Impact-first ‘premium’ stands at $0.13 per dollar, but it is the price that must be paid – new Miller Center research

The cost of an impact-first investing approach stands at an estimated $0.13 per dollar deployed – and it is worth paying for, according to a new study published today by the Miller Center for Global Impact, in partnership with seven impact investment firms. The Miller Center is based at Santa Clara University in California, US.

The report, The True Cost Of Impact-First Investing, defines impact-first investing as an investment strategy where achieving impact takes priority over providing financial returns, meaning it will accept lower-than-market rates of return in order to create a positive social or environmental impact.

The concept of “impact-first investing” has gained ground in recent months, as the debate about whether impact investors can “have it all” – impact and market-rate returns – grows more heated. While 84% of impact investors report targeting market rates of returns and a growing number put financial above impact performance as a priority, increasing evidence points to the need for subsidised capital and blended finance to meet the needs of social enterprises delivering work on the ground. 

It is the belief of the participants in this study that there is a tradeoff between impact and financial return

The report makes clear where it stands on the debate: “It is the belief of the participants in this study that there is a tradeoff between impact and financial return.” High-impact social enterprises which are at early stages of growth often lack suitable capital, facing a “valley of death” where they are too big to receive grants but too small to attract investors, the research explains.

The study is the result of a collaboration between eight impact-first fund managers: Acumen, Global Partnerships, Halcyon, Kiva, MCE Social Capital, Miller Center for Global Impact, Open Road Impact, and Village Capital. They shared data on costs, capitalisation, transactions and impact for one fund each, together representing US$197.2 of assets under management. This was benchmarked against a sample of traditional funds, comparable in size and type (venture capital and private debt) obtained via private markets data provider Pitchbook.

• Read more: Towards a community of impact-first investors

‘Impact dark matter’

The report finds that impact-first funds were not less efficient than traditional funds: impact-first funds completed more deals per year, at a lower cost per deal. But because they tend to target smaller, more complex transactions, the cost for each dollar deployed was higher. 

In the samples used for the study, it cost traditional funds about $0.08 to deploy $1 of investment; for impact-first funds, the cost per dollar stands at $0.21, meaning the impact-first “premium” stands at $0.13.

This is due to impact-first deals usually being smaller, more complex, and requiring more hands-on support, the study explains: it is the cost of creating impact, not a reflection of poor fund performance. “What looks like inefficiency is actually the cost of delivering impact where markets fail.”

Brigit Helms (pictured), executive director of the Miller Center and lead author of the study, said: “For years, people have assumed impact-first funds are just less efficient. Our data says the opposite: we perform on par with commercial funds per investment. The true cost shows up per dollar deployed, and that's not waste, it's the price of doing this work well.

“None of us needed convincing that impact-first investing carries real costs. What we needed was the data, and that meant trusting each other enough to open our books. That all eight of us said yes tells you how much this problem matters.”

The report says: “Traditional funds appear more cost-efficient per dollar by avoiding the uncompensated value creation that impact funds take on…Delivering deep impact for 13 cents on the dollar could be considered excellent value for money.”

The true cost shows up per dollar deployed, and that's not waste, it's the price of doing this work well

The impact investing field should evaluate impact-first funds, not on the financial returns they provide, but on the “system-level value” they create, according to the report – although researchers admit that this “impact dark matter” is currently hard to quantify and sits outside existing metrics.

Filling the subsidy gap

Impact-first funds can carry higher costs while keeping capital affordable for social entrepreneurs thanks to their structure including a layer of subsidised, or catalytic, capital – from philanthropic or government-backed sources – which accepts lower returns or higher risk than market benchmarks. In the study sample, the catalytic layer represents at least half of the funds’ capital, and sometimes all of it, making it a “defining feature of impact-first structures”.

In this context, the researchers advocate for using more philanthropic funding to provide the catalytic capital needed to enable impact-first investment structures. There is currently a “subsidy gap” where not enough catalytic capital is available, and closing it would be “one of the most direct ways” to meet the needs of high-impact social enterprises in the so-called valley of death.

The report points to the “multiplier effect” of impact-first investing for philanthropic capital, in comparison to simple grant making for example. “Catalytic capital is one of the most efficient uses of philanthropy and a necessary ingredient in building inclusive markets, and that impact-first investing is a strategy that puts it to work.”

• Read more: Finding catalytic capital: Asia’s big challenge

Top image: Founded in 2012, Jibu is an African safe water network with 11,000 retail points across eight countries. Its growth was made possible thanks to impact-first investments.