Impact investors make financial investments in businesses that aim for positive social and environmental as well as a financial return on their investments. Impact investors play an increasingly important role in the ‘missing middle’: SMEs that are too large for micro-credit and grants yet too small and risky for commercial banks. SMEs are the backbone of the economy, both in rich countries and in developing countries, but in low-income countries their contribution to the economy is much smaller than in the western world mainly because of poor access to finance.
In developing countries there are hardly any financial institutions that are prepared to provide loans to SMEs. The risks are simply too big, particularly in agribusiness where harvests can fail due to draught or political instability. An impact investor is prepared to take a larger risk and demand a lower financial return on the condition that the investment will create jobs with good benefits and working conditions and that the investment will have a positive impact on the environment. In other words: the impact investor makes a trade-off between risk, return and social impact whereas commercial banks mainly take risk and return into consideration.
In addition, most commercial banks would not consider any sort of financial investment less than 2 mio Euro’s, because assessing the business, validating the assumptions and going through the due diligence process would take too much time and effort. An impact investor would typically start considering applications at 50,000 Euro’s. For micro-financers these sums are too large and for commercial banks too small. Hence the financial needs of SMEs used to end up in the missing middle.
To a growing extent development organizations are embracing cooperation with the private sector, particularly with small and innovative businesses. Meanwhile, western companies and investors are looking for opportunities in developing countries, attracted by promising economic growth, large areas of agricultural land as well as increasing middle classes.
These companies are also increasingly aware of social and environmental issues. Both sectors now realize that they need each other. But what’s even more important: they need investors. Impact investors provide them a with a good option. They operate like venture capitalist funds but are able to take more risk for a lower return on investment.
The investment selection process
First, an impact investor fund will make a quick assessment of the business proposals. Questions like: Did an experienced entrepreneur apply for an investment? Did he or she invest in the business and will he or she manage the business? What is the business model or in other words: how will the business make money? What will the social and environmental impact be? The first assessment will usually be made during a conversation and only if the outcome is positive, the business plan will be read in detail.
The assumptions in the business plan will be scrutinized and the entrepreneur will probably be asked to answer some questions. If the answers are satisfying the entrepreneur will be asked to deliver a more detailed business plan including market analyses, an operational plan, financial projections and planning, a risk assessment and background information on the management of the proposed business.
Once the impact investor is convinced of the business plan the due diligence process can start: the investor goes through the financial and other administration to ensure that everything is clear and that there are no hidden risks. Only then the investor and investee can negotiate the deal and legalize the agreement. Then the real work can start: setting up the business and creating financial and social returns.
How does BoP Innovation Center connect businesses to Impact Investors?
BoPInc is one of the initiators of the Inclusive Business Fund and of the Inclusive Business Accelerator.
The IB Accelerator builds a global network of local platforms as well as an online network that supports the delivery of substantial numbers of investment-ready inclusive business plans to impact investors.
The Inclusive Business Fund invests in innovative companies aimed at generating a positive social, environmental and economic impact.
This article comes from the blog of the BoP Innovation Center and is republished with permission.