Ideas
Geeta Goel

Impact investing: Making the case for low-margin, high social return investments

Burgess COMMENTARY

Peter Burgess

Impact investing: Making the case for low-margin, high social return investments

Photo credit: Utente Elitre

Impact capital plays different roles in different scenarios, depending on whether it's directed to early-stage, high-risk investments, more mature companies, or organizations that will likely need ongoing concessional support.

In the first two scenarios, capital from impact investing primarily acts as a catalyst to commercial capital. For instance, it helps to showcase the viability and sustainability of new business models and products; it drives existing enterprises toward improved services, penetration into new geographies or providing services to new clientele; and it drives some profit margin.

Organizations that can cover their costs but that are unlikely to generate commercially attractive returns represent a different opportunity. For such organizations, mainstream capital will likely remain out of reach. But I’d argue that impact capital, which is meant to generate not just financial returns but social impact, has a vital role. Let me explain.

Lower margins, significant social value

Some sectors might never deliver returns that meet commercial investors’ expectations. Products and services that meet basic needs of the underserved, for instance, typically imply lower margins and higher costs of delivery. Two examples:

• Providing high-quality education to first-generation learners and ensuring that they achieve certain learning levels likely costs more than offering the same services and outcomes to children of well-educated parents. The reason for the cost difference is simple: First-generation learners often have to overcome a more significant learning deficit than the children of better educated parents.

• Similarly, providing water and sanitation services to urban slums is more expensive than providing the same services in middle-income neighborhoods. Again, the reason is straightforward: Urban slums lack basic water and sanitation infrastructure, while middle class neighborhoods are connected to city networks.

Most organizations working in these spaces try and mitigate these higher costs of servicing lower income populations through unique pricing structures, cross subsidization and/or much larger volumes. However, there will always be cases where it’s nearly impossible to recover full costs and generate attractive returns.

Loans? Or grants?

Should we rule out the option of deploying investments in such cases, and simply resort to grant dollars? I’d make the case that, in these and other instances, impact capital (concessional loans, equity or guarantees) is often the right answer. Why? Because the impact investment community isn’t just after maximum profits. We’re after scalable solutions to long-standing social problems. Loans aren’t appropriate for every philanthropy-supported endeavor. But in some cases, they may be a far better fit than grants. And given that their availability far outstrips that of philanthropic dollars, they’re a tool we should use.

Let’s look at two additional examples that illustrate the role that loans can play.

NGOs often undertake projects or act as service providers for the government. They’re necessarily dependent on government for recovery of costs. However, such payments often entail a time lag. Meanwhile, the NGOs, which need access to working capital to continue their operations, may be forced to take out loans. Depending on government policies regarding the cost of reimbursements, etc., the NGOs may or may not have the ability to bear the costs of market-relevant interest rates on working capital. In such cases, concessional working capital lines from impact investors are a much better option than grants. Such loans allow the NGO to establish a credit history and expose it to the more rigorous financial discipline of dealing with lenders versus donors.

In most developing economies, health care facilities and hospitals that serve poor clients can charge clients for simple procedures and consultations, and recover costs. But much-needed treatments that are more complex (for instance, surgeries) are more expensive. Should hospitals refuse to treat such clients? Or to provide them with such services? Or can we design a structure whereby we provide hospitals with concessional capital to support more costly treatments for the poor?

I’d argue that these two examples – along with the education and water and sanitation examples above – are among the scenarios where impact capital can and should play a role. Why?

Because all are sustainable ventures. Neither NGOs nor the hospitals described above are likely to ever offer commercially viable returns, but in all likelihood they can cover their costs. By contrast, companies that provide education to impoverished clients, as well as those that provide water and sanitation services, may be commercially viable, but are unlikely to ever be high margin.

Because a track record of payment allows these organizations to further shore up their sustainability and ability to scale, since organizations that effectively establish a credit history are then better positioned to tap loan funds from conventional sources.

Impact investing is about more than substantial financial returns

The takeaway for the impact investment community is simple: We should actively support sustainable, high-impact ventures, even if they don’t offer the promise of financial returns that are high enough to attract commercial capital. That’s a key part of our mandate as impact investors.

Don’t mistake me: I am not by any means saying financial returns are bad. (Read my whole series for more insight on how to balance financial and social returns.) I’m only saying that they are not the whole goal of impact capital. I’m reiterating that if we want to build scalable ventures that address the needs of the underserved, we need both forms of impact capital. Impact investors should continue to push the frontiers of cost reduction, better quality, target segment, etc. We have the mandate and the flexibility to put our funds to work in a variety of ways. After all, we are not profit-maximizing investors; we are impact-maximizing investors. Let’s be true to that goal!

This post is part of an occasional series on mission-related impact investing, and on its role as a tool for extending and accelerating social progress that directly benefits children and families living in urban poverty.

Editor's note: this post was originally published on the Michael & Susan Dell Foundation's blog. It was adapted and cross-posted with permission.

Geeta Goel is responsible for leading the Michael & Susan Dell Foundation’s global Mission Investing function.

Robert Cremeans • 4 months ago Maybe I don't understand the definition of impact as you use it. its a finality. but if you want to talk about empowering positive social change with a whole cycle plan of improvement and actions that will generate immediate growth and social benefit while witnessing growth in profit potential and return I think I can demonstrate the scalable model your looking for. The problem is we must explore and plan change for the whole field in which our model will operate so that we can guarantee that our impact is not just an injection but a continuous merger of life, benefit and value. • Reply•Share ›

Avatar guest • 3 months ago Geeta, I think this analysis is really misguided. You conclude with 'After all, we are not profit-maximizing investors; we are impact-maximizing investors. Let’s be true to that goal!' Silly and outdated thinking. Honestly, is any significant amount of your own money invested in impact investments? Probably not, since this advice would rankle any normal investor and does nothing to help encourage private investment from the broader capital markets. Impact investment is about risk taking with capital (often early stage companies that require very active shareholders/managers), and you will never encourage this level of effort and risk taking by promoting a donor mindset.

So unless your vision is a world where increasingly insolvent Western countries use taxpayer funds to continue to subsidize projects in less developed countries (who you presume will never get off the dole?), then I think a better goal is to encourage more research into impact investments that do in fact generate solid financial returns. There is significant growth in many developing economies and very interesting impact investment ideas, and it looks like you haven't done much of your own research on this:

http://www.economist.com/news/...

http://www.ecpinvestments.com/...

etc... • Reply•Share ›

Avatar Ted Barber guest • 24 days ago An interesting comment. I would suggest that Geeta is thinking through a critical question in the impact investment space, one that gets to the core question of priorities. It is entirely possible to achieve combined financial and social returns, and there are attractive opportunities for investors along a spectrum from socially responsible investing (where maximizing profit is the highest priority), to giving equal consideration to financial and social returns, to Muhammad Yunus' definition of a social business where investors seek only a return of capital in order to recycle their philanthropic dollars into other impact ventures. I would relegate 'silly and outdated thinking' to the idea that we should be thinking of how to maximize profit one day, and donating to charity the next. Is Geeta referring to 'normal' investors, or making the case for supporting innovation at the intersection of business and philanthropy? • Reply•Share ›

Avatar john Gitau • 3 months ago Geeta, your post is excellent and your have built your case very systematically and cogently. There is need to always remember that if governments especially in the developing countries did their work as they ought to, we wouldn't need social impact investing that much. Let's remember that countries with strong export bases are those subsidized by governments. So, good idea to see how social impact investment can be progressively developed by, as Geeta demonstrates, tempering expectations from potential investors. In any case, those looking for super profits have the whole terrain of commercial business for their capital. • Reply•Share ›