The Trouble With Impact Investing: Parts 1-3

July 11, 2012

Pt. 1 There’s only one bottom line. It ought to be impact.
Posted in SSIR on Jan. 24, 2012
By Kevin Starr
To learn more about DRK’s impact investing, contact

For all the hoopla, the definition of impact investing is still a dog’s breakfast. Inclusive definitions throw in everything from small donations (huh?) to investments that provide a market rate of return or above (which sounds a lot like plain vanilla investing). Here’s our—the Mulago Foundation’s—working definition: impact investing is the practice of putting money—loans or equity—into impact-focused organizations, while expecting less than a market rate of return. Investments that provide a big return don’t count: the market will take care of those, and we don’t need conferences to get people to put money into them.

On its face, impact investing seems like a great deal—organizations get cheap money (er, “patient capital”) and investors get real impact. It’s great when it works that way, but the case for impact is often dubious, and there is a lot of confusion about when impact investing works and when it doesn’t. What worries us in that not-for-profit organizations in our portfolio are under increasing pressure to take loans, and some have even lost donors to the impact investing camp.

Both philanthropy and impact investing are valid ways of doing good, but applied in the wrong way, either can do harm. For us, the right funding structure is the one that provides maximum impact for the target population. Mulago works to meet the basic needs of people in some of the poorest countries on Earth, and we’ve ended up with a portfolio that is 95 percent philanthropy. Here’s why:

1) Few solutions that meet the fundamental needs of the poor will get you your money back.

Scalable rural livelihoods, basic health care, basic education solutions, clean water—with very few exceptions, you don’t make money off this stuff, sorry. For example, the one education organization in our portfolio is Bridge International Academies, a remarkable for-profit company that provides a high-quality education to Kenyan kids for $4 a month. While they hope for market rate of return, it’s going to be a long time at best, and there are multiple levels of uncertainty. Investors are piling on, though, and why? Because there are very few deals like this out there! Fully unsubsidized clean water for really poor people? Essential services to millions of one-acre farmers? Saving lives from the most common diseases? Forging new distribution channels? Forget it—you’re not going to make any money. These represent profound market and government failures.

2) Overcoming market failure requires subsidy.

A businessman in Africa told me that Coca-Cola lost money there for 12 years. In other words, it required over a decade for one of the most competent companies on Earth to break even on the sale of a mildly addictive sugary drink that is absurdly cheap to make. Imagine what it takes when you’re focused on impact. Microcredit, the iconic impact investment of the last decade, required more than $100 million in subsidies before it became a profitable business—and the impact has been disappointing at best.

When overcoming market failure to reach the poor, it takes subsidy to do the R&D, launch the business, build the market, and sometimes even to deliver the product or service over time. Delivering at a price point the poor can afford almost always translates into very small margins. A good example is D-Rev, a small organization designing products that improve the health and incomes of poor people. They use donor subsidies to design products to the point where they are ready for manufacture and distribution at scale by for-profit companies (and sometimes not-for-profits). Because D-Rev can receive royalties via licensing agreements, funders they approach for grants often want them to take loans. Bad idea. To reach the target population, the margins—and hence the royalties—must be small. D-Rev is designing products that would never be designed otherwise: saddling them with loans simply means that they a) have to jack up prices and/or b) produce fewer designs more slowly.

3) Revenue does not equal profit.

Organizations in our portfolio that make crop loans to smallholder farmers, sell essential medicines, or market tools to improve rural incomes are often badgered to take loans and/or structure as for-profits. There seems to be this idea that if a revenue stream exists, it could be turbocharged to make a profit. That’s simply not so: the best organizations out there—the ones under the most pressure from impact investors—are already operating efficiently, squeezing out as much revenue as possible while serving the target population well. Think of them as businesses generating the most impact, while losing the least amount of money possible. Just give them the money.

4) Impact investing can drive organizations off mission.

All talk of double- and triple-bottom lines aside, there really is only one bottom line. It’s either impact or profit—and the demands of investors can pull an organization away from the target population toward those able to pay more. We’ve seen it happen, and we’ve seen more than a few organizations start in more affluent markets with the intention to move down-market to the real target population when the numbers are right (they almost never do). One thing we’ve never seen is an investor pulling a loan, because of a lack of impact or failure to reach the target population.

There’s more and more talk of blended capital, of a host of investors out there awaiting the emergence of profitable enterprises that will improve the lives of the poor in fundamental ways. The thing is that they’re mostly waiting, and waiting longer than anyone thought. In the real world of the poor, real change still means stepping up with money that you don’t expect to get back, while demanding maximum returns in the form of impact. When you find someone who can do that, just give them the money.


Pt. 2 Impact investors—especially those who consider investing an alternative to grant making—need to step back and think about exactly what problem they want to solve.
Posted in SSIR on Apr. 18, 2012
By Laura Hattendorf

I just got back from the Skoll World Forum in Oxford and it’s clear that impact investing is playing an ever-larger role in the world of social entrepreneurs. That is a good thing, but here’s a critical question for the would-be impact investor: Are you a private equity investor in emerging markets? Or are you focused on solving an important social problem at the base of the pyramid?

Much of the trouble with impact investing has been the result of fuzzy thinking about those two roles. They are not mutually exclusive, but how you make decisions, deploy capital, and support organizations is likely to be much different depending on which approach is primary.

At Mulago, we are focused on solving problems for the extreme poor. Our work became more interesting as the idea of impact investing invaded philanthropy and private equity. To make sense of the investment opportunities that clog our inboxes, we have had to think hard about financial sustainability, the role of capital in scaling ideas, and the needs of our portfolio organizations.

To find clarity we return to our mission, which is to make the very poor a lot better off. We don’t care whether an organization is a for-profit or non-profit. What we want to know is whether it will have a big impact on our target population.

When we look at the world of impact investing through this lens, we find remarkably few for-profit ventures that both reach our target population and have the potential to become viable business enterprises. Cash flow projections are wildly unrealistic, management teams untested, and market failures unacknowledged. There’s 10 times the risk profile of a standard US venture deal without the same potential upside.

All of this does not mean that market financing is not playing a big role in creating social impact. In emerging markets like India, Mexico—even Ghana—global investors (without the impact label) are driving big gains in livelihoods, healthcare, education, and access to energy. If impact investing is merely laying a social screen on money that is already targeted for investment, more power to all.

But there’s an elephant in this room.

Impact investing, and its seductive message of doing good and making money, is having a profound impact on philanthropy. The role and impact of grants is being questioned. Social enterprises with revenue models are having unrealistic economic expectations imposed on them. But most of all, impact investing creates the illusion that traditional business models can solve big problems in places where poor governance and huge market failures are the rule. In our experience, this is simply not the case. If you invest through the impact lens, the right capital structure needs to be applied to the right organization at the right time.

Three well known social enterprises—Bridge International Academies (BIA), Embrace, and One Acre Fund (which, full disclosure, are part of the Mulago portfolio)—illustrate the variations on this theme.

Jay Kimmelman, the founder of BIA, has a big idea: delivering a quality education to very poor kids in the slums of Africa at a potential scale that is breathtaking. The only way to achieve his mission, however, is to invest heavily—from the very outset—in very sophisticated systems and experienced management, because these are what drive the economics of the business. And the only way to raise the capital he needs to do this is through private equity investors. There really is no middle ground. When Jay got started, either he was going to build a big business quickly or he wasn’t going to build one at all. Jay took the gamble and, largely based on his previous success as an entrepreneur, was ultimately able to bring investors along.

Embrace, the product innovation company behind the Embrace infant warmer, started as a nonprofit, only to emerge four years later, as a for-profit company that will have an ongoing royalty relationship to the startup nonprofit. In 2008, moving their first product through R&D and clinical trials was simply not a good fit for debt or equity funding. There were too many unknowns and a relatively inexperienced management team, both of which would have limited their ability to attract investors. But now that they have a viable product, along with a more mature management team, debt and equity are the right forms of capital to fuel manufacturing, distribution, and future product development. Early stage, exclusive grant capital allowed the company to get past R&D and make private financing a realistic option.

Ironically, many social enterprises with rapidly growing earned revenues are actually organized as nonprofits. One Acre Fund, for example, generated $5 million in earned revenue last year (and is on track to generate $12 million this year), yet has no intention of morphing into a for-profit enterprise. Why? Because the leadership knows, based on iterations of field trials, that serving a market of rural, smallholder farmers requires long-term subsidies for agricultural extension, new market development, and product/service innovation. In this case, impact investors (i.e. donors) are not getting their money back, but their funds are highly leveraged and being used to solve very real problems that plague subsistence farmers all over Africa.

Nobody wants to be dependent on donor subsidies. Relative to private investment capital, the dollars available are tiny and the process to secure them is ridden with inefficiencies. But if the objective is social impact at the true bottom of the pyramid, then entrepreneurs need to think hard about the kind of capital they need, given the mission, stage, and scale of their enterprise. At the same time, impact investors—especially those who consider investing an alternative to grant making—need to step back and think about exactly what problem they want to solve and how best to deploy capital to do it.


Pt. 3 Real impact investing is not for the timid.
Posted in SSIR on Jul. 11, 2012
By Kevin Starr

When you do a three- part series called “The Trouble with Impact Investing,” people might reasonably conclude that you just don’t like impact investing. Not so—I think that if we do it right, impact investing might do a lot of good. At the Mulago Foundation, we’ve done three deals with good results and there are more in the pipeline.

The trouble isn’t with the idea itself, but how it’s played out so far. I’ve worked with more than 200 social entrepreneurs in the past couple of years and talked to lots of investors. Here is how we could blow it:

1. We’re not serious about impact.
When it comes to impact investments, the business model is usually the primary focus, and enterprises place surprising little emphasis on assuring real impact. Too often, the case for impact is pretty sketchy. A few examples:

Financing a mosquito net factory to combat malaria, when the issue is distribution, not supply.

Improved woodstoves presented as a means to prevent deforestation, when there isn’t a shred of evidence to connect the two.

A carbon finance deal to give away water filters to prevent emissions from wood-fired boiling, even though people in the area don’t boil their water.
Moreover, while the philanthropy world is still pretty bad about measuring impact, the impacting investing world is worse. Real impact measurement is a drag on the financial bottom line and investors are usually willing to assume it’s there, so few feel compelled to do it. What’s weird to me is that while all impact investors know that you could never maximize profit without measuring it, they often fail to recognize that the same is true of impact.

2. There’s no real market here.
Financial markets work because, despite hiccups, money flows effectively toward profitable firms. Philanthropy is hugely inefficient because there is no analogous market for impact. How an efficient market is supposed to emerge in impact investing remains murky. Talk of double and triple bottom lines is unhelpful—for a market to work, there can be only one bottom line, and it’s either profit or impact. One solution might be that impact investors decide what level of return they need, and then search for the firms that offer the most impact at that expected rate of return. Or maybe they decide on an expected level of impact, and shop for firms that can give it to them at the best rate of return. Whatever workable solutions emerge, impact investing will be pretty useless unless it can function in a meaningful way as a market for impact—and no solution will be workable unless impact is consistently measured and reported.

3. For-profits tend to drift off the target population.
Impact investing isn’t necessary unless there is some degree of market failure to overcome. Overcoming market failure is risky and expensive, requires innovation and R&D, and generally provides low returns on investment. We’ve seen too many for-profits drift up the socioeconomic spectrum in response to the needs of investors, and too many firms fool themselves about reaching deeper into the poverty strata once they are established with the more affluent. Investors need to commit to—and firms need to hold the line on—serving the original target population.

4. Impact ends up scattered and limited.
Philanthropy can make a real difference when it is directed toward scalable solutions and broadly applicable social innovations. Boutique projects don’t really move the needle. The same is true for impacting investing. Investing business-by-business in scattered geographies isn’t going to make much difference. We have to catalyze industries. It’s a useful exercise to ask, “Does this model have the potential to make a big difference for a million people and, if so, just how would that happen?” Rarely does that happen with a single firm. What it will take is clustering businesses, building value chains, and spurring competitors. We’re going to have to be more clever.

5. We’re too risk averse.
Studies and surveys point to huge sums poised to flow into impact investment. I find that it’s more useful to watch what people do rather than listen to what they say. And what they’re doing is . . . not that much. Startup for-profit social entrepreneurs have a hard time getting funded at all, while impact investors pile onto a very few enterprises that seem like safe bets. (The TONIIC group provides a refreshing counter-example, with a bunch of funded start-ups and an accelerating pipeline.) A lot of the investors I talk to complain that they can’t find enough fundable deals, and a lot of funds don’t seem to be spending much money. It seems to me there are three possible explanations: 1) investors aren’t serious about trading return for impact; 2) it’s a lousy field of would-be investees; or 3) we’re too afraid of risk. Given the good intentions of the investors I meet and the brilliance of the social entrepreneurs with whom I work, I’m placing my bets on #3.

Impact investing should be about trading some amount of profit to make good stuff happen that wouldn’t have happened otherwise. These are early days in a brave new world, and that makes it all the more important is that we understand our real impact and figure out how to apply real market dynamics. So: spend your damn money, put impact first, measure what happens, and share your results. We can still fix the things we’ve gotten wrong, and if we do this right, it might go big.


To learn more about DRK’s impact investing, contact