Saturday, September 21, 2013

Impact Investing and Social Entrepreneurship

Two weeks ago I went to the SOCAP (Social Capital Markets) conference, an annual event hosted by Impact Hub Bay Area, which runs coworking spaces for social entrepreneurs.

The conference was at the Marina, a neighborhood along the northern coast of the peninsula.  There was a really nice view of the Golden Gate Bridge and the mountains behind it.

The aim of SOCAP is to foster and promote
...a new form of capitalism is arising that recognizes our ability to direct the power and efficiency of market systems toward social impact.
The conference brings together impact investors such as the Omidyar Network and social entrepreneurs such as myself.  Impact investing is on the rise right now as an alternative to traditional philanthropy.  Any arrangement where benefactors expect a less than 100% loss could be considered impact investing.  They might get 50% of the money back or even make a return on the investment.  According to standard economics and finance theory, this is less efficient than traditional investment, which maximizes returns, coupled with traditional philanthropy.  This is because you should be able to get the most returns from traditional investing and thus have more to give out.

Many businesses have some negative externalities, such as making some workers obsolete.  Even if this is "efficient" because overall welfare is increased, some people will be winning a lot while others unequivocally lose.  This could be prevented by having the winners compensate the losers, but in real life, there's no good mechanism for doing this.  One because it's hard to attribute one person's loss with another person's winnings.  But also because the % of winnings people might need to give up may be high and not many people would willingly give up that much.  If the winners are systematically undercompensating losers, things like neighborhood degradation could count as negative externalities.  Traditional investing lead to these kinds of situations, where philanthropy plays the role of redistributing winnings.  Then philanthropy is like the left hand handing out tiny band-aids while the right hand is periodically knocking people over.  Here are some reasons why impact investing might lead to better outcomes, though.

1. It might be better instead to invest in activities that have smaller returns but don't have as many negative externalities or that redistribute winnings systematically as part of the operations of the business.  In fact, economic theory also says that internalizing externalities would be more efficient.  Therefore, the lower returns are only artifacts of different system boundaries and differences in accounting.

2. Projects that rely on traditional philanthropy get good at applying for grants to get more funding rather than getting good at making an impact.  It is difficult to evaluate the effectiveness of a project within the context of traditional philanthropy.  It would be better if indicators of project success were generated as a part of the operations of the project.  If a project is able to make back 70% of the original grant, it could be a good indicator that the project is well-managed.  Plus, that money can be reinvested into itself.  The additional philanthropic dollar can be stretched much longer.  

3. Since a dollar can be stretched in impact investing, not as much is needed to make an impact project sustainable.  This means impact investing can be accessible to more people on the benefactor side.  It also opens up a variety of new kinds of financial arrangements, making financing more accessible to more people on the recipient side.

4. Encouraging projects to become financially sustainable also imparts valuable knowledge about management and finance to communities that need to build up human resources.  This is a very big and significant positive externality from impact investing that doesn't show up on the balance sheet.

No comments: