Three years ago, Honey Care, the small company that helps rural farmers generate additional income by taking part in beekeeping activities, managed to boost its growth significantly by opening its capital to foreign investors.
Why a Western investment fund would seek to partner up with a Kenyan SME whose client base is on the lower end of the wealth pyramid might seem counter-productive at first, yet Honey Care has become a highly sought after investment for a small branch of the global financial sector interested in socially responsible business opportunities.
Impact investing refers to a specific type of investments for companies and non-profits whose core mission is to address social or environmental issues, usually via specific investment funds.
In recent years, the promise of generating profits while “doing good” and use market forces to spur development has generated an incredible amount of attention, not unlike the enthusiasm micro-credit elicited in its early days.
In 2009, Monitor Institute estimated the market could reach $500 billion by 2020, and a year later, JP Morgan and Rockefeller Foundation released together their own estimate, at between $400 billion and $1 trillion. Now multiple players are involved, from major banks to private funds to development agencies and nonprofits that dedicate themselves entirely to this type of activity, each with their own set of priorities – finance or impact first.
And a whole ecosystem of business incubators, accelerators, technical assistants and consultants trying to help new ventures get launched has grown around a sector largely dominated by the developed world.
A few years into the craze, the enthusiasm is still growing and many NGOs in East Africa and elsewhere are finding themselves being asked to consider making the move to a for-profit business model and open up to investors.
Yet the industry still hasn’t yielded any concrete results to confirm that impact investments are indeed viable, for a very simple reason – most investments of this nature would take years before they can bear fruit and feed a pool of reliable data.
However, early signs indicate that the sector’s potential has been at best largely overestimated. In a recent report, the World Economic Forum estimated the current market size to be around $25 billion; it would therefore need to achieve significant, if not impossible growth in order to reach the $500 billion promised by 2020.
The reasons behind this disconnect could be summed up this way: impact investing has revealed itself to be a whole different game than what players expected, a game for which they need not only to learn new rules, but establish these rules altogether.
To begin with, there is no consensus on what impact investing is, because the concept of impact hasn’t been clearly defined yet.
When it came up with the $1 trillion figure, JP Morgan encompassed large deals in the real estate, energy or infrastructure sectors, such as the ongoing Lake Turkana wind farm project, deals that will certainly help the economy grow through job creation and infrastructure development, but will have an indirect impact on poverty.
Others choose to concentrate exclusively on SMEs that address social and environmental issues up front and in an innovative way, and hold the potential to later bring their solutions to scale – these companies are called social enterprises.
“Many businesses in the world could be classified as social enterprises,” says Alexei Bezborodov, head of field operations at Honey Care. “What sets it apart is taking a critical role at your social impact on all the stakeholders you’re working with.”
But how to measure impact is no simple feat. In fact, the science of impact measurement is itself so young that there is still much debate as to what tools and indicators should be universally used, whether impact can really be measured at all and over what period of time.
Businesses and investment funds are currently left to devise and apply their own tools, which implies extra labour costs. A lack of standardised metric system also makes it difficult to compare different companies’ performances, although new tools like the Global Impact Investing Rating System, IRIS metrics and others developed by Toniic or the European Venture Philanthropy Association will hopefully benefit from a wide adoption and help resolve that problem.
Good deals are hard to find. Social enterprises in East Africa are operating in a challenging context with poor infrastructure, underdeveloped value chains, inadequate skilled labour to fill managerial positions, and a customer base with very limited purchasing power.
These conditions are often deemed too risky by western investors, who all end up fighting for what they think are safer bets: mature companies with a proven track record, of which there aren’t many.
As a result, there is a real lack of available funding for early-stage ventures, even though that’s where the money is most needed. In the subcategory of ICT-related investments, funders are more willing to finance early-stage ventures, but often struggle to find entrepreneurs who are ready for investments.
“The issue that we often face is less around the tech-savviness of the entrepreneurs than about the business acumen of the entrepreneurs from a standpoint of business fundamentals: organising a team, being able to iterate a product, engage customers in such a way that there is a positive feedback loop, organise the business as whole as a scalable, potentially high-growth initiative,” says Alex Bashian of Invested Development, a Boston and Nairobi-based fund looking for opportunities in alternative energy, mobile and agriculture technology.
Good deals are expensive. Investments are small and resource-hungry, due diligence takes longer, businesses need more time to mature, entrepreneurs need more support and mentorship.
“It takes a long time to go from sourcing to a point where we’re able to shake hands and invest,” says Duncan Onyango, regional programme director for East Africa at Acumen, a non-profit that invests in social enterprises and runs an office out of Nairobi.
“But we’re seeing more opportunities in the region, our pipeline is growing.”
Operating costs for western funds can quickly add up, especially if they don’t have a regional office and operate from the US or Europe. Ironically, the challenge for fund managers isn’t so much to find capital as to disperse that money into investments and do it at a reasonable cost.
No one knows what the return rate should be (measured by the Internal Rate of Return or IRR), and to what extent investors should favour impact over financial returns, and vice-versa.
Currently, a vast majority of investments target high rates of return (around 20 per cent ), even though many investors say they would occasionally consider lower returns if a very high impact could be ensured.
This is commonly seen by investors as a sign that impact investments can yield high impact without compromising on returns, but might in fact reveal how much pressure is on these funds to perform.
“Impact investors are being pushed to get returns on their total portfolio, but because they can’t disperse it all, they have to look for higher returns on a smaller portion of their portfolio,” says Annie Roberts, a partner at Open Capital, a financial services and strategy consulting firm in Nairobi. And when operating costs get too high, fund managers take refuge in deals that they know will generate high returns.
Nobody can truly evaluate the potential of impact investments – yet. It will take a few more years for early players to demonstrate their success and deliver tangible results about how their portfolio has been performing, and shift the conversation from “targeted returns” to “actual returns”. One big question for investors is how and when to exit.
“The sector doesn’t seem to be at the point where a social enterprise would do an IPO in Nairobi yet,” says Jason Loughnane of Grameen Foundation, whose impact investing fund has invested in Honey Care.
“If an investor is going to exit, it will most likely be through a strategic sale to a competitor or to a larger company. Those type of exits just haven’t happened yet.”
Many social enterprises are seeking to fill a void caused by market or government failures, but it’s hard to predict when the market or the government will be able to take over — what kind of exit should be expected for a network of low-cost health clinics, schools or farming inputs is up for debate.
From the point of view of social enterprises, there is still a lack of stories of successes and failures that show whether companies can sustain the pressure of delivering financial results while staying faithful to their social mission on a long-term basis.
This is not to say that impact investing doesn’t work. Pioneer organisations like Omidyar Network, Gray Ghost or Acumen can already boast of having helped launch thousands of social enterprises (Acumen, for instance, currently has $30 million worth of investments in East Africa) that are playing a major role in addressing the issue of market development for the bottom of the pyramid.
But recent debates indicate that the sector will need to drift further away from traditional finance and develop its own set of practices, tools and approaches in order to thrive.
Lastly, the local financial sector will need to figure out how to jump in the bandwagon and take a share of a market that is still dominated by western players.
There must certainly be a way for Kenyan banks and funds to play a bigger role in the creation of socially-minded SMEs, and rip the benefits of market development.