Incentivising Impact: Should Impact Investors practice what they preach?

I had the privilege of attending the first ever HCT Group (a high impact enterprise involved in transport) investor day recently. This was the first time the company met with a group of investors, at a time when it was NOT seeking capital, to explain itself and discuss progress against both financial and impact targets.  We expect to have more of these events for our clients in the future, and see it as a useful practice borrowed from the mainstream.

An award was meant to be given to the best question from the audience, but when it turned out to have been asked by Dai Powell, the CEO, the award was given to someone else instead. What was Dai’s question? “Do any of the investors who have backed Impact Investment Funds (IIFs) vary their returns based upon the social impact achieved by the fund managers?”

This sounds a very simple straightforward question but there is actually quite a lot behind it. First of all, readers should know that HCT recently closed a £10 million financing with a range of impact and mainstream investors. ClearlySo advised on this offering, which had several interesting features. The one which is most relevant to this article is that is the interest rate paid by HCT to investors would be reduced if HCT matched or exceeded certain impact targets. This is understandable, as IIFs exist to increase the social impact achieved, as well is to earn a satisfactory financial rate of return. We are aware of a few other notable transactions which also have this feature but it is by and large an exception rather than the rule in impact investment. If we wish to increase the social impact achieved by entrepreneurs then surely it is sensible for the fund managers to put in place incentives to grow that social impact. This is obvious, straightforward and requires no further explanation.

But if we follow the logic then it makes sense for the IIF fund managers also to be similarly incentivised. As by definition they exist to encourage social impact, this would seem obvious. I myself have been at dozens of meetings where entrepreneurs are lectured to by IIF fund managers about the urgent need to measure, demonstrate and increase social impact achieved.  Therefore it is extremely interesting and bizarre to note that none of them face similar pressure.

Not a single case comes to mind of an IIF whose returns to investors are adjusted for the impact achieved.  I cannot think of any funds which Big Society Capital (BSC) has backed which have such a “ratchet”, nor is BSC itself held to account in this way. In the interest of transparency and equanimity I should also confess that we as a leading intermediary face no such ratchet, and we too lecture entrepreneurs on the importance of generating, measuring and increasing the social impact achieved. In fairness to BSC, I should add that our agreements with them require us to report to them about impact.

I think that all of us in impact investing agree that economic incentives are a useful mechanism to adjust organisational behaviour. We recognise this as a matter of principle, we speak out in public on the importance of this issue and we work with entrepreneurs to try to put such incentives in place. For the sector to get to the next level it might be interesting to reward the providers of capital in this fashion as well.