Op#mizing	
  the	
  Investment	
  Process	
  	
  
for	
  Returns	
  and	
  Impact	
  
Madeleine	
  Evans	
  
Please	
  con...
Impact	
  inves#ng	
  and	
  the	
  big	
  ques#ons	
  
 An	
  introduc#on	
  
§  An	
  impact	
  investor	
  has	
  a	
  financial	
  and	
  a	
  non-­‐financial	
  objec6ve,	
  ...
 The	
  big	
  ques#on	
  
What	
  drives	
  an	
  investment’s	
  impact	
  and	
  
financial	
  returns?	
  
	
  	
  
	
 ...
5	
  factors	
  that	
  maIer	
  for	
  performance	
  
 The	
  big	
  ques#on	
  
What	
  drives	
  an	
  investment’s	
  impact	
  
and	
  financial	
  returns?	
  	
  
Opera6ng	
  environment	
  
The	
  building	
  blocks	
  of	
  performance	
  
Financing	
  environment	
   	
  
Managemen...
Opera6ng	
  environment	
  
The	
  building	
  blocks	
  of	
  performance	
  
Financing	
  environment	
   	
  
Managemen...
Core	
  opera#onal	
  synergies	
  
§  The	
  business	
  model	
  &	
  technology	
  define	
  whether	
  
profitability	
...
Opera6ng	
  environment	
  
$$	
  
i	
  
Decision	
  by	
  management	
  
§  The	
  opera6ng	
  environment	
  affects	
  ...
Opera6ng	
  environment	
  
Management	
  &	
  
stakeholder	
  
values	
  
$$	
  
i	
  
Decision	
  by	
  management	
  
§...
Incen6ves	
  &	
  
requirements	
  
Incen#ves	
  &	
  requirements	
  
$$	
  
i	
  
Decision	
  by	
  
management	
  
§  ...
Conducive	
  financing	
  environment	
  
Financing	
  environment	
   	
  
$$	
  
i	
  
Decision	
  by	
  
management	
   ...
The	
  impact	
  investor’s	
  toolbox	
  
 The	
  big	
  ques#on	
  
How	
  can	
  investors	
  manage	
  these	
  
drivers	
  to	
  produce	
  blended	
  value?	
 ...
§  These	
  building	
  blocks	
  can	
  be	
  adjusted	
  as	
  part	
  of	
  investment	
  strategy	
  in	
  order	
  
...
Opera6ng	
  
environment	
  
A	
  
Management	
  &	
  
stakeholder	
  values	
  
Business	
  
model	
  &	
  
technology	
 ...
Opera#ng	
  models	
  in	
  detail	
  
What	
  rela6onship	
  between	
  profitability	
  and	
  
impact	
  should	
  I	
  ...
Opera#ng	
  environment	
  in	
  detail	
  
§  Customers	
  will	
  pay	
  a	
  premium	
  for	
  the	
  
business’s	
  p...
Incen#ves	
  explicit	
  in	
  the	
  contract	
  
§  Apply	
  crea6ve	
  contract	
  structuring	
  to	
  ensure	
  ince...
Incen#ves	
  explicit	
  in	
  the	
  contract	
  
§  Develop	
  a	
  valuable,	
  long-­‐term	
  financing	
  rela6onship...
Opera6ng	
  environment	
   Financing	
  environment	
   	
  
Assess	
  the	
  big	
  picture	
  
Business	
  
model	
  &	...
Madeleine	
  Evans	
  is	
  a	
  direct	
  equity	
  investor	
  with	
  research	
  and	
  
advisory	
  experience	
  in	...
The	
  content	
  in	
  this	
  presenta#on	
  is	
  the	
  product	
  of	
  a	
  year	
  of	
  inves#ga#on,	
  culmina#ng...
Assess	
  the	
  big	
  picture	
  
Get	
  in	
  touch.	
  
Evans.madeleine@gmail.com	
  
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Optimising the investment process for greater impact a toolkit for impact investors

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Optimising the investment process for greater impact a toolkit for impact investors

  1. 1. Op#mizing  the  Investment  Process     for  Returns  and  Impact   Madeleine  Evans   Please  contact  the  author  before  ci1ng  this  presenta1on  or  using  the  material  in  other  works.    
  2. 2. Impact  inves#ng  and  the  big  ques#ons  
  3. 3.  An  introduc#on   §  An  impact  investor  has  a  financial  and  a  non-­‐financial  objec6ve,  with  certain   performance  requirements  for  a  given  level  of  risk1     §  These  investors  face  a  unique  strategic  challenge:  simultaneously  managing  these   two  objec6ves  to  produce  an  investment  with  “shared”  or  “blended”  value2   §  This  presenta6on  offers:   §  A  framework  for  understanding  the  drivers  of  blended  value   §  A  strategic  toolbox  for  cul6va6ng  impact  and  desirable  risk-­‐adjusted  financial  returns  in   one’s  own  porGolio     §  Insight  is  drawn  from  DFIs  and  funds  inves6ng  in  for-­‐profit  or  social  enterprises   Entrepreneur   proposes  an  idea   Entrepreneur   goes  a@er  profit   Investor  wonders  what   happened  to  impact   Accep#ng  below-­‐market  returns  for  a   given  risk  in  exchange  for  greater  impact   Requiring  market  risk-­‐adjusted   returns  on  impact  investments   Social-­‐first  Finance-­‐first  
  4. 4.  The  big  ques#on   What  drives  an  investment’s  impact  and   financial  returns?         How  can  investors  manage  these  drivers   to  produce  blended  value?        
  5. 5. 5  factors  that  maIer  for  performance  
  6. 6.  The  big  ques#on   What  drives  an  investment’s  impact   and  financial  returns?    
  7. 7. Opera6ng  environment   The  building  blocks  of  performance   Financing  environment     Management  &   stakeholder   values   Business   model  &   technology   Decision  by  management   Financing   incen6ves  &   requirements    The  building  blocks  of  performance   §  A  simplified  view  of  performance  drivers,  grounded  in  incen6ve  theory  and   expanded  in  light  of  impact  inves6ng  prac6ce  
  8. 8. Opera6ng  environment   The  building  blocks  of  performance   Financing  environment     Management  &   stakeholder   values   Business   model  &   technology   $$   i   Decision  by  management   Financing   incen6ves  &   requirements   $   i    The  building  blocks  of  performance   §  A  simplified  view  of  performance  drivers,  grounded  in  incen6ve  theory  and   expanded  in  light  of  impact  inves6ng  prac6ce   §  Five  “factors  that  maTer”  drive  resource  alloca6on,  impact  &  financial  returns   PorGolio   results  
  9. 9. Core  opera#onal  synergies   §  The  business  model  &  technology  define  whether   profitability  and  impact  are  easy  to  jointly  achieve     §  Cross-­‐subsidy  models  rely  heavily  on  management   ini#a#ve  to  generate  impact  from  profitable   opera#on   §  The  fact  of  profitable  opera#on  can  ensure  impact  in   “lock-­‐step”   §  Conflicts  limit  value  for  the  investor  by  forcing   management  to  trade-­‐off  profitability  for  impact   §  Synergies  maximize  value  as  impact  enhances   expected  profitability  and  vice  versa   1.  Business  models  maIer   §  Prac6cal  examples:   §  So@ware  business  funds  founda#on  that  develops  charter  schools  in  the  Bronx   §  Solar-­‐powered  water  pump  is  sold  in  Kenya   §  Tex#le  factory  converts  to  more  costly  wind  power     §  Leather  tanning  opera#on  in  Bolivia  invests  in  technical  training  and  primary  educa#on  for   workers,  developing  posi#ve  rela#onships  that  reduce  risk  of  costly  strikes  or  boycoIs   $$   i   Decision  by  management   Business   model  &   technology  
  10. 10. Opera6ng  environment   $$   i   Decision  by  management   §  The  opera6ng  environment  affects  the  cost  and   revenues  of  business  ac6vi6es,  making  certain   business  models  more  likely  or  feasible   §  Consumer  preferences   §  Supply  chain  dynamics   §  Regula#on  &  government  programs   §  NGO  ac#vism   §  Beliefs  about  the  environment  need  to  be   consistently  updated   §  Changes  in  the  opera#ng  environment  may  turn   complementari#es  into  conflict  or  vice  versa   Business   model  &   technology   2.  The  opera#ng  environment  maIers   §  Prac6cal  examples:   §  European  customers  pay  premium  for  “Fair  Trade”  label  on  flowers  à  aIen#on  to  labor   health  &  safety  standards  creates  value  despite  costs  by  boos#ng  revenue     §  NGOs  protest  community  impact  of  Ugandan  power  plant  à  ac#ve  engagement  and   reseIlement  premiums  creates  value  by  reducing  risk  of  associated  cost-­‐overruns  
  11. 11. Opera6ng  environment   Management  &   stakeholder   values   $$   i   Decision  by  management   §  Management  values  influence  resource   alloca6on  by  shaping  intrinsic  rewards   §  Prac6cal  examples   §  Turn  a  tradi#onal  for-­‐profit  business  into  a   business  subsidizing  separate  impact  ac#vi#es   §  Create  profitable  businesses  in  high-­‐impact  areas   §  Generate  impact  at  expense  of  profitability  or   return  when  objec#ves  are  in  conflict     Business   model  &   technology   3.  Management  values  maIer  
  12. 12. Incen6ves  &   requirements   Incen#ves  &  requirements   $$   i   Decision  by   management   §  External  rewards  or  punishments  contained  in   financing  payoff  structure  can  guide  resources   toward  op6mal  performance   §  Maximize  both  profit  and  impact  under  lock-­‐step   or  synergy  model   §  Enhance  impact  when  management  pursues   profit  at  expense  of  impact   4.  Incen#ves  and  requirements  maIer   §  Requirements  in  terms  and  condi6ons  enhance  and  complement  incen6ves   §  Ensure  investor  has  ability  to  monitor  performance  and  correctly  apply  incen#ves     §  Control  level  of  impact  or  financial  performance  prior  to  investment     §  Prac6cal  examples   §  Marginal  cash  payoff  structure  of  equity  or  debt  incen#vizes  beIer  financial  performance   §  Share  bonus  for  hi^ng  certain  impact  targets  un#l  investor  exit  directly  incen#vizes  impact   §  Minimum  impact  requirements  callable  as  event  of  default  let  investor  and  management   bargain  over  punishment  for  low  impact  later   §  Offer  of  financing  condi#onal  on  demonstra#ng  certain  observable  impact  or  financial  metrics  
  13. 13. Conducive  financing  environment   Financing  environment     $$   i   Decision  by   management   Incen6ves  &   requirements   $   i   Contract  &   rela6onship   §  The  financing  environment  affects  the   scope  for  crea6ve  contract  structuring  and   long-­‐term  financing  rela6onships,   constraining  external  incen6ves  and   requirements     §  Funding  op#ons   §  Legal  requirements  on  por_olio   §  Forces  of  compe##on   §  Beliefs  about  the  environment  need  to  be   consistently  updated   §  Changes  in  the  financing  environment  may   undermine  the  power  of  implicit  incen#ves   §  Prac6cal  examples   §  Compe##on  from  solely  for-­‐profit  lenders  constrained  environmental  impact  objec#ves   pursued  by  DFIs  un#l  financial  value  of  such  objec#ves  was  widely  accepted   §  Rising  compe##on  can  undermine  implicit  incen#ves  for  impact  as  value  of  financing   rela#onship  diminishes  from  investee’s  perspec#ve   5.  Financing  environment  maIers  
  14. 14. The  impact  investor’s  toolbox  
  15. 15.  The  big  ques#on   How  can  investors  manage  these   drivers  to  produce  blended  value?    
  16. 16. §  These  building  blocks  can  be  adjusted  as  part  of  investment  strategy  in  order   to  improve  expected  returns  for  a  given  level  of  impact,  or  vice  versa     §  Arrangements  that  align  management’s  incen6ves  with  the  investor’s   objec6ves  help  minimize  the  fric6ons  that  limit  or  distort  performance   §  Three  simple  tools,  already  used  by  many  investors  for  different  objec6ves   §  Selec#on  and  screening  for  conducive  business  models  and  investment   environment   §  Structure  of  the  investment  contract     §  Long-­‐term  financing  rela#onship  and  (condi#onal)  offers  of  future  financing   §  Incen6ve  theory  and  investor  experience  suggest  how  to  use  these  tools  to   achieve  or  enhance  the  blended  value  of  investments   Blended   value    The  investor’s  role   Smart   acquisi6on   Smart   financing  
  17. 17. Opera6ng   environment   A   Management  &   stakeholder  values   Business   model  &   technology    1.  Selec#on  and  screening     §  Investors  can  focus  screens  on  compa6ble  business   models,  opera6ng  environments  and  management  values   §  Invest  in  profitable  businesses  whose  fact  of  opera#on   produces  a  definable  &  jus#fiable  impact  (e.g.  providing  life-­‐ enhancing  services  to  underserved  loca#ons  or  popula#ons)   §  Iden#fy  and  invest  in  businesses  that  exhibit  underlying   synergies  between  profitability  and  measurable  dimensions   of  impact  of  interest  to  stakeholders  the  investor   §  Invest  in  businesses  in  opera#ng  environments  where   preferences  of  customer/stakeholders  are  increasingly   aIaching  a  financial  value  to  posi#ve  impact     §  Insights  from  interviews   §  Screening  for  “social  entrepreneurs”  is  popular  in  new  early-­‐stage  funds  but  is  not  a  silver   bullet;  conflicts  can  remain  in  the  business  that  undermine  returns  for  a  given  impact   §  Shi@s  in  consumer  values  and  NGO  agendas  to  reward  strong  labor  standards  and  punish   poor  environmental  standards  provided  cri#cal  support  for  these  standards  in  DFI  por_olios   §  Management  who  personally  values  impact  is  cri#cal  to  maintaining  impact-­‐oriented  policies   within  the  business  when  the  opera#ng  or  financing  environment  reduces  the  desirability  of   impact  ac#vi#es  (e.g.  standards,  abatement,  community-­‐engagement  ac#vi#es)  
  18. 18. Opera#ng  models  in  detail   What  rela6onship  between  profitability  and   impact  should  I  expect  to  see?     Separate   ac6vi6es?   Impact   feedback?      Separate  and        subsidize   A  core  ac#vity  generates  profit,  and  impact  is   created  through  separate  ac#vi#es  funded  by  a   por#on  of  profits  from  the  core  business     Y   None      Lock-­‐step   Impact  is  generated  by  the  simple  fact  of  profitable   opera#ons   N   N/A      Synergy   Greater  impact  enhances  profitability  of  core   business  (reduces  expected  costs  or  enhances   expected  revenues)  and  vice  versa     Y   Enhances   profitability      Trade-­‐off   The  two  ac#vi#es  conflict,  and  management  is   forced  to  allocate  resources  to  either  profit-­‐ genera#ng  ac#vi#es  or  impact-­‐genera#ng  ac#vi#es   Y   Drags  on   profitability   §  Management  allocates  resources  toward  profit-­‐genera6ng  and  impact-­‐genera6ng  opera6ons,   which  may  be  separate  or  integrated   §  Impact  may  “feed  back”  and  affect  revenue  and  cost  structure  of  profit-­‐genera6ng  ac6vi6es   §  Posi#ve  feedback  enhances  profitability,  while  nega#ve  feedback  drags  on  profitability   Screening  opera#onal  models  
  19. 19. Opera#ng  environment  in  detail   §  Customers  will  pay  a  premium  for  the   business’s  products  or  services  if  the  business   aIains  posi#ve  social  impact  or  mi#gates   nega#ve  impact   §  Nega#ve  impact  carries  a  direct  cost  (cost  of   complying  with  mi#ga#on  rules,  etc.)     §  Nega#ve  impact  carries  an  expected  cost  to   the  business  (NGO  demonstra#ons  damage   reputa#on,  etc.),  such  that  mi#ga#ng  risk   enhances  expected  financial  performance     §  The  investee’s  supply  chain,  distributors  etc.   reward  impact     §  Posi#ve  impact  opens  up  new  higher-­‐revenue   or  lower-­‐cost  business  opportuni#es   Conducive  to  synergies   Likely  to  cause  trade-­‐offs   Selec#ng  a  conducive  opera#ng  environment   §  High  impact  is  highly  costly  rela#ve  to   altera#ve  low-­‐impact  scenario   §  High-­‐  impact  goes  unrewarded  by  customers,   supply  chain  etc.  rela#ve  to  low-­‐impact   business   §  Nega#ve  impact  goes  unpunished  by   regula#on,  NGO  ac#vism,  etc.    
  20. 20. Incen#ves  explicit  in  the  contract   §  Apply  crea6ve  contract  structuring  to  ensure  incen6ves  and   requirements  are  op6mized  to  produce  desired  porGolio  results   §  Think  beyond  contracts  that  purely  incen#vize  profit  maximiza#on  in   cases  where  the  underlying  business  model  exhibits  trade-­‐offs  or  follows   a  separate  and  subsidize  model,  and  management  cannot  necessarily  be   trusted  to  pursue  impact  as  the  investor  would  like   §  Incorporate  explicit  incen#ves  for  impact  into  the  investment  contract  in   the  form  of  e.g.  equity  share  bonuses  or  step-­‐downs  in  interest  rates  in   order  to  alter  cost-­‐benefit  calculus  of  genera#ng  impact     2.  Crea#ve  contract  structuring   Investment   contract   Incen6ves  &   requirements   §  Insight  from  investor  interviews     §  Investment  contracts  always  incorporate  strong  incen#ves  for  financial  performance  (e.g.   simple  debt  or  equity  investment  contract)  but  seldom  for  impact  (save  one  investor)   §  Control  rights  generated  by  minimum  impact  requirements  are  frequently  used  by   development  finance  ins#tu#ons  to  incen#vize  pursuit  of  very  important  impact  objec#ves   §  Control  rights  let  investors  gauge  the  driver  of  devia#ons  from  expected  impact  and  respond   in  order  to  maximize  financial  performance  and  impact  in  the  longer-­‐term  
  21. 21. Incen#ves  explicit  in  the  contract   §  Develop  a  valuable,  long-­‐term  financing  rela6onship  that  offers   addi6onal  implicit  incen6ves  for  the  investee  to  pursue  desired   impact  standards  or  outcomes   §  Addi#onal  financing  (implicitly)  condi#onal  on  mee#ng  impact  targets   can  alter  cost-­‐benefit  calculus  to  management  of  pursuing  impact   §  A  financing  rela#onship  must  provide  value  rela#ve  to  compe#ng  for-­‐ profit  investors  in  order  to  create  incen#ves:  lower  financing  cost,   technical  exper#se  or  market  connec#ons  (especially  as  necessary  to   enable  impact  that  brings  financial  value),  or  poli#cal  risk  mi#ga#on   3.  Long-­‐term  financing  rela#onship   Financing   rela6onship   Incen6ves  &   requirements   §  Insights  from  investor  interviews   §  Implicit  incen#ves  for  both  impact  and  financial  performance  common   §  Offer  of  future  financing  condi#onal  on  impact  is  a  cri#cal  tool  for  encouraging  management   teams  to  pursue  impact  objec#ves  to  investor’s  sa#sfac#on     §  The  value  of  the  financing  rela#onship  is  o@en  resourced  by  impact  investors  as  a  bargaining   chip  when  deciding  how  to  take  ac#on  in  response  to  a  devia#on  from  expected  impact   §  For  DFIs,  leveraging  value  of  rela#onship  as  incen#ve  for  management  to  return  to   compliance  o@en  takes  precedence  over  enforcement  of  legal  rights  
  22. 22. Opera6ng  environment   Financing  environment     Assess  the  big  picture   Business   model  &   technology   Applying  the  intui6on  to  improve  porGolio  performance  and  minimize  trade-­‐offs   §  Assess  building  blocks  of  performance  for  compa#bility  or  fric#on  among  performance  drivers   §  Apply  impact  investor’s  toolbox:    Smart  selec#on  and  smart  financing   Management   &  stakeholder   values   Incen6ves  &   requirements   Compa#ble   or  fric#on?   Compa#ble   or  fric#on?   Compa#ble   or  fric#on?   The  big  picture  for  investors  
  23. 23. Madeleine  Evans  is  a  direct  equity  investor  with  research  and   advisory  experience  in  both  impact  inves6ng  strategy  and  tac6cs  as   well  as  impact  measurement.       Madeleine  is  also  the  co-­‐founder  of    Finance  MaIers,  a  London-­‐ based  organiza#on  bridging  the  gap  in  knowledge  and  networks   between  mainstream  finance  and  the  UK’s  growing  impact   investment  sector.     She  received  an  Master  of  Public  Administra#on  with  Dis#nc#on   from  the  London  School  of  Economics,  where  she  aIended  as  a   Thouron  Scholar  and  focused  on  development  economics  and  policy.     Madeleine  holds  her  undergraduate  degrees  from  the  University  of   Pennsylvania’s  Huntsman  Program,  with  a  B.S.  from  the  Wharton   School  and  a  B.A.  in  Interna#onal  Studies  from  the  College  of  Arts   and  Sciences.     She  speaks  English,  Spanish,  and  German.    About  the  author  
  24. 24. The  content  in  this  presenta#on  is  the  product  of  a  year  of  inves#ga#on,  culmina#ng  in   a  Masters’  disserta#on  en#tled:  “Mee1ng  the  challenge  of  impact  inves1ng:  How  can   contrac1ng  prac1ces  secure  social  impact  without  sacrificing  performance?”   The  disserta#on  presents  a  strategic  toolbox  for  investors  with  financial  and  non-­‐ financial  objec#ves.  Content  is  based  on  lessons  from  economic  theory  of  contracts  and   from  in-­‐depth  interviews  with  sixteen  Bri#sh,  German,  and  U.S.  impact  investors.         The  relevance  of  each  strategic  tool  will  depend  on  the  investor’s  control  over  the   underlying  por_olio,  the  legal  and  funding  constraints  on  contracts,  the  degree  of  ac#ve   management  pursued  by  the  investor,  and  the  objec#ves  of  compe#ng  investors.  The   toolbox  is  meant  as  a  direct  resource  for  investors  in  a  por_olio  of  companies  or   projects,  but  the  intui#on  should  be  valuable  for  funds-­‐of-­‐funds  as  well.     Copies  of  the  paper  or  details  of  methodology  are  available  from  the  author.    About  the  research  
  25. 25. Assess  the  big  picture   Get  in  touch.   Evans.madeleine@gmail.com  

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