Sasha Dichter Has it Right – The Debate Over Rates in Impact Investing

Sasha Dichter’s post “Below Market” hits the nail on the head.

I of all people am a huge fan of simple language, but I think we’ve settled on the wrong terms in pursuit of simplicity. What we’re really trying to say is that the level of financial return that would adequately compensate an investor for the risk she is taking in a pioneering impact-first investment would have to be astronomically high – 30%, 40%, even 50% IRRs – to compensate for the risk of investing in new, untested business models. In fact, if you think about it, since most impact-first investments are in areas that are unproven (and, therefore, much riskier), one would have to deliver even higher financial returns for “impact first” investments to adequately compensate investors for the risks they are taking.

I remember engaging in a heated debate with an investor in one of the social businesses I ran in SE Asia.  We were working on the budget and trying to reconcile my perceived need to provide additional employee support (a core component of our theory of change) vs. achieving an industry return.  His main point was: “We don’t believe in below market returns for social venture capital.  If our return isn’t the same as the market, more capital won’t flow into the sector.”

I was floored.  You want me to run a business that endeavors to solve a massive labor inequality while being equally as profitable as the well-financed, dominant industry players?  That’s like baking your cake and eating it too.  Not to mention, which market are you looking at?  Do we really want to be like some of the major players in our industry in Southeast Asia or even in the USA?

Our disagreement was ultimately around metrics.  He was measuring progress solely on financial returns as a proxy for efficiency and competitiveness.  His thinking goes, if you aren’t hitting the same industry standards in COGS, EBITDA, and so forth then you must not be competitive or sustainable.

In this particular case, however, I would argue that if you accurately identify and measure the areas where your model creates impact, you can control your “inefficiencies.”  More importantly, you can tweak your systems and expenditures to ensure you are using these funds (real or opportunity cost) to achieve the desired outcome.

I came up with a simple formula:

Business Return (A) + Social Costs (B) = Market Rate of Return (C)

I believe this works well with business models that solve labor market inequalities through training/employment generation (e.g. ex-convict rehabilitation employment programs).  The formula speaks the language of finance (efficiency/profitability), while leaving space to measure and appreciate exactly where the business is creating social impact.

I want to point out, though, that Social Costs does not mean Social Return or Social Impact.  It might be better referred to as Social Investment. This is simply the financial investment, identifiable inefficiency (i.e. lower worker productivity, increased turnover), or other costs that the business consciously invests to achieve its desired social outcome.  Measuring this financially or otherwise opens a whole new can of worms!

~ by responsiblenomad on June 19, 2013.

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