Impact Investing May Be a Bad Fit for Social Enterprises

To make social enterprises work, we must reconsider the way we label and promote them for investments.

To make social enterprises work, we must reconsider the way we label and promote them for investments.

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During my last career break in 2014 after I sold my business, I volunteered with a firm that did impact investing. They advised and raised funds for social enterprises.

My job was to help improve the marketing mix that the firm had, as well as introduce potential investors.

The company was quite a significant operation. It had full-time staff located in multiple countries. The operators and backers were all luminaries who had distinguished themselves in related fields. It was also seed-funded by one of the most famous foundations in the world.

I did only a short stint, but remained in touch with the scene on and off ever since.

The experience and insights I’ve gained has led me to conclude this — promoting social enterprises using the concept of impact investing may not work.

Square peg in a round hole

The whole concept of impact investing revolves around promising investors a reasonable level of financial returns — usually, a single-digit rate that beats inflation — and a ‘measurable’ rate of social returns.

The most commonly cited challenge in impact investing is in the difficulty of measuring social returns. You start first, with having to define the concept of ‘social returns’ itself within the myriad of social causes out there.

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Then you face the challenge of creating a reasonably all-encompassing methodology to measure it so that investors can track the social returns of an enterprise over time, and also compare between different opportunities.

For example, how do you compare the social returns from a handicraft seller produced by rescued child prostitutes in Cambodia against an Indonesian cooperative that is trying to help palm sugar farmers go organic?

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Even if you did create one recognized by global investors, the problem of consistently collecting reliable data to feed into the assessment model is always a huge struggle — especially in developing countries with corruption and poor infrastructure where many social enterprises tend to be.

Scaling is very difficult

Social enterprises also often have weak distribution channels for their products and services.

Big businesses are, more often than not, looking to maximize profit, and the majority of their customers are also looking for the best deal (in dollars and cents).

Trying to sell through big distribution and marketing partners is very difficult for small social enterprises without production scale. Without massive scale there can be no economies of scale. Without economies of scale your products will always carry a premium price — affordable only to the privileged few who has the luxury to spend on ‘causes’.

This problem has been alleviated by the age of e-commerce but is still a realistic challenge nonetheless — because growing to scale in the world of e-commerce today also takes a lot of business expertise and marketing dollars.

The right heart in the wrong place

Let’s get back to the financial returns bit.

There is a more subtle but fundamental problem at the heart of the whole social enterprise scene… the people behind them and their business models.

Many social entrepreneurs come from philanthropic or NGO backgrounds, with little or no real business experience. This results in the creation of unrealistic business models or expectations right from the start.

Individuals with the heart for philanthropic work are also often ill-suited for the dog eat dog business world. They often lack the clout, shrewdness and network required for wheeling and dealing.

Keep in mind that running a business focused on pure profit alone is already hard enough. Historically, great success has only been achieved by the rare few.

Having to balance making some profits against a promised level of social returns to your investors is arguably harder. To scale up that finely balanced success…even harder still!

The reality is, if you look at the big and successful social enterprises, many were built by people who turned to social causes only after succeeding handsomely in business first.

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Charities, should remain as charity

The truth is, many social causes are inherently… unprofitable in itself. Branding it as a social enterprise may be a good marketing move, but it doesn’t turn the business model sustainable.

Some causes are better suited for charities or NGOs to run. It just isn’t going to be a profitable business — or profitable and sizable enough to attract serious capital.

Many social enterprises I’ve heard of are seeded by grants or money from the founders themselves. After the initial sum runs out they’ll fail to attract venture capital; and thereafter fall back on donations and volunteers to keep going.

At the end of the day, even if they do attract new capital, it is often given out of philanthropic intentions, and not for the financial returns the social enterprises promise to give.

Take the label away

So look, I’m not a genius, nor a very successful businessman.

I’m sure many other astute investors would have also figured out the above points. Hence they would struggle to make impact investment decisions unless they were prepared to write it off as charity.

The company that I volunteered with was itself, operated as a for-profit business (although it had another related entity registered as a charity). Somewhat ironical but validating my theory that the middle ground label is very difficult to navigate and operate in.

Arguably startups like Beyond Meat and Impossible Foods are social enterprises. Their entire business model is aimed at lowering meat consumption, one of the biggest contributors to climate change.

But they do not call themselves social enterprises. They are fully for-profit and have raised hundreds of millions. But if you look at their investor composition, it includes a good mix of socially driven angels and venture capital funds as well as commercially motivated ones.

They are proof that if you take the ‘social enterprise’ and ‘impact investing’ labels away, it can still work.

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Great change requires pragmatism

The people in that impact investing firm I volunteered with worked really hard for many years. But their experience suggests to me that the attempt to label and promote social enterprises by quantifying social returns and balancing it against financial ones, probably won’t work.

There are no lack of social entrepreneurs in the world today. But the reality is, few social enterprises become big and scalable enough for its social impact and financial returns to be significant enough for institutional investors to look at. For the ones that do succeed, they take a while to create significant impact since the low rate of financial returns (by design) makes reinvestment in growth difficult.

Approaching it from the other direction seems to have worked better — investment funds coercing big firms to take environmental and social impact into account, by threatening to pull their money out. This is evidenced by the growing success of the whole ESG (Environmental, Social, and Governance) movement.

For social enterprises that begin life as startups, if it makes a profit and becomes self-sustainable instead of relying on donations, that would be great. But deliberately targeting a fixed level of financial returns and balancing it against social returns targets may be unrealistic in many cases.

In putting capital to work for smaller enterprises, dividing the line clearly between philanthropy (aka charity) and for-profit investing may be more practical. Creating a middle ground call ‘impact investing’ is just too tricky.