio 2013). Furthermore, different levels of outcome can be distinguished (see illustration “The results staircase” below). These include the development of new attitudes and/or skills among members of the target groups, changes in their behavior, and changes in their living conditions. Each step constitutes a prerequisite for the next level of change (Fig. 6.2).

6

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Activity

Output

Definition

Resources used for the intervention (time, money or in-kind resources)

Interventions carried out by the social enterprise

Examples

Financial investment by an impact investor

Number of clients Actions, tasks, served by the programs, projects, compaigns organization

Tangible, direct results of the activities that can be measured, e.g., in terms of number of lives touched, number of activities carried out, number of institutions reached

Outcome

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Impact

Social effect (change), both long-term and short-term achieved for the target beneficiaries as a result of the intervention undertaken.

Long-term effects of interventions that go beyond the primary beneficiaries and reach additional target groups such as communities and families or that lead to changes on an institutional level.

Higher self-esteem of the beneficiaries

Lower crime rate within the community.

Fig. 6.1 Impact value chain model OECD-DAC (Source Jackson and Harji [2016])

Fig. 6.2 The results staircase (Source Own depiction based on Phineo gGmbH [2016])

However, there are other, differing definitions of the terms used in the impact value chain, specifically with regard to meaning of impacts and

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outcomes. Whereas the terminology set by OECD/DAC is widely used in Continental Europe, actors from Anglo-Saxon countries often define impact as the overall change occurring on a societal level and outcome as the change resulting from a specific intervention. In order to deduce impact, it is therefore necessary to determine the so-called base case or counterfactual position (at best resorting to a control group, Sect. 7.2.4). The base case identifies what would have happened without the intervention and serves as a starting point for determining the additionality of an intervention. The concept of additionality considers the question whether an investment had impact on the addressed issues that would otherwise not have happened and thus aims at providing evidence for the success of an investment. The extent to which an observed effect would have occurred regardless of the intervention concerned is called deadweight. This includes effects attributable to interventions by other actors (Simsa et al. 2014) (Fig. 6.3) Other influencing aspects often discussed in the literature in the context of determining the specific impact of an intervention address displacement and drop-off: Displacement aims at assessing of how much of the outcome has displaced other outcomes, e.g., labor moving from

Input

Activity

Output

Outcome

- What would have happened anyways

Impact

Definition

Resources used for the intervention (time, money or inkind resources)

Interventions carried out by the social enterprise

Tangible, direct results of the activities that can be measured, e.g., in terms of number of lives touched, number of activities carried out, number of institutions reached

Changes to social systems

Specifc change within the primary taget group do the specific intervention

Examples

Financial investment by an impact investor

Actions, tasks, programs, projects, campaigns

Number of clients served by the organization

Lower crime rate within the community.

Higher self esteem of the beneficiaries due to the intervention

Fig. 6.3 Impact value chain model Clark et al. (Source Own illustration, based on Clark et al. [2004])

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one firm to another rather than new employment being created. Drop-off takes into account the deterioration of an outcome over time. Impact would thus be calculated by adjusting outcome for the effects achieved by others (alternative attribution), for effects that would have happened anyway (deadweight), for negative consequences (displacement), and for effects declining over time (drop-off) (Social Impact Investment Task Force 2014). For alternative definitions and differing concepts see Wörrlein and Scheck (2016). Regardless of the model, it is important to notice that all the steps in the impact value chain have to be connected by a causal link between the intervention and the results (Sect. 7.3). Establishing this relation is often described as a theory of change, impact thesis, or logic model. A theory of change maps the underlying assumptions about how impact will result from planned interventions by focusing on the link between what a program does (its activities or interventions) and how these lead to the desired societal change (impact and outcome). This can be done by first identifying the desired impact (long-term changes beyond the primary target group) and then working back from these to identify necessary antecedents such as outcomes and outputs. This is accompanied by a clear articulation of the underlying assumptions connecting the different steps. A theory of change thus increases the visibility of a change process and provides the basis for testing the investment assumptions about intentional impacts (Reisman and Olazabal 2016). As different as the various objectives of social organizations are, as different are depictions of their theory of change. In addition to a graphic illustration, verbal explanations are added in order to make the logic model transparent and comprehensible to third parties (Fig. 6.4). Table 6.1 gives an overview of the most frequently used terms in IMM and their meaning.

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Reduced problem behaviour

Overarching objectives

Reduced likelihood of substance abuse Children develop new skills Family functioning is improved

Intermediate outcomes

Communication within the family is improved Parental skills are improved Seven weekly sessions of 2 hrs Activities with moderator – parent, children separate

Activities

Activities with moderator – parent, children together Coaching on specific skills and areas of family life

Fig. 6.4 Theory of change, planning triangle for a substance abuse initiative (Source Own illustration based on Harries et al. [2014])

6.4

IMM Along the Investment Process 6.4.1

The IMM Process

The goal of IMM is to maximize or optimize (relative to cost) the process of generating social impact. The European Venture Philanthropy Association (EVPA), a community of venture philanthropy investors, recommends five steps of IMM, namely. 1. setting objectives, 2. analyzing stakeholders, 3. measuring results, 4. verifying and valuing impact, and 5. monitoring and reporting (EVPA 2013). The European Commission’s GECES Sub-group on Impact Measurement recommendation for a social impact measurement process is based on this concept (GECES Sub-group on Impact Measurement 2014). Phineo, a German rating and consulting agency for social impact distinguishes three overarching steps in IMM:

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Table 6.1 Overview terminology Activities Additionality Attribution Base case

Counterfactual Deadweight Displacement Drop-off Impact

Impact value chain Input Materiality

Outcome Output

Theory of change

Actions, programs, or projects the organization carries out Referring to the extent to which an investment has made a difference and has resulted in change Deducting the effect achieved by the contribution and activity of others Identifies what would have happened without the intervention and serves as a starting point for determining the additionality of an intervention Measures what would have happened to beneficiaries in the absence of the intervention, often by means of a control group Changes that would have happened anyway, regardless of the intervention Assessment of how much of the outcome has displaced other outcomes Allowing for the decreasing effect of an intervention over time Long-term effects of interventions that go beyond the primary beneficiaries and reach additional target groups such as communities and families or that lead to changes on an institutional level Illustration and logical link between inputs, activities, output, outcome, and impact Resources used in delivery of the intervention, can be time, money, or in-kind Data that is of such relevance and importance that it could substantively influence the assessments of providers of financial capital with regard to the organization’s ability to create value over the short-, medium, and long term Social effect (change), both long term and short term achieved for the target beneficiaries as a result of the intervention undertaken The tangible results from the intervention, effectively the points at which the services delivered enter the lives of those affected by them, expressed e.g., in terms of people reached, products or services The means (or causal chain) by which activities achieve outputs and outcomes, and use resources (inputs) in doing that

Source Own depiction based on Social Impact Investment Task Force (2014) and GECES Sub-group on Impact Measurement (2014)

1. Planning results comprises understanding the social problem, setting objectives, and developing the logic model; 2. Analyzing results includes the preparation of the analysis, the formulation of indicators, data collection, and data analysis; 3. Improving results focuses on learning and improving as well as on reporting (Phineo gGmbH 2016).

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Fig. 6.5 IMM along the investment process (Source Own depiction)

IMM can thus be conceived as an umbrella term for a combination of planning, assessment, documentation of outcomes, and reaction to the assessed outcomes. The specific steps comprised in IMM, independent of the concept or author, should not be understood as linear but rather as a continuous development, in which steps might to some extent happen simultaneously (Wörrlein and Scheck 2016). In order to understand the theory of change as well as to link the intended changes to the overall scale and scope of the societal problem as well as the strategy of the organization, it is essential to not think about IMM as a stand-alone activity but rather as an integrated tool accompanying the entire investment process (Fig. 6.5). 6.4.2

Pre-investment Analyses

When searching for potential investments during the sourcing process, impact investors need an easy-to-use first screening mechanism to assess the general fit of the potential opportunity with their own investment strategy. For this purpose, investors often communicate their general investment criteria broadly and sometimes use simple questionnaires to

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be filled out by potential investees. This quick check covers basic parameters such as geography, impact sector, funding volume, or legal structure filtering for potential deals. Investees that would potentially align with the investor‘s strategy are then explored in more detail during the due diligence process. Regarding the impact due diligence, an investor usually aims at verifying the company’s theory of change, meaning, it aims to determine if the chosen approach has yielded impact yet. In addition, the impact potential for the duration of the investment is determined as well as potential impact risks and opportunities. There is no standardized approach when it comes to the impact due diligence. Investors use individual or standardized questionnaires, conduct interviews with experts in the field, and sometimes engage external consultants to conduct impact analyses. The result of the impact due diligence can then be used for the presentation of the investment in investment committees, as well as for structuring the investment with regard to impact milestones to be reached. 6.4.3

Post-investment Analyses

Having invested in a company, impact investors then continue with IMM during the holding period of the investment. Selected indicators on the output as well as on the outcome level are used to monitor the development of the investment on an ongoing basis. Impact data is collected and regularly reported to interested stakeholders, often together with financial data in a monthly rhythm. When an impact investor chooses to exit an investment, impact data becomes especially important when selling a stake to a strategic investor who would like to expand its impact. The impact created during the investment period can then serve to estimate a unit price for impact.

6.5

Challenges in IMM

Many investors still focus on the financial return of their investments; social return is still a secondary priority (NPC/Clearly So report on investment readiness). This is mostly due to a variety of challenges and difficulties linked to IMM: An unmanageable multitude of tools exists and conceptual, methodological as well as practical issues hinder further standardization and transparency in the field. The following list is most

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likely not comprehensive but aims to provide an overview of the most critical challenges as well as possible solutions: ● Attribution: The problem of attribution relates to the problem of linking interventions to results and establishing causal relations between them. Often, a wide range of interventions from very explicit activities aimed at single objectives to complex bundles of activities ranging across different sectors and/ or geographies with multiple actors and projected outcomes are undertaken. Although it may be highly unlikely to attribute certain changes in a definite way to an organization’s interventions (or to other stakeholders’ activities, respectively) this issue can best be addressed by clearly articulating the theory of change, by stipulating underlying hypotheses, mapping potential cause-and-effect relationships, and systematically prioritizing stakeholders and objectives. ● Counterfactual: Along the same lines, the problem of the counterfactual comprises the question of what would have occurred in the absence of the intervention and a comparison with what has occurred with the intervention implemented. Similar to the issue of attribution, by disclosing the interventions’ assumptions, the recipient of the impact information can close in on the ambiguity about the counterfactual. ● Subjectivity: The assessment of social impact almost always includes a value judgment about what is deemed to be social, right, or ethical to do. Thus, determining the achieved impact and allocating a certain (monetary) value to

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it is often not possible everywhere for everyone to the same degree. The subjectivity thus significantly hinders the comparability of impact data. ● Lack of common language and terminology: Not all actors understand especially outcome and impact in the same way, and the single steps of impact management are interpreted and applied differently across the sector. This hinders a common understanding about what outcome/impact should be and how impact assessment might be implemented. It is thus crucial for impact investors to be transparent about their use of terms and have a common understanding of them between all actors involved. ● Choice of methodology and metrics: It has proven to be impossible so far to set a common methodology including a universal set of fixed indicators top-down for all sectors and social enterprises due to (among others): – The variety of the social impact sought by social enterprises, – quantitative indicators often failing to capture essential qualitative aspects, – the trade-off between achieving comparability between activities through using common indicators and utilizing indicators that are useful and relevant. Independent from the approach an organization chooses for describing its impact, it is therefore advisable to include the beneficiaries in the process from the very beginning in order to understand all aspects of impact as well as define metrics in collaboration with the investees in order to provide the most accurate and successful assessment system.

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● Data quality: Adequate data in terms of quality as well as quantity is often hard to obtain. Furthermore, historical data often does not exist. In general, three different types of “evidence” can be used to imply causal connections: Logical chains of argument, anecdotes, and statistical reasoning. In the field of impact assessment, these three approaches are more usually known (respectively) as theory of change, qualitative analysis, and quantitative analysis of impact (Reeder and Colantonio 2013). The three approaches constitute different levels of evidence, depicting the theory of change having the lowest threshold for implementation but also the lowest level of proof. Depending on the development stage of the organization, the resources available as well as the possible access to and quality of data, it might be reasonable—while striving for the highest level of evidence—to consider different levels of evidence when assessing impact and to disclose the respective approach in the assessment documentation (Fig. 6.6).

Credibility Anecdotes / Quotes

Case Studies

Structured interviews

Basic

Pre and post tests

Standardized Tests

RCTs

Advanced

Fig. 6.6 Levels of evidence in IMM (Source Own illustration based on Harries et al. [2014])

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● Unintended social consequences: Most planned interventions—although striving for positive change— entail some unintended, even negative effects, not envisioned or considered when designing the original intervention. Such detrimental consequences not only need to be identified and assessed but—in the context of full disclosure—need to be managed in a way that the positive effects can be maximized and the unintended, negative externalities associated with them can be minimized or even off-setted (Centre for Good Governance 2006). ● Assessment capabilities and proportionality: Even if done at a minimum level, IMM requires the deployment of resources in terms of time or financial investment needed for the evaluation. However, the amount of time spent and the degree of accuracy sought and achieved in any assessment exercise must be proportionate to the size of the social enterprise and the risk and scope for the intervention being delivered. Furthermore, a certain level of expertise and knowledge about social impact assessment should be available within the organization in order to conduct a meaningful analysis. It can be thus advisable to align impact assessment requirements with incentives in order to allow the social enterprise to devote resources to it (So and Staskevicius 2015). ● Aggregation on a fund level: Impact investments address a variety of social and/or environmental challenges. As it is impossible to compare the social return of, for example, a deforestation program in Asia with an education initiative in Europe, experts have since long been looking for a possibility to aggregate social performance across sectors as well as on a fund level. One approach trying to tackle this issue is the so-called gamma factor (Grabenwarter and Liechtenstein 2012): It aims at setting a target value for several indicators—on the output, outcome, and (if desired) on the impact level and then comparing the actual achievements against these target values. The result can be expressed in a relative manner and thus aggregated on an enterprise as well as portfolio level. The approach comes with certain

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disadvantages as the process of setting the target value can be manipulated by the investees as well as the funders and could be set deliberately low in order to achieve a high gamma factor. However, to the best knowledge of the authors, this is the only possibility at the moment to quantify and aggregate social performance on a fund level.

Bibliography Brinckerhoff, P.C. 2000. Social Entrepreneurship: The Art of Mission-Based Venture Development. New York: Wiley. Busch, Timo, and Gunnar Friede. 2018. The Robustness of the Corporate Social and Financial Performance Relation: A Second-Order Meta-Analysis. Corporate Social Responsibility and Environmental Management 25 (4): 583–608. https://doi.org/10.1002/csr.1480. Centre for Good Governance. 2006. A Comprehensive Guide for Social Impact Assessment. http://unpan1.un.org/intradoc/groups/public/docume nts/cgg/unpan026197.pdf. Clark, C., W. Rosenzweig, D. Long, and S. Olsen. 2004. Double Bottom Line Project Report: Assessing Social Impact in Double Bottom Line Ventures. New York: Columbia Business School. Dees, J. Gregory. 1998. The Meaning of ‘Social Entrepreneurship.’ http://www. redalmarza.cl/ing/pdf/TheMeaningofsocialEntrepreneurship.pdf. EVPA. 2013. A Practical Guide to Measuring and Manaing Impact. Brussels: European Venture Philanthropy Association. Foster, William, and Jeffrey L. Bradach. 2005. Should Nonprofits Seek Profits? Harvard Business Review, February. https://hbr.org/2005/02/should-non profits-seek-profits. GECES Sub-group on Impact Measurement. 2014. Proposed Approaches to Social Impact Measurement in European Commission Legislation and in Practice Relating to EuSEFs and the EaSI. Global Impact Investing Network (GIIN). 2016. The Business Value of Impact Measurement. New York: Global Impact Investing Network. Grabenwarter, Uli, and Heinrich Liechtenstein. 2012. In Search of Gamma. An Uncoventional Perspective on Impact Investing. Barcelona: IESE Business School. Harries, Ellen, Lindsay Hodgson, and James Noble. 2014. Creating Your Theory of Change. NPC’s Practical Guide. London: New Philanthropy Capital. Jackson, Edward, and Karim Harji. 2016. Setting Standards for Evaluating Impact Investing: What Does Africa Want? Kramer, M. 2005. Measuring Innovation: Evaluation in the Field of Social Entrepreneurship. Boston, San Francisco, Geneva: Foundation Strategy Group.

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Nicholls, A. 2005. Measuring Impact in Social Entrepreneurship: New Accountability to Stakeholders and Investors? ESRC Research Seminar, April, Local Government Research Unit, London (Unpublished). Organisation for Economic Cooperation and Development/The Development Assistance Committee [OECD/DAC]. 2000. Results Based Management in the Development Co-operation Agencies: A Review of Experience. http:// www.oecd.org/dac/evaluation/dcdndep/31950681.pdf. Phineo gGmbH. 2016. Social Impact Navigator—The Practical Guide for Organisations Targeting Better Results. Berlin: PHINEO. Reeder, Neil, and Andrea Colantonio. 2013. Measuring Impact and NonFinancial Returns in Impact Investing: A Critical Overview of Concepts and Practice. London: London School of Economics and Political Science. Reisman, Jane, and Veronica Olazabal. 2016. Situating the Next Generation of Impact Measurement and Evaluation for Impact Investing. The Rockefeller Foundation. https://assets.rockefellerfoundation.org/app/uploads/ 20161207192251/Impact-Measurement-Landscape-Paper-Dec-2016.pdf. Simsa, Ruth, Christian Schober, Clara Moder, and Ruth Rauscher. 2014. Methodological Guideline for Impact Assessment. Working Paper No. 01/2014. http://thirdsectorimpact.eu/site/assets/uploads/post/methodolo gical-guideline-impact-assessment/TSI_WorkingPaper_012014_Impact.pdf. So, Ivy, and Alina Staskevicius. 2015. Measuring the ‘Impact’ in Impact Investing. Harvard Business School. Social Impact Investment Task Force. 2014. Measuring Impact. Subject Paper of the Impact Measurement Working Group. Social Impact Ivnestment Taskforce. Established Under the UK’s Presidency of the G8. Wörrlein, Lena, and Barbara Scheck. 2016. Performance Management in the Third Sector: A Literature-Based Analysis of Terms and Definitions. Public Administration Quarterly 40 (2): 220–255.

CHAPTER 7

Assessment Tools and Methodologies

7.1

How to Choose a Method 7.1.1

Introduction

According to a survey by JPMorgan Chase & Co. and the Global Impact Investing Network (GIIN), 95% of impact investors assess the social impact of their investments (Saltuk and El Idrissi 2014). At the same time, an enormous variety of impact assessment methods has been developed: The database for tools and resources for assessing social impact (TRASI) by the Foundation Center (https://measureresults.issuel ab.org), for example, lists over 150 tools, methods, and best practices. None of these methods can be singled out yet as the best for assessing social impact as they all address different questions and aspects that constitute a part of impact evaluation. Rather, methods or tools complement each other in providing a more complete overview of the societal effects an intervention has achieved. The choice of method is influenced by various parameters and depending on the specific context, some methods have a comparative advantage over others. Determinants for choosing an impact assessment method are above all the following.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 W. Spiess-Knafl and B. Scheck, Impact Investing, Palgrave Studies in Impact Finance, https://doi.org/10.1007/978-3-031-32183-2_7

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7.1.2

Target Audience of Impact Assessment

Recipients of impact information can be external as well as internal. External stakeholders comprise investors, clients, beneficiaries, or the general public. Internally, management, boards, employees as well as volunteers could be interested in the results of impact assessment. It is recommendable to engage in a dialogue with the prime audience of the IMM in order to better understand their information needs. If various stakeholders should be reached with the impact assessment at the same time, it could be useful to prioritize them in order to set a focus and clarify possible contradictory expectations. 7.1.3

Objectives of Impact Measurement and Management

In order to design the appropriate assessment framework, it is crucial to identify the motivation for using impact information. This decision is naturally linked to the target audience: External stakeholders might need impact information to meet certain reporting requirements or support risk management and/or investment decisions. Especially finance-first impact investors might prefer more quantitative data in this context. Other motivations might stem from marketing and/or fundraising purposes requiring more qualitative information, pictures, or stories (Asian Venture Philanthropy Association 2016). Internal stakeholders might strive for strategic insights in order to become more effective in addressing social problems. IMM thus would rather focus on organizational capacity and logic models. 7.1.4

Reporting Determinants

In order to be able to allocate scarce resources as efficient as possible, stakeholders need transparent and standardized information about the organization in question. Otherwise, the cost of information procurement might be too high and can be the reason for an investment (time, money, or in-kind support) to not being undertaken (Richter and Furubotn 1999). This so-called decision-usefulness paradigm assumes that resource allocation will be more efficient when rational economic decisions are made possible and is based on agency theory (for a general discussion of decision-usefulness and stewardship frameworks in reporting see Coy et al. [2001]; for agency theory see Eisenhardt [1989],

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Fama and Jensen [1983], Hoskisson et al. [1999], and Jensen and Meckling [1976]). Classic accounting literature has thus developed overriding reporting principles as foundation and prerequisites for providing consistent and useful information (Financial Accounting Standards Board 2008). Although these principles have been developed for financial reporting, they can be applied to the case of social impact reporting as the underlying objective—providing stakeholders with information influencing their decisions on investments—is the same. This conceptual framework consists of two primary reporting principles, namely relevance and reliability. These are further specified by the secondary reporting principles of comparability and cost-benefit. Relevance means that only information should be reported that significantly influences the recipient’s decision. Reliability addresses the concern about the correctness and arbitrariness of information in order to allow for objectivity and intersubjective verifiability. The principle of comparability comprises so-called vertical comparison for one organization over time as well as horizontally for different organizations in similar situations at the same time. The cost-benefit principle at last is intended to ensure that costs and benefits of reporting remain in an appropriate proportion (Financial Accounting Standards Board 2008). It is important to consider that it will never be possible to completely fulfill all principles within the scope of an impact report simultaneously: There always is a trade-off between the different dimensions and it might be accepted to neglect one principle in order to achieve another one. For example, to completely accomplish the criterion of comparability between different organizations is particularly challenging in the area of impact investing and might be deferred in order to take into account the specific theories of change of all investees and therefore apply the principle of relevance. Therefore, the choice of a particular IMM method also depends on the optimal individual specification of these principles.

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7.1.5

Scope of Impact Measurement and Management

In addition to the different forms and types social impact can have (e.g., with respect to sector, target group, time horizon, intentionality), impact also happens on different levels of society. Thus, it needs to be decided what the scope of IMM should be. Possible levels are – The micro level: these are the changes on an individual level or on a program level. – The meso level: this represents the wider community or an organizational level. – The macro level: these are changes on societal level, e.g., within an entire population or industry. These levels should not be confused with impacts or outcomes which define the primary beneficiaries (impacts) that also could be situated on a meso or macro level as well as the changes that go beyond the primary target group (outcomes) which could also be on a micro level (Fig. 7.1).

7.2

Existing Impact Measurement and Management Methods 7.2.1

Introduction

The plethora of IMM tools and methods is hardly manageable: The majority of the concepts have arisen for a specific purpose in the investment process or have been intended to solve a particular problem in one particular organization. Often, they have been developed by practitioners and consultants (The Rockefeller Foundation and The Goldman Sachs Foundation 2003). Furthermore, the huge variety can be explained by the diverse objectives and recipients of IMM (Sect. 7.1) as well as the various sectors, topics, and types of organizations active in the field. The development of most of the methods has often been effected without comprehensive grounding in theory and has in the further course been transferred to various other organizations. Moreover, existing concepts are aimed at different lifecycle stages of organizations, demand differing deployment of resources and qualification of the users and are aimed at different audiences. In addition, they only capture partial aspects of social performance (Clark et al. 2004; Wei-Skillern 2007).

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Macro (e.g. society, industry) Meso (e.g., organisation, community)

Micro (e.g., individual, program)

Fig. 7.1 Possible scope of impact assessment (Source Own depiction)

Despite the broad offering, an overarching trend in terms of focus and application of the methods can be observed: Methods to assess impact are becoming more sophisticated and complex suggesting that the impact investing market is maturing as investors and social businesses begin to recognize the value of proactively managing and measuring impact (Olsen and Galimidi 2008). 7.2.2

Differentiating IMM for Different Financial Instruments

Simultaneously to the development of IMM in terms of rigor, depth, or scope, a differentiation of IMM according to the financial instrument used can be observed. Specifically, when assessing the effects of equity and debt investments, investors approach IMM differently. Equity investors usually invest through highly individualized large transactions in a comparatively small number of investees. For IMM this translates into tailor-made impact analyses and a quite in-depth impact due diligence. As capital is often disbursed in tranches and payments

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are linked to pre-defined impact milestones, ongoing extensive impact monitoring, and reporting processes are implemented post-investment. A lender/debt investor typically provides a rather standardized product to a large number of organizations. The focus of IMM is thus rather set on the pre-investment phase and is conducted in a standardized way due to the large amount of borrowers to be assessed. Post-investment, normally not many IMM activities take place as there is no incentive for the borrower to report as long as the repayments to the lender proceed as defined. 7.2.3

Categorization of IMM Methods

In an attempt to categorize existing IMM methods, the authors have tried to structure existing IMM tools according to the purpose they serve and to the stage of the investment process where they are applied. These methods constitute the “core” toolbox impact investors are currently using. In addition, a variety of tailor-made solutions has been developed serving single investor’s specific purposes. Investors previously or simultaneously engaged in traditional ESG-investing also use tools from the sustainability field, such as the Global Reporting Initiative’s (GRI) guidelines (Fig. 7.2). As depicted in Chapter 2, the United Nation‘s Sustainable Development Goals (SDGs) have become established as the overarching framework of objectives impact investors try to tackle. Standards promoting best practice processes how to conduct IMM are the IFC‘s Operating Principles for Impact Management (https://www.impactprinciples. org/) and the European Commission’s guidelines on impact measurement as proposed by the GECES Subgroup on Impact Measurement . These standards provide a reference point to ensure that impact considerations are integrated throughout the investment life cycle. In order to ensure the independent verification of the IMM results, there have been attempts to establish external certification mechanisms. GIIRS was intended as a fund rating system but it is not being further developed as of now. The B Corp Certification is a label demonstrating that a business is meeting certain standards of performance, accountability, and transparency on different social and environmental criteria. It is not targeted specifically at social enterprises or impact investors and does not certify IMM processes or the actual measurement results.

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Fig. 7.2 Categorization of IMM tools (Source Own depiction)

However, some actors in the sector use it for signaling the sustainable set-up of their operations. The most widely adopted methodology on actual impact measurement and the initiative that has convened the largest number of stakeholders is the impact management platform (IMP: https://impactmanagementpl atform.org/). The forum has developed guidance as well as a vast collection of best practice cases and peer-learning material. Its five dimensions of impact encourage investors to address the following questions in their impact assessment: – What outcomes does the effect relate to, and how important are they to people experiencing it (usually described with the SDGs an investor is working towards). – How much of the effect occurs in the time period. – Who experiences the effect, and how underserved are they in relation to the outcome. – How does the effect compare and contribute to what is likely to occur anyway.

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– Which risk factors are material, and how likely is the effect different from the expectation. This methodology is being used by impact investors as well as by some ESG-investors and is applicable across asset classes. Regarding actual metrics being used in IMM, some investors use classic cost-benefit analysis or some version of it (such as social return on investment) in order to monetize social or environmental changes. Another resource that is being continuously further developed is the GIIN‘s Impact Reporting and Investing Standards (IRIS+: https://iris.thegiin. org/). It provides investors with a free catalog of generally accepted and tested performance metrics across SDGs. The following chapter will illustrate some of these tools and others that investors have developed for their own use, in more detail. 7.2.4

Methods for Assessing and Evaluation of Social Impact

In the following, an exemplary selection of IMM methods and tools will be presented. It is by far not exhaustive; They have rather been chosen to illustrate the variety of the methodological spectrum by establishing diverse categories relevant for impact investors. The clear assignment of a method to a certain category respectively is sometimes not entirely possible; many methods rather belong to multiple categories. This will be depicted accordingly. The categories chosen stem from the discussion in the previous chapters and address (besides general information about its name, origin, and short summary) the following aspects: Target audience: Different stakeholders dispose of different expectations toward social impact assessment. The overview will thus distinguish external stakeholders (investors, the general public, clients, beneficiaries) and internal stakeholders (management, board, employees, volunteers). IMM function in the investment process: Requirements of IMM vary depending on the stage of the investment process they are being used for: A first instant for IMM constitutes the question of predicting a potential social impact that could be achieved or analyzing the results that have been accomplished by the social organization in retrospect. A second distinguishing factor lies in the use of the

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impact information for either internal purposes (e.g., capacity building of the social organization) or external purposes (e.g., reporting). The overview thus distinguishes several pre-investment and post-investment stages, namely screening and due diligence (pre-investment), capacity building, reporting, and exit (post-investment). Investee maturity: As discussed in the previous chapters, IMM requires significant resources and expertise on behalf of the evaluator. Thus, for each method it will be mentioned if its application is recommended for rather sophisticated or for small-scale/early stage social enterprises. Reporting principles: As discussed in Sect. 7.1.4, the four main reporting principles (relevance, reliability, comparability, and cost-benefit) can never be all maximized simultaneously. Depending on the desired focus, different methods have to be chosen. Function: Depending on their overall purpose prompted largely by their originators, IMM tools in a narrower sense, can broadly be clustered into three functional categories: – Standards/Management systems: Guidelines for ongoing monitoring and evaluation processes in order to managing operational performance as drivers of impact in detail. – Certifications: Based on screenings, usually by an independent third party, often represented with a final score or symbol (stars, etc.), – Assessment methodologies: Summarized, mainly quantitative (sometimes even monetarized) results of social interventions at a certain point in time, usually without explicitly analyzing operational data over time Customizability: Social organizations operate in diverse settings with different business and impact models. Similarly, impact investors often have a variety of expectations toward the IMM process. Thus, it might be recommendable to choose the most adequate method and customize it to the specific need. This can be done, e.g., by adding additional indicators, supplemental information in the form of anecdotes or pictures. However, it has to be

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kept in mind that this probably entails a decrease of comparability over time and across organizations. The following methods and tools can be seen as examples representing the variety of approaches touching on every aspect discussed previously and are presented in alphabetical order: Name

Best Available Charity Option (BACO)

Origin Summary

Social Venture Capital Fund Acumen, launched in 2007 Instead of seeking an absolute number for social impact across a diverse portfolio, BACO aims to quantify an investment’s social impact and compare it to the universe of existing charitable options for that explicit social issue External: Investors and funders Qualitative Monetization x – Screening and due diligence x – Capacity building – Reporting x – Exit x Sophisticated High comparability—quantitative measures High costs—extensive analyses Medium relevance—quantified social impact disregards more granular information Medium reliability—analyses based on assumptions and choice of alternatives Assessment Low to moderate

Target audience Quantitative x Use cases

Investee maturity Reporting principles

Function Customizability

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Name

Balanced Scorecard for Social Purpose Organizations

Origin

Function Customizability

Originally developed by Robert Kaplan and David Norton (1997), in 2000 its co-developer, Robert Kaplan, adapted the approach for non-profit organizations The Balanced Scorecard proposes that companies measure operational performance in terms of four outcome perspectives: financial, customer, business process, and learning and growth. The modified framework for social purpose organizations comprises a fifth perspective, namely social impact. All metrics can be set individually and tracked over time. Special importance must be paid to the connections between the dimensions and the respective metrics Management Qualitative Monetization – Screening and due diligence x – Capacity Building x – Reporting – Exit Small scale to sophisticated Low comparability—quantitative measures but highly individualized for the specific organization Low costs—free template High relevance—impact is captured in a dedicated perspective with several metrics Low reliability—usually established as internal management tool and self-assessment Management System High

Name

B Rating System

Origin Summary

Developed by the American non-profit organization B Lab The rating system contains two parts: The B Impact Assessment and the B Impact Report provided by B Lab. The B Impact Assessment is a free, web-based tool calculating an overall score based on five impact areas in order to provide a holistic view of an organization, the B Impact Report is a one-page report documenting these results. Furthermore, the score can be compared to the results of other businesses External: Investors and funders Qualitative Monetization – Screening and due diligence x

Summary

Target audience Quantitative x Use cases

Investee maturity Reporting principles

Target audience Quantitative x Use cases

(continued)

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(continued) Name

B Rating System

Customizability

– Capacity Building (x) – Reporting x – Exit Early and development stage High comparability—quantitative measures Low costs—free online tool Medium relevance—across several impact areas, but quantified social impact disregards more granular information Low reliability—self-assessment tool without external verify cation Certification Assessment Low

Name

Fair Trade Certification

Origin

Fair Trade Labelling Organizations International (FLO), a non-profit membership organization comprised of separate non-profit organizations called Labeling Initiatives (LIs), and regional farmers’ networks representing approximately 1.4 million Fair Trade farmers and workers Fair Trade certification allows agricultural products to bear the label “Fair Trade Certified”, which makes the fact that 100% of the product was produced in a manner that meets minimum standards with respect to environmental impact, working conditions, and governance. Approved products can be traded with the Fair Trade brand and logo Investors and funders, customers Qualitative Monetization – Screening and due diligence x – Capacity Building – Reporting x – Exit x Sophisticated High comparability—binary decision of yes or no certification High costs—detailed certification process, certification, and inspection fees Low relevance—all aspects of impact integrated into one final decision High reliability—external accreditation and certification

Investee maturity Reporting principles

Function

Summary

Target audience Quantitative x Use cases

Investee maturity Reporting principles

(continued)

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(continued) Name

Fair Trade Certification

Function Customizability

Certification None

Name

Randomized Control Trial (RCT)

Origin

Randomization is a method commonly used in natural science and clinical trials to test hypotheses by means of experiments Experimental or quasi-experimental method using counterfactual, often in form of control groups to determine the causal effects and generated impact of the intervention compared to the status quo: Participants are randomly allocated to either the treatment or the control group. Thus, selection bias can be minimized and the comparison between the two groups allows to determine treatment effects with other variables kept constant External: investors, funders, the general public Internal: management Qualitative x Monetization – Screening – Management operations (x) – Reporting x – Exit Sophisticated Medium comparability—quantitative measures but based on specific intervention Very high costs—extensive analyses Very high relevance—can potentially prove cause-and-effect relationship of intervention Very high reliability—proven intervention including base case control group Assessment High

Summary

Target audience Quantitative x Use cases

Investee maturity Reporting principles

Function Customizability

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Name

Social Reporting Standard (SRS)

Origin

Function Customizability

Developed by a consortium of TU Munich, Universität Hamburg, Ashoka, Schwab Foundation for Social Entrepreneurship, BonVenture, Phineo, and PWC All aspects of performance: social impact, risk, and organizational capacity Investors and funders Qualitative x Monetization – Screening and due diligence x – Capacity Building x – Reporting x – Exit x Small scale to sophisticated High comparability—Consistent structure and “comply or explain” principle Low costs—Comprehensive templates and exemplary reports High relevance—Developed with investors as well as social entrepreneurs including all aspects of performance Medium reliability—Proven intervention including base case control group Standard/Management System Low to moderate

Name

Social Return on Investment (SROI)

Origin Summary

Developed from social accounting and cost-benefit analysis Takes into account the anticipated social benefits expressed in the monetary value of expected social returns of an investment against its costs, discounted to the value of today’s value. It can take the form of a relative return on investment (ROI) expressed in percentage, a ratio, or a Net Present Value (NPV) number SROI ratio = (Present Value of Impact) / (Value of Inputs) External: Investors and funders Qualitative Monetization x – Screening and due diligence x – Capacity building – Reporting x – Exit Sophisticated

Summary Target audience Quantitative x Use cases

Investee maturity Reporting principles

Target audience Quantitative x Use cases

Investee maturity

(continued)

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(continued) Name

Social Return on Investment (SROI)

Reporting principles

High comparability—quantitative measures Very high costs—extensive analyses Low relevance—quantified social impact disregards more granular information Low reliability—analyses based on many assumptions and difficult verifiable hypotheses Assessment (SROI calculator) Management System (SROI framework) Low to moderate

Function Customizability

7.2.5

Data collection

The Universe of Data Collection Methods After having decided on the target audience, the objectives, the scope as well as the appropriate method for assessing impact, the next steps usually involve the gathering of the data needed. In this context, a range of data collection methods can be distinguished. They differ in terms of expenditure required (time, cost as well as expertise) and reliability of the evidence. These two dimensions (expenditure and reliability) constitute a trade-off—i.e., the more reliable a data collection method, the more resources are needed to implement it. The challenge is to balance these two dimensions in a meaningful way and to do as much as necessary, and as little as possible in order to set up a reasonable and practical IMM process. For many sectors and social issues, a considerable amount of information is already available: Good external sources are, for example, official statistics or findings from surveys and academic studies. In addition, many organizations dispose of internal data that can be used, e.g., in project documentation, evaluation records, or annual reports (Phineo gGmbH 2016). If the existing data is not sufficient, or no data exists at all, new data needs to be collected. In general, data collection methods can be differentiated in qualitative and quantitative approaches. Qualitative data have a descriptive function and can provide a deeper insight into the specific situation or set of circumstances. Their advantage lies in the ability to illustrate causal relationships as well as interdependencies and to provide

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emotionally convincing details. Qualitative data collection methods are, for example, interviews, focus groups, observations, anecdotal evidence, case studies, and photo or video documentation. Quantitative data collection methods should be used if the information needed can be expressed in numeric or monetary terms. They result in a better comparability of impact information across groups, organizations, or sectors if proof is required that an organization has achieved a quantifiable success. Quantitative approaches are rather evidence-based and can include methods such as measuring, counting, statistics analyses, and various forms of tests or longitudinal studies with control groups. Indicators Indicators are measurable variables that can be used to represent the change that has been achieved in terms of outputs, outcomes, or impacts. They are usually linked to the overall objectives of the intervention and aim to illustrate to what extent these have been reached. There are qualitative and quantitative indicators: Qualitative indicators are best suited to understand changes in attitudes, motivation, or behaviors and explain the underlying reasons for this (Muir and Bennett 2014). They often provide a high explanatory value but are relative and subjective. Quantitative indicators aim at explaining an observed phenomenon in a numerical way, e.g., how many, how much, or how often. The advantage of quantitative indicators is their objectivity and comparability. However, they often only are able to capture some aspects of social impact without and it is difficult to depict e.g., attitudes or feelings without losing much explanatory value. Furthermore, direct and indirect indicators need to be distinguished: Direct indicators can directly depict the phenomenon they should represent, for example, the number of participants or the increase of income generated by an intervention. Often, however, it is not possible (or too expensive) to directly assess or express the observed changes, for example, if the entire target population cannot be counted and it is necessary to extrapolate from other data. Another use case would be the description of changes in attitudes, behaviors, or feelings, such as self-confidence. In these circumstances, if direct indicators are not available a number of socalled indirect or proxy indicators might be used in order to adequately depict the situation. In general, when developing indicators, it is commonly suggested to formulate them in a SMART way bearing in mind quality (the kind of

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change you want to depict), quantity (the scope of the change), and time (the time by when the change should have taken place; QQT). Experience has shown that usually more than one indicator is needed to appropriately reflect societal changes. However, a too large number of indicators is difficult (if not impossible) to assess and to manage. Thus, it is recommendable to focus on the most important indicators (the so-called key performance indicators or KPIs) and derive a manageable set of indicators on the output, the outcome, and, if feasible, on the impact level. The Global Impact Investing Network (GIIN), along with Acumen, the Rockefeller Foundation, and B Lab has developed the Impact Reporting and Investment Standards (commonly known as IRIS), a catalogue of standardized financial, operational as well as social metrics that impact investors can choose to track (https://iris.thegiin.org/metrics). Lean Data and the Use of Mobile Technology for Data Collection As illustrated in the previous chapters, IMM is often complex and resource-intensive hindering a widespread application by investors as well as investees. Recently, however, an approach termed “lean data” has gained traction by leveraging mobile technology for impact assessment purposes (Dichter et al. 2016b). The project, launched by the social venture capital fund Acumen (with grant support from the Aspen Network for Development Entrepreneurs and the Omidyar Network), aims at enabling social enterprises to gather high-quality impact data quickly and inexpensively (Acumen Fund 2015; Dichter et al. 2016a). The initiative is based on principles that can be abbreviated with the acronym BUILD (Dichter et al. 2016b): – – – – –

Bottom-up: Focusing on the beneficiaries’ needs and interests. Useful: Striving for data quality sufficient for decision-making. Iterative: Allowing for learning, adaptation, and replication. Light-touch: Using cost-efficient tools and technologies. Dynamic: Enabling fast data collection within a rapidly changing environment.

Two main features constitute the core of the approach: a shift from impact assessment mainly for reporting and compliance purposes toward creating value for the organization and its beneficiaries and the more efficient data collection with new technologies. It focuses heavily on the spread

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of mobile technology and uses, for example text messages, to ask few central questions relevant for assessing impact. Combining mobile technology with a focus on beneficiaries’ (and thus often customers’) needs constitutes a promising new avenue for generating impact insights quickly and at a reasonable cost (Acumen Fund 2015).

7.3

Outlook

The last concluding chapter wraps up the previous chapters and gives a guide to assessing the social impact. This book has shown that social enterprises have gained prominence and investors are increasingly looking for ways to invest in products which provide financial returns but also create social value. Part of the reason is that the problems of our days are manifold and increasingly complex. Policies crafted by public authorities are helpful and foundations are important in getting projects started. Although substantial progress can be observed in addressing severe social and ecological problems worldwide, an immense degree of social hardship remains: poverty, hunger, access to clean water, or child mortality are just some examples of material challenges in large parts of the developing world. All social innovations need capital to scale their initiative. Thus, impact investing has been discussed vividly lately as a supplemental funding source for addressing societal problems. It is driven by the need to fund social innovations. This book has shown what is happening in the market for impact investments. There are still various weaknesses and imperfections observable in the market. Secondary equity markets are slowly developing and standards are not yet fully established. There is still potential to involve additional investors in the impact investing industry. It will need the development of the market and more deals. There is potential for more innovation. The blockchain technology is currently being discussed and new approaches have to be tested (Scott 2016). Given that developing countries have access to mobile technology (Bannick et al. 2015) believe that the near-term opportunities are financial technology, education technology, and consumer internet.

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Olsen, Sara, and Brett Galimidi. 2008. Catalog of Approaches to Impact Measurement. Assessing Social Impact in Private Ventures. Silicon Valley: Social Venture Technology Group with the Support of The Rockefeller Foundation. Phineo gGmbH. 2016. Social Impact Navigator—The Practical Guide for Organisations Targeting Better Results. Berlin: PHINEO Richter, Rudolf, and Eirik G. Furubotn. 1999. Neue Institutionenökonomik: Eine Einführung Und Kritische Würdigung. 2., Durchges. U. Erg. Aufl. Tübingen: Mohr-Siebeck. Saltuk, Yasemin, and Ali El Idrissi. 2014. Spotlight on the Market. The Impact Investor Survey. New York: J.P. Morgan, GIIN Global Impact Investing Network. Scott, Brett. 2016. How Can Cryptocurrency and Blockchain Technology Play a Role in Building Social and Solidarity Finance? UNRISD Working Paper. https://www.econstor.eu/handle/10419/148750. The Rockefeller Foundation and The Goldman Sachs Foundation. 2003. Social Impact Assessment—A Discussion Among Grantmakers. New York: The Rockefeller Foundation/The Goldman Sachs Foundation. Wei-Skillern, Jane. 2007. Entrepreneurship in the Social Sector. Los Angeles: Sage.

Index

A Alternative Bank Schweiz, 82 Ashoka, 75 Assessment tools, 137 Attribution, 130

Corporate social performance, 118 Corporate Social Responsibility (CSR), 7, 18 Counterfactual, 130 Crowdfunding platforms, 82 Crowding-out, 67

B Balanced Scorecard for Social Purpose Organizations, 147 Best Available Charity Option, 146 Big Society Capital, 76 BonVenture, 78 B Rating System, 147, 148 Bridges Ventures, 79

D Debt capital, 103 Developers, 22 Development Impact Bonds, 88 Donors, 54

C Capital cost restrictions, 62 Catalytic investments, 92 Categorization of IMM tools, 143 Child labour, 40 Convertible grants, 104 Corporate financial performance, 118

E Environmental Impact Bond, 88 Equity capital, 101 Ethical banks, 74, 77 European Venture Philanthropy Association (EVPA), 75

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 W. Spiess-Knafl and B. Scheck, Impact Investing, Palgrave Studies in Impact Finance, https://doi.org/10.1007/978-3-031-32183-2

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158

INDEX

F Fair Trade Certification, 148, 149 Financing Agency for Social Entrepreneurship (FASE), 76 Financing instruments, 99, 102 Forgivable loan, 104 Foundations, 55 G GLS Bank, 82 Grant Giving, 7 Grants, 105 Guarantees, 91 I Impact data collection, 151 Impact indicators, 152 Impact management platform, 143 Impact measurement and management, 117, 138 Impact metrics, 144 Impact reporting, 138 Impacts, 122 Impact value, 122 Impact Value Chain Model, 124 Impact Value Chain Model OECD-DAC, 123 Income streams, 64 Inputs, 122 Investors with market-oriented financial return expectations, 57 Investors with reduced financial return expectations, 56 L Legal form, 17 Localizers, 22 M Merkur Cooperative Bank, 82

Mezzanine capital, 104 Mission drift, 120 Motives, 53

N Negative screening, 84 Networkers, 21 Networks, 74, 75 Noaber Foundation, 79

O Oltre Venture, 80 Outcomes, 122 Outputs, 122

P Pay for results models, 86 PhiTrust, 80 Positive screening, 84 Pricing strategies, 25 Private beneficiaries, 64 Public beneficiaries, 64

R Randomized Control Trial, 149 Recoverable grants, 104 Results chain, 122 Results staircase, 123 Return expectations, 54 Revenue share agreements, 104

S Scalers, 22 Scaling, 21 Schwab Foundation for Social Entrepreneurship, 75 Selection criteria, 77 Shareholder activism, 84

INDEX

Skoll Forum for Social Entrepreneurship, 75 Social business model innovation, 23, 24 Social Enterprise School, 14 Social entrepreneurship, 14 Social Impact Bonds, 87 Social Impact Crowdfunding Platforms, 74 Social innovation, 15 Social Innovation School, 14 Social investment advisors, 74, 76 Social investment banks, 76 Socially responsible investing, 7, 52, 84 Social problems, 26 Social Reporting Standard, 150

159

Social Return on Investment (SROI), 150, 151 Social Success Note, 89 Social venture capital funds, 74, 76 Sustainability conflicts, 63 Sustainable Development Goals, 27 T Terminology of impact measurement and management, 127 Theory of Change, 126 Trade-Off Conflicts, 60 Triodos Bank, 82 V Venture philanthropy, 5