Business Marries Charity

The hopes and hazards of bringing market mechanisms to philanthropy

Social-impact investing—venture capitalism, more or less, that aims for a mix of human and economic returns—is becoming all the rage.

At first blush, the common shorthand term “impact investing” may seem redundant. All financial investments are made with the intention of having an impact. The twist here is a desire among some idealistic investors, philanthropists, foundations, and financial institutions to meld moneymaking with societal improvement. It’s a growing niche. According to a recent report by J. P. Morgan, some $8 billion in impact investments were made just in 2012, and interest has grown since then.

“Put simply, impact investments are intended to deliver both financial returns and social and environmental benefits,” writes Rockefeller Foundation president Judith Rodin in a recent book, calling them “a new way of deploying capital that can combine the demand for profitability with a desire to solve social and environmental problems.” In their book about “transforming how we make money while we make a difference,” Antony Bugg-Levine of the Nonprofit Finance Fund and Jed Emerson of ImpactAssets write of pioneers who “are maximizing the total value of their investments and organizations, creating a high-octane blend of economic performance and sustained environmental and social impact.”

The movement enjoys buzz from the highest levels of government, philanthropy, and venture capital. A private blue-ribbon group that includes representatives of the Omidyar Network, Case Foundation, Morgan Stanley, Soros Economic Development Fund, Bridgespan Group, and the Ford, Rockefeller, and F. B. Heron foundations recently suggested that “the power of markets can help to scale solutions to some of our most urgent problems.”

Some advocates frame impact investing as not only a new way of allocating funds, but an improvement both to markets and to philanthropy. “Questions have been arising,” writes Rodin, “about the nature of capitalism itself and whether its current practice really serves our society and the planet.” Clara Miller of the F. B. Heron Foundation, both philanthropic executive and impact investing thought leader, argues that too many charitable resources are tied up in traditional forms of investment. Foundations, she says, shouldn’t just make grants but actually invest all of their money in ways that will improve the overall economy, especially as it affects the poor.

Factoring in nontraditional returns like social effects leads to a range of expectations about profits. Amit Bouri, CEO of the Global Impact Investing Network, notes that some impact investors expect standard market returns, while others will accept below-market returns along with the social effect they desire. Sometimes this tradeoff is masked with the claim that the investor is simply seeking his or her economic return over “a longer time horizon.”

Global capital

The quintessential impact investments take place in developing countries and are designed to bring products or services to the poor in ways that are friendly to health, ecology, and prosperity. One impressive result of impact investment is the commercial venture that markets the Universal Anesthesia Machine in sub-Saharan Africa. The machine is a hospital-quality device that can operate without electric power to safely sedate patients during medical procedures. The distributor is a freestanding, limited liability corporation run by the Nick Simons Foundation, which has long focused on improving health in developing countries. Experience has shown that impressive gadgets can end up being useless in poor countries if they aren’t owned and maintained by some entity that values them, so the UAM is not given away but sold to hospitals and governments at a price that encourages the buyer to protect the product and recovers its cost. Meanwhile, the revenue stream back to the firm from that commercial sale allows it to finance ongoing manufacturing and product improvement.

Another prominent example of an impact investment is the Nairobi-based company M-KOPA Solar. It sells a variety of solar-powered products to Africans who have no access to the electricity grid. Its lights provide an alternative to darkness or costly and polluting kerosene lamps. Its solar-powered radios and phone chargers not only allow communication, but link rural villagers to the mobile payment system that has become a backbone of East African commerce. Customers lease M-KOPA’s equipment toward purchase, typically in 18 months, after which the household can devote its income to other purposes. M-KOPA’s 100,000 customers often come out ahead economically because of the money they no longer spend on expensive kerosene. And the fume-free lighting improves indoor air quality and thus family health. A network of 1,000 retail agents and shops and a staff of 400 allow the company to sell to 2,500 new households a week, with recent expansions from Kenya into Uganda and Tanzania.

M-KOPA was started by an investment banker who had worked for the Johannesburg-based AfriCap Microfinance Fund and Bank of America. Its investors include the Bill & Melinda Gates Foundation and Gray Ghost Ventures, founded by Atlanta real-estate developer Bob Pattillo. Pattillo and his wife had run a traditional family foundation, directing most of their grants to support public education in Atlanta, where she served on the school board. His father, also a real-estate developer, had advised him to “invest your philanthropy in the communities where you do business.”

But at a church gathering, the younger Pattillo was exposed to impact investing—in the form of microfinance as a means to put working capital in the hands of very poor people overseas. “Really energized by the idea,” he contributed to a fund overseen by Deutsche Bank, making his first “program-related investment”—that is, a grant of money that is intended to be paid back, or to accrue equity in a venture, with the recipient being an entity whose work matches the foundation’s philanthropic goals. Federal regulatory changes that made it easier for program-related investments to count toward a foundation’s required 5 percent annual payout were important in making this possible for Pattillo.

Not only did Pattillo invest, he went to Bangladesh and India to meet microfinance borrowers directly. He is still touched to recall how one of them invited him back to her hut. The owner of a sundries stall in the local market, she engaged him in deep conversation about her dreams—to educate her children, to contribute to the cost of modernizing wastewater treatment in her village, even to get involved in the political life of Bangladesh. Then she surprised Pattillo by asking about his dreams. “It came to me that instead of writing a philanthropic check, I could buy shares,” he says.

Pattillo liked to follow the progress of his investments and came to believe that microfinance made for a changed and healthier relationship between him, as a wealthy investor, and the poor he hoped to help. “A light bulb went off in my head,” he says. “She was going to make choices about what to do with her loan. She could choose how to use the money, choose among microfinance banks, push the loan officer to get a better rate. That was altogether different from, say, technical assistance offered by a charity—which might not be right for her and might lead her to drop out without the charity even knowing it.”

At first Pattillo assumed that “microfinance would be philanthropy in which you lose your money slowly,” as he puts it memorably. But he found that loan repayment rates were robust—so solid that he’s put 70 percent of his personal net worth into impact investments today, the largest portion of that in microfinance banks. “I’ve seen how much further the capital goes in a developing economy. I completely switched my philosophy,” he says. “I’ve learned that the poor may be poor in finance but not in imagination, resilience, or work ethic. They deserve credit just like you or me.” (For more information about microfinance, see “Micro Lending, Major Impact” on page 48.)

These limited-profit impact investments in developing countries might be described as a new form of capitalism. Alternatively, you could think of them as a new form of development assistance—one that calls on recipients to cover a portion of the costs, or pay back a loan, while tracking results so the practice can be refined in the future. These are great advances compared to traditional government-provided foreign aid—so much of which was wasted or redirected into counterproductive purposes. But as winning as these new mechanisms are, do they really represent a fundamentally new form of investing?

Balancing many bottom lines

At least superficially, the answer can seem to be yes, both in terms of the means and goals of impact investors. Like Bob Pattillo, many impact investors pursue their aims through a combination of for-profit venture capital and philanthropic program-related investments. Steve and Jean Case are prominent advocates of this hybrid strategy. Steve, who built AOL in the early days of the Internet, is now chairman of a Washington-based impact-investment firm that provides capital for firms like Revolution Foods, a supplier of healthy foods to schools, Sweetgreen, a supplier of organic foods derived from local produce, and Everyday Health, a “suite of apps” designed to help users monitor their health. Jean, who chairs the Case Foundation, has been encouraging other signatories to the Giving Pledge to take up impact investment. The Case Foundation has plans to make at least $1.5 billion in impact investments.

The Bill & Melinda Gates Foundation has also dedicated $1.5 billion to program-related investments, more than tripling its corpus since 2009. “We are trying to solve some pretty hard problems, and we need to bring everything to bear,” foundation CEO Susan Desmond-Hellmann told the New York Times. “If we don’t involve private industry, we’re leaving out a powerful tool.” The Gates Foundation most recently staked $52 million on the pharmaceutical company CureVac, with hopes of producing more and cheaper vaccines for the developing world.

The Heron Foundation is another proponent. Its goal, says Clara Miller, is “to put not just some but all of our dollars toward mission.” Making program-related investments out of a charitable endowment was first popularized by the Ford Foundation, but Heron goes much further—aiming “to deploy all Heron capital for good.” Not just grantmaking but also the investment of the foundation’s $300 million in assets should be aimed at making measurable social gains and “lifting people out of poverty,” she believes.

Heron targets its investments to “growth-stage businesses whose product or service will employ the poor and/or formerly unemployed, at relatively high wages.” Miller says that “if there’s an employed person in the house, children will approach school with a different attitude.” Prior to Miller’s tenure, Heron estimates that only 40 percent of its endowment investments were directly aimed at “mission.”

Heron’s investments include “triple-bottom-line” enterprises that aim to earn a profit while helping the poor and improving the environment. Among them is EcoLogic, a business in California’s Central Valley that manufactures “green, convenient, and effective packaging” for various beverages and is dedicated to hiring those of low income. That investment, like most of Heron’s, is not made directly but through third-party organizations that offer impact-investing services to a range of clients, including foundations. Pacific Community Ventures is one of the groups Heron invests through. It describes itself as a venture fund “providing capital to growing companies either located in or hiring a large percentage of their workforce from low-income communities in California.” Miller explains that Heron prefers to invest through such partners “because we don’t have the capacity to be a bank” which researches and manages financial details.

The risks that such investments pose do not faze Miller. If losing money on an individual investment is not a sin in the for-profit world, her staff likes to remind her, it should not be a sin for nonprofit investors either. To help reduce risks industrywide, Heron provided $2 million to the Sustainable Accounting Standards Board, a nonprofit developing industry standards for impact investors. Another initiative called IRIS (Impact Reporting and Investing Standards) offers regular reporting for impact investors on the “social, environmental, and financial performance of their investments.”

In addition to using these intermediary firms and audit groups, many impact investors seek out “benefit corporations” as partners. These are companies with explicit social and environmental goals they rank equal to or above profit making. They are certified by the nonprofit B Lab, which looks for four goals in addition to financial success: “offering quality jobs, building strong communities, championing healthy environments, and alleviating poverty.” Shareholders in B-corporations don’t have an inherent expectation of earning market returns—a fundamental alteration of the normal shareholder-management relationship.

Taken together, these various entities begin to look like the building blocks of a new financial system. It is clearly inspired by the power of the market to find efficiencies, be honed by competition, and generate new ideas. Yet at the same time, this brave new world of impact investing also represents an implicit challenge to the market, claiming what amounts to higher moral ground.


Does impact investing pose a comparable challenge to traditional philanthropy? Impact investors do not reject ordinary grantmaking—that is, funds disbursed without expectation of a financial return. Pattillo, for instance, continues with his private donations, like paying some of the costs of constructing primary schools in India (which, once open, support themselves via tuition). Bugg-Levine and Emerson predict that “the traditional model of separating financially focused investment and charitable giving will no doubt continue.”

Miller believes that traditional philanthropy is the most appropriate way to support basic research, the arts, and education (particularly as it affects the disadvantaged). Heron’s own grantmaking is not markedly different from its impact investing—its focus is on increasing employment among lower-paid workers. In both spheres it insists on a revenue-oriented and results-based approach.

Not long ago Heron made a $1.5 million grant to support Cooperative Home Care Associates. The South Bronx nonprofit provides home health care to low-income households. The agency is owned jointly by its 1,920 employees, and Miller believes the morale boost provided by cooperative ownership, plus its high-quality operations, yield higher wages for the employees. Just like when making an investment in a for-profit company, Heron didn’t just consider the solidity of the firm, and the goodness of the cause, it also factored in market conditions—the aging of baby boomers will result in health needs that make CHCA a good bet for a substantial grant.

Many times, an impact investment will meld not just the charitable and for-profit sectors, but also some government money and purposes as well. So-called social-impact bonds are one example. When a social-impact bond is set up, a private investor provides operating capital for a public service provided by a nonprofit grantee. If the charitable work results in savings to the government (for instance, lower costs for disability payments because of a charity’s work in rehabbing injured persons), then the SIB provides for a sharing of these savings with the original investor. That yields a “return” on the money put into the SIB.

For instance, Goldman Sachs, with additional support from Bloomberg Philanthropies, has entered into a social-impact bond with New York City. The investment bank is providing operating funds for a rehabilitation program for older teens at the city’s notorious Riker’s Island jail. By some estimates, it costs the city nearly $100,000 annually to house a single inmate at Riker’s. At present, a teen released from the jail has a 50 percent chance of being back behind bars within a year (and 70 percent within three years). Just a 10 percent reduction in that recidivism rate will allow the program to pay for itself, and Goldman will break even; if the improvement goes beyond that, Goldman will receive a profit. The outcomes are being tracked by a premier research firm, and the $9.6 million investment will be compensated according to its findings.

Meanwhile, Goldman recently bet another $9 million on a Boston program to curb gang activity. Former Treasury Secretary Lawrence Summers, who has himself put money into a social-impact bond, describes the investment as “a big deal.” If it works, it is a win-win-win situation: for investors, for taxpayers, and for the teens and the communities they come from.

Will government commandeer impact investing?

Despite their obvious attractions, these public-private experiments deserve a word of caution. Rockefeller’s Judith Rodin has suggested the reach of impact investing might be increased should public-employee pension funds begin to take up the approach. Such a suggestion implies either a belief that impact investments can consistently generate the 7-percent-plus returns that such funds desperately need to remain solvent today, or that she thinks the softer, less tangible benefits of impact investing justify cutting the monthly checks of retired teachers and cops. One wonders how pensioners themselves might view the matter. (As it happens, Bob Pattillo counts as his worst impact-investing mistake the day he convinced a major pension fund to invest in a microfinance funds pool, only to see a regulatory crackdown on the practices of the South Asian microfinance industry, plunging the pension fund into losses and an abrupt pullout.)

Another public push for impact investing is a new $200 million Small Business Impact Fund, administered by the federal Small Business Administration. Loans from such funds are meant “to support small business investment strategies that maximize financial return while also yielding enhanced social, environmental, or economic impact.” Other government attempts to accelerate impact investing are being peddled by the National Impact Investing Advisory Board, a new entity peopled mostly with left-leaning foundation executives.

One worries here about government, in effect, implicitly asserting that small business generally should seek these “triple-bottom-line” goals—when most startups have a hard enough time just showing a profit. Moreover, efforts to pull impact investing under the wing of government could destroy its potential to bring market strengths and disciplines into philanthropy. Instead, impact investing could become part of a new regulatory regime in which a variety of pressures and incentives are used to manipulate private investing, pushing money into causes defined as pro-social while denigrating investments that serve economic need and efficiency (and therefore make money). This risks becoming a back route to a suffocating sort of economic planning and slowed economic growth.

More broadly, to believe that impact investments are the only or best path to combining social, environmental, and economic benefits, one must put aside the observation—demonstrated time and again—that the commonest way the world is transformed for the better is via traditional for-profit investments that produce powerful, self-sustaining new products like cell phones, ultrasound scanners, low-cost building materials, and safe, abundant foods. Providing a new good or service that is so appealing it is profitable remains the best way to improve society. Impact investing may have great value in filling gaps. But when it is prescribed as a large-scale substitute for commercial innovation, it will almost surely cause a degradation of living standards, less wealth for maintaining a clean environment and succoring the less fortunate, and a reduced pace of technological quickening.

As an example of how purely commercial innovations can lead to a range of unexpected and unplanned social benefits, consider the introduction of cell phones into the fishing industry of the southern Indian state of Kerala. The region’s many small fishermen typically wasted a significant portion of their sardine catch because they had no way to know which of many ports might offer them the best price, or even which ports were not even buying any more sardines at all. A 2007 analysis by economist Robert Jensen found that the arrival of paid cell phone service in the area produced not only increased income among Kerala’s fishermen, but “the complete elimination of waste,” and therefore “both consumer and producer welfare increased.” That seems very much like the “triple-bottom-line” investments that proponents of impact investing seek. Profits were made. The poor were helped. The natural environment was stressed less. Though no one particularly set out to achieve that result, the power of market forces in producing optimally efficient outcomes caused it to happen. It’s a story that repeats itself over and over.

In its own way, the recent years’ emphasis on marketing to the so-called bottom-of-the-pyramid (the poor in the developing world) has brought consumer goods from shampoo to laundry detergent to populations which had not previously had access to them—access created through marketing insight based in the traditional profit motive.  One could even go so far as to say that relatively low-cost prescription drugs have reached many of the world’s poor thanks to the same sort of differential pricing schemes which are used by airlines and even McDonald’s—which, as the Economist has long noted, charges different prices for Big Macs in different economies.

No doubt solar-charged flashlights are an improvement over kerosene lamps. But if conditions in poor countries could be made favorable to traditional capitalist investment, one nuclear power facility, or pharmaceutical factory, or road-building plant might do much more for the poor of the developing world than all the boutique impact investments of the last decade. Contemporary philanthropy that seeks to help the poor should not forget that including the poor in the very core of our free-market economic system is the very kindest and most reliable way to lift them up.

Historically, the best philanthropists were reluctant to create a sort of parallel economy (least of all, a wholly new economy) to serve the poor. Rather, they used their giving to offer the poor the tools they need to succeed in the mainstream. Carnegie’s libraries encouraged literacy and a love for knowledge. Settlement houses taught practical skills. The Boy and Girl Scouts bolstered virtues that underlie successful careers and families, ranging from thrift to delayed gratification to personal responsibility.

Commerce, government, and philanthropy all have distinct roles in society. And occasionally partnerships may be advantageous. But it is a mistake to remove the guardrails and combine these distinct spheres too closely—or to think that doing so is the path to a new and better general economic model.

From a startup firm in rural Africa, to an elaborate new financial instrument for improving government social services in the largest U.S. city, there is no doubt that impact investing is drawing capital today to original ideas and enterprising leaders. That is clearly a force for good. But impact investing must be a complement, not a replacement. It is no substitute for our experience-forged system of allocating economic resources on a decentralized commercial basis—which saves and improves millions of lives the world over in each passing year.