Inevitably following a disaster, there is a tremendous amount of scrutiny regarding the response of charitable organizations and the government. If private sector actors become involved through impact investing, the scrutiny will increase. Critics have already voiced numerous concerns about the role of the private sector in addressing social problems. Interestingly, one of the leaders of the microfinance movement, Mohammed Yunus, is not a complete supporter of impact investing, although the movement of microfinance has been placed under its umbrella. Yunus’ proposal of what he calls social business in lieu of social entrepreneurship is that all investors should renounce any expectation of profit beyond their initial investment. He suggests that this promise should be built into the regulatory framework of the industry. For more information, read his latest book Building Social Business.
Yunus is not the only critic of impact investing, although he is arguably the most prominent. Even supporters would agree that applying for-profit models to philanthropic projects runs a high moral risk of mission drift within an organization. Mission drift is what happens when the pursuit of profit undermines the original mission of the organization. Capitalist values such as profitability, efficiency and self-interest are not on first glance the most natural partner for moral values. Vigilance, whether on the governance or regulatory level, is imperative to prevent mission drift and to ensure that the incentive of managers continues to be driven first by the social needs that the enterprise is intended to serve. But in order for the sector to continue to attract those leaders who have the potential to inspire positive change and growth, we must inspire a culture-shift to promote flexibility and innovation above older dysfunctional models.
The current nonprofit model is well-intentioned, but inexact and immeasurable. Public financing and eventually private financing will lessen due to overstretched resources in disasters and wastefulness in the response. It is imperative that social enterprise become more efficient and organized in order to accomplish its mission. The process of metrics standardization and measurement could also increase the costs of management fees and require significant time and resources from the fund, in addition to the opportunity cost of the time that could have been better spent by sourcing new investments. Another criticism is that the heavy costs will detract from the original mission for which the money was invested, thereby siphoning money into administrative overhead for requirements, like standardized metrics to attract investors, and away from core projects. This sentiment is countered by the argument that a comparable set of standards will provide the framework that impact investment needs to grow as an asset class. While there will be an upfront cost, standardization is critical to the scalability of the asset class and will attract substantial new investment that will make up for the cost over the long term. A more rigorous standard for tracking it would be beneficial to the recipients of aid as well as the aid community.
But a barrier exists. In order for impact investments to be held to the rigorous efficiency standards used by the private sector, a system of standardized measurements for the social and environmental impacts is imperative. Standardization of metrics is needed because the contexts and strategies of impact investors are diverse. Mainly, independent funds and enterprises have created their own systems of measurement, which makes comparison time-consuming, expensive, and inexact. For this reason, a number of respected actors put together the Impact Reporting and Investing Standards (IRIS). The idea is to provide investors and the public with a version of the income statement, balance sheet, and cash flow statement that are used as a snapshot of company health for mainstream investments. The essential qualitative elements of what having an impact means may escape measurement, but IRIS’ suggested indicators could help an investor gain a more thorough understanding of the reach of an investment. This system will help with building a pipeline of investable opportunities as well as exit strategies for existing endeavors. The standard is in the adoption phase under the leadership of the Global Impact Investing Network of industry leaders, B Lab, and the Rockefeller Foundation.
The IRIS criteria aid investors to evaluate funds, assist enterprises to attract funding, and allow professional organizations to issue standardized reports and recommendations. The consolidated statement promoted by IRIS would include sections to cover the organization and product descriptions, operational and product impact, and financial performance. The criteria are envisioned to include quantifiable impact indicators such as the number of employees, level of wages, employee diversity, technical assistance or training provided, and use of smallholder suppliers.
In addition to creating standardized metrics, there needs to be a means for comparison between various investment opportunities. The Global Impact Investing Rating System (GIIRS) is a third party rating system that incorporates IRIS criteria into its rating process. Similar to mainstream financial rating agencies including Standard & Poor’s and Moody’s, GIIRS provides company and fund ratings in order to facilitate comparison. Each enterprise receives an overall rating plus sub-ratings in up to fifteen categories including accountability, consumer, environment, employee, and community. The system being proposed by IRIS and GIIRS could help mainstream the industry to a point where it could be implemented on something as large-scale as post-disaster reconstruction. Certainly, the industry will need to mature in order to take on post-disaster reconstruction in a scalable manner.
Overall, there is growing optimism about using business principles and models as a force for good. Public/private partnerships or some hybrid model such as impact investing can allow for the private sector discipline to address public problems. Challenges include measuring performance, scaling up to achieve greater returns both social and financial, and assuring rigor and transparency in the sector. The private sector is governed against profitability, which is the key determining factor of success. The public sector has a responsibility to fulfill the mandate of serving the people of the nation. Social enterprises are mission-driven, but represent a hybrid of the private sector profit motive and the public sector commitment to their mandate. After a disaster, the money that pours in from recovery is often difficult to trace, especially when entrenched corruption is an issue. But the private sector may be able to better address key issues such as job creation and the restoration of business activity that are essential to recovery. It could also incentivize sustainable redevelopment to rebuild cities for the future instead of replicating the past.
Edgewood Insights 