On hype, Impact Investing and the Valley of Death

How do we build bridges across the Valley of Death? That’s the arresting image in a recent Oxfam paper on ‘impact investing’. The valley of death (see diagram) is the gap that firms face as they move from small start ups to Big Biz. In the start-up stage they raise cash wherever they can find it – family, friends, microfinance. Once they are big enough, they have stock markets and banks queuing up to lend them cash. But in the middle there’s a big hole, also known (not surprisingly) as the ‘Missing Middle’.

Valley of Death‘Impact Investing’ is one effort to fill the gap. II means investing with a double motive: to make some money, and simultaneously to do some good, including previous excluded groups in the benefits of the market etc.

But ‘Impact Investing: Who Are We Serving?’ finds there are some serious problems with the model. The first is that the massive hype from product salesmen and government officials desperately seeking ‘private sector solutions’ gets in the way of sober scrutiny – we don’t actually have much solid evidence on the impact of impact investing, whether good or bad.

The paper also argues that II is following the same cycle of mission decay that critics see in the rise and fall of microfinance, as initial pioneers willing to take a low level of profit in return for social impact are elbowed aside by new entrants and spin doctors claiming you can have your cake and eat it:

‘Impact investment arose out of a desire by investors to preserve capital while making positive impact. In doing so, itImpact investing 3 was able to reach enterprises and have impacts that financial markets were not able to serve. Newer entrants are instead chasing higher returns while hoping to preserve impact. This paper argues that this risks discrediting the sector through generating unrealistic expectations about financial returns from impact investments.’

Here’s a nice example of genuine II:

‘Take the example of cooperative Kawa Maber, located in northeastern Democratic Republic of Congo, where infrastructure, whether in the form of Internet or functioning roads, ranges from poor to nonexistent. Extortion is a constant challenge, and the threat of ethnic and political violence or a catastrophic weather event is ever-present. The business does not even have a formal address. Despite these challenges, Root Capital underwrote a loan to Kawa Maber. Where formerly these farmers were forced to sell their coffee at cut-rate prices to middlemen in the region, as a cooperative with ties to European buyers farmers now benefit from bargaining power that comes with selling at scale. An investment in Kawa Maber could not be supported by a fund targeting market-rate returns. Yet, Kawa Maber is revenue generating and creates abundant impact. Without the creativity of Root Capital and the investors and donors that support it, Kawa Maber would likely fall into the ‘valley of death’.’

How to distinguish real II from hype? The paper argues that the key lies in ‘intentionality’ – ‘not every business that has an impact is an impact investment, as the intention to do good does not drive the business’. Without intention, there is unlikely to be serious scrutiny over whether, for example, a new mobile phone mast actually helps poor and excluded families or displaces them. Instead, all such concerns are washed away in a tide of feelgood hype.

p3-partnership-231x300The paper ends with some sensible recommendations for would-be impact investors:

  1. A shift of approach in the market is needed; from one wherein we tailor funds around the needs of investors to instead developing products that serve the needs of enterprises seeking to combat poverty. Specifically, new financial tools that reflect the predominantly ‘low and slow-returns’ of most enterprises prioritizing social impact;
  2. Greater transparency is needed around reporting both the impact and financial returns (gross and net) achieved by impact investors;
  3. Donors and philanthropists need to deploy smart subsidy and patient capital to support enterprises capable of making a meaningful contribution to poverty reduction, and to support hybrid financing models alongside impact investors seeking a net return on capital;
  4. More independent research is needed to understand the enterprise-level experience and analyze which structures, approaches, and incentives best assist enterprises to maintain an intentionality to optimize impact;
  5. We call on impact investors to agree to a voluntary code of practice that enshrines the intentionality to behave and take decisions in ways that have a primary focus on achieving impact;
  6. Impact investors should adopt incentives for optimizing, measuring, and reporting impact as well as achieving financial return targets.

I’ve long been instinctively sceptical of the overselling of impact investing and other private sector magic bullets, so it’s great to have my prejudices confirmed ;-). My only quibble on all this eminently sensible stuff is ‘where’s the link to market systems approaches’? The II model seems very linear – shove money into a product or service in such a way that it benefits poor people. But does that mean it completely ignores the wider issues (eg gender discrimination) that stop people benefiting from markets in the first place?

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5 Responses to “On hype, Impact Investing and the Valley of Death”
  1. Pete

    I disagree on enterprises having “the intentionality to behave and take decisions in ways that have a primary focus on achieving impact;”. It needs to be a partnership between the investors and those that use the money otherwise it is philanthropy.

    I invested a reasonably small amount in one organisation that turned out to only have this focus on impact – they treated my money as a donation. They are now appealing for new investments, but I doubt they will be very successful.

    I have had a much better and longer relationship with Shared Interest, a UK based organisation that invests in Fair Trade. They do focus on impact, but they also have a very strong intention to protect the capital invested with them. In times of normal inflation they pay interest at 2% below the Bank of England’s interest rate. This protection of capital and proven track record has enabled them to grow to currently manage £36 million.

    I look forward to the Impact Investment market maturing and getting to a state where people investing for their pension can reasonably safely invest some of their money into enterprises that put impact ahead of high gains, but not ahead of security. If the money is relatively safe it could draw in huge funds that would really have a very big impact.

  2. Duncan, thanks for highlighting the paper. Impact investing should sit somewhere on a spectrum that includes philanthropy, (government) subsidies and commercial capital, it is different from those and it should, because what would it add otherwise, the difference should be an understanding that impact (clearly defined/captured or not) is a form of return that is truly, let’s say intentionally, valued. The key point is your comment about “having your cake and eat it” and it is why the emphasis on intentionality of the business model is indeed important (notwithstanding Pete’s comment above that the entrepreneurs should be aligned with the investors and should treat impact capital as capital that comes with responsibilities akin to investment capital, not as philanthropic money). A related issue, in my opinion, is the focus on scale (the impact investing corollary to private equity’s focus on growth), which I wrote about here: https://www.linkedin.com/pulse/impact-investing-east-africa-should-only-scale-joris-de-vries. Finally, your parting shot about Impact Investing’s linearity, while that might be true, that should not discredit it as a tool contributing to solving problems, even if it doesn’t solve everything, but being intentional and clear about what Impact Investing can and should do is important to avoid misunderstanding what it is and what it can accomplish.

  3. Helen Schneider

    Re: Duncan’s final question about how Impact Investing fits with market systems approaches, at FFI we are adopting/adapting the latter to apply to the biodiversity conservation sector (where respecting human rights and being ‘pro-poor’ is fortunately also high on the agenda. We see (participatory) MSD as an overarching framework that increases actors’ understanding of the whole system which in turn can help identify how, where, when and with whom different (classically more linear) approaches such as SME development and Impact Investing are best applied. A short learning paper on our early experiences in adapting PMSD to conservation, together with an adapted market system selection tool can be found at the bottom of the page on this link for anyone interested: