Impact Investment. Allman Keith А.

there are problems unique to individual impact investments that stem from investors' disparate sources of capital, sometimes causing irrational risk/return profiles. A brunt of this book seeks to provide solutions to individual impact investment problems through a sound and rigorous investment process. Investment products are also evolving to help mitigate some of these problems and further develop the industry.

      However, when looking at a portfolio investment strategy there are contentious issues that divide market participants. Some argue that portfolios can be constructed where there is no trade off between financial and social return. Others believe that for an effective, for-profit commercial strategy to be successful there has to be compromise and capital placed in a gradient of investments, from high impact to traditional. The final chapter in this book explores such topics and takes a position on effective portfolio strategy.

      Notes from the Field

      Throughout this book, readers will notice excerpts called “Notes from the Field.” These are experiences that the authors have had that directly relate to the topic at hand. We hope that these extracts provide context to the topics.

      What This Book Is Not

      There are two important distinctions that should be made from the start regarding the focus of this book: It is not focused on microfinance nor social/green bonds. While we will reference microfinance in a number of sections and provide examples, the focus is not on how to make a loan to an individual nor solely on how to invest funds into a microfinance institution (MFI). There are many good books specifically on this topic. Similarly, social and green bonds have gained popularity, but they are also very specific forms of debt that lend to an entirely different strategy and analytical process.

      Setting Forth

      Impact investing is a unique and demanding field that requires an unusual range of skill sets. This book dives into both social and financial analyses in detail and provides online resources that readers can use professionally. Those with limited financial backgrounds will gain valuable insight into the investment process and the underlying components required to invest competently. Those with limited social impact backgrounds will learn the topics and methods necessary to evaluate and measure social impact. Most importantly, readers will learn how both the financial and social impact aspects of impact investing intertwine, creating a challenging, but highly rewarding form of investment.

      Chapter 2

      Sourcing and Screening

      Investors are in an exceptional position in that they have to do very little beyond saying that they have money to invest in order to get the attention of entrepreneurs. They will receive pitch after pitch for investment opportunities. However, for most investors, resources such as funding and employee's time are limited, and the repercussions of focusing on and choosing too many bad investments are severe. A well-planned sourcing and screening process can avert time- and resource-draining mistakes. Passive sourcing may work for seasoned investment houses whose reputations attract the best and most desirable entrepreneurs. However, for individual investors, advisers, or new funds, an active sourcing strategy is necessary to find enterprises that excel beyond their peers.

      Sourcing strategies generally focus on three critical aspects: geography, industry sector, and impact. Although the first two are common for mainstream investing, the third aspect, impact, is unique to impact investing. Impact investors seek an assurance that the investment fits their criteria and is likely to have a positive societal impact. Active sourcing can be done by trying to connect with local or foreign entrepreneurs; however, time and resources can easily be drained if the country of domicile or business operations is too risky for the investor, if the sector is outside of the investor's expertise, or if the impact is insubstantial. Of these sourcing elements, geographic appropriateness is unique in that it does not require dialogue with a prospective company to properly assess. Top-level analyses can be done to expose problems with investing in certain countries and prevent drained resources from pursuing investments that ultimately are too precarious due to sovereign risk.

      Sector appropriateness requires less analysis, but often requires at least some type of information from the prospective company and blends into the screening phase. Usually, an investment teaser or pitch is available and initial dialog is initiated with the target company. Asking the right questions at this time is essential to quickly screen away investments that are inconsistent with an investor's strategy.

      An effective screening phase focuses on key components of an investment's sector, stage, business, strategy, finances, and social impact. Deal-breaking issues should be revealed as early as possible, while primary strengths and weaknesses must be weighed carefully before moving the investment along to the next phase of investment process.

      Sourcing Strategy

      Sourcing potential investments is truly the inception of the investment process for any investor, whether impact focused or not. The methods employed and the decisions made at the sourcing stage lead to a variety of paths that often have an influential role for decisions at later stages of the investment process. A robust and effective sourcing strategy can help ensure that the paths with the highest probability of closing a strong investment in an efficient manner are taken, while paths that lead to wasted time, stalled negotiations, or eventual value declines are avoided.

      While the concept sounds relatively simple, what does it actually mean to be sourcing? Passive sourcing is a luxury of many well-established venture and private equity funds, where some of the best entrepreneurs deliver well-laid-out business plans with financial projections or early stage businesses with rapid growth that are poised for success. Many early-stage or less-well-known impact investing investors and funds will be inundated with entrepreneurs pitching business ideas, but the average quality of the investment will be lower.

      There are numerous reasons why the quality is perceived to be lower:

      1. Some of the best entrepreneurs in developed markets take their business ideas to well-known investors and investment incubators, where they compete for funding and, more importantly, mentorship and connections from successful entrepreneurs. While these are typically tech-oriented, it does dilute the pool of high-level entrepreneurs.

      2. The social impact element can be implemented with varying degrees of intensity. Although the heart of impact investing suggests that financial return can be achieved with social returns, there is always a point at which the social mission can impede on financial viability. Many social entrepreneurs create business plans that can be viewed as weaker from a business functionality point of view because the social mission is too aggressive.

      3. Impact investments often have heightened risk because of their geographic focus being mostly outside of the developed world.

      For these reasons, a passive strategy is not ideal for impact investing.

      Active sourcing involves targeting investments that are aligned with the investor's focus, risk tolerance and expertise in a region and sector. The easiest place to start is determining if a region or geography is suitable for investment. Local investors clearly will not have to deal with such a macro analysis, but for any individual or fund that has a regional or global scope, country market analysis should be the first step. Country analysis is also particularly important for impact investors since the source of funding and the need for funding are typically in two very different geographies. For this reason, a more intense review and example analysis is provided on this topic.

      Geographic Analysis

      Geographic appropriateness can be thought of as the first and widest filter to move items to a deeper screening. Such an analysis starts by collecting a robust collection of data sets that capture basic investing requirements and specific investment thesis characteristics. A method of weighting the importance of the data sets should be implemented in order to determine a list of countries of interest and a heat map of their relevant qualities.

      Data Sets

      There are innumerable data points for each country, but a few key ones that both debt and equity investors should take a deeper look at. A straightforward method to understand the sourcing potential and investment