In early March, ride-sharing startup Lyft announced that it had raised $530 million in venture capital, taking advantage of the recent upsurge of the ride-sharing industry.1 Investors have poured billions of dollars into ride-sharing companies like Uber, Lyft, and many others throughout the world, as these companies have found an innovative way to satisfy consumer demands.
Is it possible to use this resourcefulness to address the world’s social and environmental needs?
For many years, governments and nonprofit organizations have combated a laundry list of worldwide social problems, including poverty, disease, homelessness, and lack of education. While their efforts have shown positive results, both governments and nonprofits do not wield the financial power to successfully implement long-lasting social and environmental change. The emergence of impact investing has presented a tremendous opportunity for the betterment of the world’s social problems: access to trillions of dollars in private capital.
Establishing a Market for Social Impact Investments
There has been long-standing divide between investment for financial gain and philanthropy for social advancement. This notion is being challenged by the emergence of impact investing, which intends to achieve a social impact alongside financial return. This “double bottom line” is not a new concept—for years, pressing social issues have compelled some investors to seek out more socially responsible allocations of capital. However, mainstream investors avoided investing for social impact, believing that it implied sub-market returns. In short, common consensus was that social impact investments were nothing more than an honorable way to lose money. The impact investment community has refuted this belief, as many socially responsible funds are targeting market-rate returns alongside positive social and environmental goals.
The impact investment space now stands at a critical juncture as many investors seek to enter this rapidly growing market. It is beyond doubt that access to mainstream investors—including pension funds, insurance companies, university endowments, and many others—would have tremendous benefit for projects aimed at social advancement that lack adequate funding. However, there are numerous obstacles that have prevented large flows of capital into impact investments; tapping into the power of capital markets is no easy task. There are a number of uncertainties about the viability of impact investments for the mainstream investor.
Despite the growing buzz surrounding impact investments, there is still widespread confusion about what impact investing entails, which asset classes are most relevant, and how the sector will address challenges moving forward. Today, the impact investing sector lacks the infrastructure needed to scale effectively; without a collaborative effort by government, investors, and regulatory agencies, the sector will never achieve its full potential.
Organizations like the Global Impact Investing Network have attempted to increase awareness and effectiveness of impact investing by developing the sector’s infrastructure. While their efforts have driven sector growth in recent years, it is still in its early stages. To scale, investors must be given the proper tools to make informed investment decisions. The impact investing sector does not have the strict regulation that has reinforced public confidence in traditional financial markets. Certain needs, including standardized metrics of performance, transparent and freely accessible data, and third party regulation, must be met to establish a scalable impact sector.
The Role of Federal Policy & Emergence of Venture Capital
There are many people in the finance community who claim that impact investing may be the new venture capital. This is largely due to the role federal policy played in the emergence of venture capital, and how the impact sector is positioned to benefit tremendously by similar change in federal policy. The flow of investment funds is greatly affected by federal policy, and the magnitude of its influence was made evident as a new investment vehicle, the venture capital partnership, began to draw attention in the early 1970s.
The Employee Retirement Income Security Act (ERISA) regulates trillions of dollars in pension fund investments. Under ERISA, pension plan fiduciaries were not permitted to invest in venture capital partnerships, and the VC industry was nearing its final breath. In the late 1970s, policy changes allowed for pension funds to invest in venture capital, stimulating the growth of the industry – nearly $5 billion in new venture capital investments flowed in over a two year period. Access to this capital was used to fund some of today’s most successful companies, including Apple, Google, and Microsoft.
In 2008, the Department of Labor made a response to “economically targeted investments” for pension fund fiduciaries, offering no support for stimulating the impact investment sector. The interpretation was that under ERISA, a pension fund fiduciary must act solely in the interest of the plan's participants and beneficiaries, and may never subordinate the economic interests of the plan to unrelated objectives.
Many have speculated that a change in federal policy may energize the impact sector just as it did for venture capital nearly forty years ago. Enabling policies, such as easing the regulation of pension fund investments and favorable federal tax treatment, could help leverage inadequate government funding for social and environmental change.
Paving the Way for Long-Lasting Social Change
The impact sector has tremendous potential, but must clear several obstacles before it begins to improve the lives of people throughout the world. We are beginning to see innovation within the sector, such as the emergence of social impact bonds in the UK that have given social projects access to capital markets.
Reports from McKinsey show estimates of over $200 trillion in global financial assets. With an abundance of readily available capital, the impact sector is poised for expansion that could address social change more effectively than ever before. This expansion first requires definitive action to establish market infrastructure and enabling federal policy that guides sustainable growth of impact investments.
If the impact sector continues to prove its track record through success stories, similar to those of Apple and Intel in the early days of venture capital, it can prove that impact investments have a role in a profit-maximizing portfolio. We stand at the crossroads of public good and private capital, presented with an incredible opportunity to improve the lives of millions of people by harnessing the power of capital markets.