The Supply Demand Mismatch in Impact Investing
The term “Impact Investing'' was officially coined in 2007, and the industry has grown enormously in the past decades, from an absolute zero to 502 billion USD by 2019. This 502 billion USD estimation represents less than merely 1% of the asset management industry. However, despite its relatively small asset size, the enormous media coverage on this industry leads the public to believe that impact projects possess enough financing to effectively address their targeted global challenges. In turn, this rather skewed perception encourages creation of more impact startups. While few startups may be successful in getting their grants, most fall short from raising enough capital to operate their businesses and achieve their missions regardless of their business models with potential success factors, with a solid team and a mission. The enterprises which successfully obtained some investments often fall short of their impact targets, in a perpetual struggle of having insufficient capital.
In the impact investment literature, there is often an overrepresentation of the supply side of the sector, which is the experiences of the investors. However, there is a growing need to study the demand side of the impact investing sector, namely the experiences, views, and impact creating processes of those who operate the impact startups and those who are impacted or helped by these companies. This signifies a need for the literature to go beyond simply the investor needs in impact investments and start addressing the entrepreneur needs.
What challenges do the demand side face in impact investing?
Impact startups tend to face challenges in both financial and non-financial reans. Outside financing, startups that address global challenges such as social and environmental problems tend to face hardships in attracting talent to work in remote areas, the businesses are sometimes volatile due to natural and community risks, and it is often difficult to obtain sufficient hard assets such as offices, facilities, and basic infrastructure, especially in the underdeveloped regions. Beyond the non-financial challenges, investing in impact businesses comes with its own structural challenges relating to how these businesses are financed. Traditionally, the investments in impact startups comes from one or multiple of three sources: grant providers, impact lenders, and impact VCs (Venture Capitals). The common issues with these funding structures are that they lack flexibility and that investors tend to be risk averse. Lacking flexibility means that there is a tradeoff regarding the allocation of the funds: for bigger donors, there is less flexibility, versus having more flexibility for smaller donors, but less funds to allocate. Investors are risk averse in these financial structures, especially in the early stages, and therefore they tend to invest little whereas impact startups require initial high capital in order to begin operations to achieve missions and the returns are given off strategically in the long run. For instance, it was estimated that for most enterprises to make a meaningful impact upon those living in poverty, it takes approximately 7-10 years for the business itself to come to a financial break even since there are often hardships involved in the constant need to adapt their services to meet their revenue goals. These challenges are worsened by the prospects of the often short term presence of employees and instability regarding climate related shocks for enterprises in environmentally vulnerable zones.
How to address the demand side challenges to attract more supply?
To address demand side challenges that impact startupers face and to encourage more investment by the suppliers of capital, enterprises and VCs are starting to experiment with a form of blended financing. It is a strategy that combines capital with different levels of risk. The Oxfam Discussion Papers article proposes the recommendations of creating mechanisms to build transparency and accountability, such as ensuring that both investors and enterprises clearly define their impact goals in order to create matches efficiently. Additionally, in order to ensure that market needs are met, it is thought to be beneficial that investors consider smaller investments, while reducing transaction costs by measures such as working with local investors, obtaining third party support, or staging investments to focus on specific milestones. This is a growing issue in the impact investing world, however the more it is discussed, the quicker there will be efficient and effective solutions to work towards creating a balance and match between supply and demand in impact investing. This topic will be addressed at the Geneva event “Building Bridges”, where we will explore how to close the gap between the amount of investors, and the amount of projects and enterprises deemed “investment ready”, by rethinking mainstream investment strategies, the use of innovative finance instruments, and overcoming barriers such as the risk profile and environmental issues of these enterprises.
Suweda, “The Supply Demand Mismatch in Impact Investing,” Medium, December 12, 2019, https://medium.com/swlh/the-supply-demand-mismatch-in-impact-investing-a5d98e4d9af6
C. West, “Mind the gap! Five ways to accelerate investing for impact!,” Pioneer Post, 8 July 2019, https://www.pioneerspost.com/business-school/20190708/mind-the-gap-five-ways-accelerate-investing-impact
Impact Investing Index “Mismatch Between Supply and Demand,” 23 June 2020, https://investmentimpactindex.org/impact-enterprises-supply-and-demand/
Oxfam Discussion Papers, “Impact Investing, Who Are We Serving: A Case of Mismatch Between Supply and Demand?,” April 2017, https://oxfamilibrary.openrepository.com/bitstream/handle/10546/620240/dp-impact-investing-030417-en.pdf;jsessionid=60B813E5B472BBD4FE8FFCBF9D189872?sequence=4