Functional Impact Investing Ecosystems Reduce Risk

Impact investors are typically seen as part of the supportive ecosystem inclusive businesses require to start, succeed and go to scale. The second Frankfurt Round Table on Social Finance on June 4, 2013, in Frankfurt, made it clear that impact investors themselves need a supportive ecosystem to reduce costs and risks of investments. The round table, organized by the German development bank KfW in collaboration with Ashoka, brought together impact investors, social entrepreneurs, and intermediaries.

Participants agreed strongly that investors require a supportive ecosystem on three main levels:

1) Different types of capital providers need to collaborate along the life cycle of a social enterprise. In early stages, entrepreneurs mostly make use of stipends and grants. When the business is small, concessional and risk tolerant debt funding is often easier to handle than opening up the ownership of the company. Equity investments and the attached shareholder interests need to be timed well to ensure ability to digest and prevent stagnation due to capital starvation. Investors along this life cycle would do well to coordinate better to help graduate investees from one level to the next. Not enough coordination is happening on this level. In addition, few investors have developed sufficiently low cost models of operation and have the risk appetite to invest in untested, early stage ventures.

2) Financial market intermediaries such as specialized rating firms and legal, tax and business consultancies, but also relevant sector conferences, capable business incubators and exposure platforms such as business plan/start-up competitions can reduce transaction costs and risks to investors and support the life cycle approach to funding needs. In addition, social enterprises often need capacity building in the form of training and coaching, and sometimes through recruiting and head hunting, to move from one level of scale and complexity to the next. Here is where investors saw the biggest gap.

3) The general business environment, including market linkages, infrastructure, the regulatory environment, and, in general, functional value chains is the level of ecosystem that allow social entrepreneurs to grow. Impact investors take these factors into account for their risk analysis, thus reinforcing the trend that investments have a tendency to cluster in few geographies and sectors.

In India, where much of the inclusive business buzz happens, a comparatively dense ecosystem of impact investors and intermediaries has evolved. A comparative KfW study confirmed that the impact investment landscape and ecosystem remains underdeveloped in most other markets in South- and South-East Asia. Nevertheless, while it is certainly too early to speak of impact investments an own asset class in these countries, individual investment opportunities do exist and wait to be exploited in the large and largely untapped frontier markets such as Pakistan, Bangladesh or Indonesia.


This blog was authored by Christina Tewes-Gradl and Jan Stilke (Project Manager, KfW), and originally posted on Business Fights Poverty.

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