The case for philanthropic impact investing
Impact investing is on the rise
Impact investing1 is a powerful way to solve societal problems with entrepreneurial means. A philanthropic approach to impact investing is needed in order to effectively and sustainably address the global absolute poverty challenge. elea has been pioneering such an approach for over 16 years and has gained valuable insights.
In 2022, the global market for impact investing exceeded the USD 1 trillion mark, according to the Global Impact Investing Network (GIIN). This means that the level of capital committed to achieving positive social and/or environmental impact, while realizing net positive financial returns, has more than doubled since 2018. If this growth momentum continues and the basic promise of achieving both impact and financial goals is kept, impact investing could develop over time into a distinctive mainstream asset class with clearly defined impact categories, established investment methods, and impact measurement systems, as well as active, liquid secondary markets that allow for attractive pricing, trading, and exit mechanisms.
However, impact investing is still a young field with a limited track record – the term was coined only 17 years ago. Many impact funds are in their investment phase (often delayed because of the effects of Covid-19) and thus have delivered only a few successful exits. The Acumen Fund, one of the few institutions with a long track record of using Patient Capital to fight poverty, recently published a report which revealed that its investments of USD 115 million into 123 organizations since 2001 have yielded a net financial return of 91% of the total cost (Patient Capital Report).
This raises the question of whether the massive demand by environmentally and socially minded private and institutional investors, who expect to achieve both impact and net positive financial returns, can be matched by suitable investment opportunities. While this may be realistic for some impact categories, such as energy, e-commerce, fintech, or healthcare, it is highly challenging for others, particularly those in emerging economies.
To allow for sustainable growth based on solid impact and financial development and avoid a rude awakening after the current growth momentum, we have chosen philanthropic impact investing at elea as a way of fighting absolute poverty with entrepreneurial means.
elea: A pioneer in impact investing
elea Foundation for Ethics in Globalization was created in 2006, at the time when the term “impact investing” was coined, and has since been a pioneer in the sector. In our fight against absolute poverty (i.e., addressing the needs of people living below USD 3 in daily income), we mainly invest in early-stage ventures that focus on agriculture, last-mile distribution, and employable skills building. More recently, we have started to explore additional themes, such as the combined fight against poverty and the climate crisis or providing access to healthcare to people living in poverty. Our ventures are located in low- and middle-income countries like Kenya, South Africa, Mexico, Peru, India, and the Philippines. At elea, we are an active investor that works closely with the venture leadership teams to help realize both social impact and financial objectives.
Since its inception, elea has invested in almost 50 ventures. We measure the impact of our investees in elea Impact Points, an artificial currency that is based on our proprietary measurement method (eIMM), and our impact results are audited annually by BDO, an international audit firm. elea is also a signatory of the IFC Operating Principles for Impact Management. According to our impact database, we have so far meaningfully impacted the lives of approximately 30 million people living in poverty. Approximately half of our equity investments were at or above expectations, one quarter were positive but below expectations, and about one quarter were failures or among those where it is too early to know.
While almost all the ventures in elea’s portfolio are pursuing a path to profitability within three to four years as a condition for sustainable impact, elea itself is a philanthropic, tax-exempt foundation according to Swiss foundation law. After an initial grant by the founding family, today elea is funded by a circle of almost 50 philanthropic investors, which include entrepreneurial families, charitable foundations, and corporations. elea is an ambitious organization with a clear growth agenda: our vision for 2030 is to positively impact 100 million people, 5% of today’s 2 billion people living in absolute poverty.
Why philanthropic impact investing?
elea chose its positioning as a philanthropic, rather than a commercial, organization based on a deep conviction that such an approach is more realistic in the field of absolute poverty at this time for the following four reasons:
- Substantial risk of early-stage investing: At elea, we invest in young, innovative companies that are between their post-start-up and early-growth phases. While these ventures are already real companies, not concept papers or prototypes, they are small and risky: their annual revenue is typically below USD 1 million, and they often do not employ more than 20 people. elea aspires to be the first institutional investor on the journey of enterprise development, after the founders, their families and friends, and possibly some angel investors. Consequently investment sizes are in the (USD) hundreds of thousands, not in the millions. Companies at this stage tend to experience ups and downs and have limited resilience. Progress is not linear, and patience is required. Compared to established venture capital markets in the US, Europe, or Asia, where a very small number of stars with outsized success can cross-subsidize many others, so far we have not come across these outsized success stories in markets serving people who live in absolute poverty. With the growing deployment of technology, the potential for this is increasing, but for the time being, successful exits will only cover a part of the shortcomings of others.
- Intense effort for sourcing and support: Investee markets in low- and middle-income countries are huge but fragmented and not transparent. Professional capacity and leadership skills are scarce, and the necessary ecosystem (e.g., incubators, accelerators, business schools, etc.) is only emerging. Systematic sourcing therefore requires substantial effort, starting from desk research based on the internet and social media up to scouting tours on-site and extensive due diligence. In 2022, we looked at over a thousand investment opportunities, developed 24 preliminary investment recommendations (PIRs), conducted 13 extensive due diligences (DDs), and decided on five new and six add-on investments. Following a successful investment decision, elea team members typically join the respective boards and actively collaborate with the founding entrepreneurs and their teams on initiatives to realize impact and financial objectives. They support the ventures wherever they can add value (e.g., vision & strategy, leadership & governance development, organization building, growth & digitalization plans, fundraising, and impact measurement). Given the comparatively small amounts of single-risk capital investments, market-standard private equity fees would never cover the cost of these significant efforts. Rather, as a rule of thumb, our risk capital investment amounts match the costs of sourcing and support one-to-one.
- Underdeveloped exit markets: As is typical of emerging asset classes, there is not (yet) an established, liquid secondary market in impact investing. In this respect, the sector may be lagging 10-15 years behind the mainstream global private markets investment industry. While elea has realized a few successful exits to date, we are careful and patient in realizing potential exits, because we want to ensure that the impact focus is preserved as companies become larger and more commercially attractive. This means that we need the financial capacity to hold illiquid and risky participations on our balance sheet for extended periods, which, again, calls for philanthropic balance-sheet support that – at this stage – could not be funded by the net positive financial returns realized through market transactions.
- Investments in impact industry ecosystems: An important element of elea’s vision is to be a role model for our sector and to positively contribute to the development of the global impact investing industry. We have invested significant resources throughout our journey to develop and refine our impact measurement methodology. We have also partnered with IMD, a Swiss-based global leader in leadership development, donating a chair and a research center for social innovation. In 2021, we published the book “THE elea WAY” with IMD to document our journey to date, discussing our insights, challenges, and lessons learned. More recently, we launched the elea Entrepreneurs’ Community (eEC) to bring our entrepreneurs together regularly to share experiences, learn from each other, and exchange views with experts, thus contributing to the development of the overall sector. In 2022, we concluded an 18-month “Leading for Impact” program with IMD, which culminated in a three-day leadership development experience on campus: 30 entrepreneurs from 23 countries solved practical problems with the guidance of world-class IMD leadership faculty. All these efforts are extremely valuable for the long-term sustainability of the sector, and they cannot be funded based on market returns but rather by philanthropic donations.
We are fortunate that we can draw on our philanthropic investors’ circle of like-minded, generous individuals and organizations who find the potential of impact investing as a way of solving societal problems as appealing as we do but who also recognize that there is a need for philanthropic contributions, in addition to more commercially oriented impact investment activities, to develop this promising industry beyond the current, somewhat hyped momentum toward an attractive and reliable level of both impact and profitability.
Author: Peter Wuffli, Founder and Chairman of elea Foundation for Ethics in Globalization
1 The term “impact investing” goes back to a report prepared by the Shell Foundation in 2006. In 2007, the Rockefeller Foundation organized a conference with leaders in finance, philanthropy, and economic development to discuss the creation of a new global investment industry that strives for positive social and environmental impact in addition to net positive financial returns. Most impact investments have a duration of ten years and include private equity/debt vehicles. Typically, impact investing is defined along four criteria: intentionality (the impact intention must be explicit), additionality (impact investing should complement “regular” investment activity), materiality (the impact component in an investment should be substantial), and measurability (the impact should be systematically measured). See also: Farber, V. & Wuffli, P. (2021). THE elea WAY – A Learning Journey Toward Sustainable Impact. Abingdon, Oxon; New York, NY: Routledge. P. 41-65