Impact Investing:
A distinctive market and “asset class”

The debate over the past decade has generated several representations of the market and they have begun to coalesce around key themes. We felt it was important to find a simple way of representing the market as an integrated whole rather than an array of discrete funding products or organisations, and for it to represent the function of the market as a funding escalator for social purpose organisations. Our analytical framework maps the market against the axes of supply and demand, as an evolution of preceding work by the Social Investment Task Force and CAF Venturesome. Our main departure from previous representations is to rearrange the supply axis by product type and risk exposure rather than potential financial return. This reveals more about the gaps, bottlenecks and misalignments within the market, which are discussed in the latter sections of this chapter.

The difference between the "sector", the "market" and the "asset class"

We are seeking to develop a mainstream market for social impact investment, a market that fuses philanthropy and commercial investment, and therefore believe it is important to provide clarity by delineating some of the terms in use. 

We use the term “social sector” to refer to the grouping of all social purpose organisations ranging from grant-funded charities to for-profit social businesses, the “social impact investment market” to refer to the realm where providers of investment capital and recipients interact to do deals (it excludes grant funding, which is not investment by definition) and the “asset class” to refer to the capital invested in different products and forms across the spectrum from debt to equity. We draw a distinction between the market and the asset class, and argue that the former includes philanthropically sourced capital as well as commercial investment capital if it is ultimately deployed to organisations by way of investment and not grant funding, irrespective of its origin. “Asset class” is strictly an investment term and therefore we exclude philanthropically sourced capital because philanthropists may not expect their capital to be returned, meaning that it could be loss-absorbing capital and for that reason may not strictly be an investment by derivation. We commend this distinction to those in the market.

Pure equity capital currently has a limited role to play

Equity generally seeks to maximise financial value and represents ownership. It can therefore be a source of threat to the objectives of social purpose organisations. Philanthropic capital, however, has been seen by the sector as an obvious source of funding for these organisations because it aims to maximise social impact without requiring any financial return. Debt, on the other hand, is a financial instrument that has different investor requirements, including a lower expected rate of return than equity, a predictable rate of financial return and which does not entail change in ownership. It is therefore in principle very well suited to financing the social sector alongside philanthropic grant funding. Debt includes lending and bonds. Charity Bonds on which investors expect a lower fixed or floating rate of interest in addition to a social return are a growing financial instrument.

People often refer to equity and debt as binary classifications of capital but intermediate capital is a fertile area of overlap where the respective attributes intersect. For example, preference shares have some equity characteristics (long-term capital, often participating) but also have debt characteristics (many are required to be shown on the balance sheet as liabilities rather than shareholders’ funds and some are repaid at par and often carry a fixed rate of coupon).

The sector’s triumph in achieving the already great diversity of intermediate capital instruments should be applauded, whether these are debt-based or philanthropy-based instruments that behave like equity capital or have equity-like characteristics.

Intermediate capital is central to the market

Intermediate capital, also often referred to as mezzanine finance and including quasi-equity, has sufficient characteristics of both debt and equity to provide a broad spectrum of finance. It is a well-established corporate finance tool in the mainstream capital markets. A striking aspect of the social impact investment market is how it has already proven itself to be alive with intermediate capital instruments, even if the terminology is not yet commonplace, whether it is philanthropic capital invested as first-loss equity-like capital or the spectrum of debt capital structured with performance-related aspects including the wide sector of Payment-by-Results Capital that includes Social Impact Bonds, which is now growing rapidly, or patient capital debt with tailored repayment and interest schedules, as well as unsecured medium and longer-term debt for working capital and development capital, among others. All of these debt products, except the most plain vanilla loans, display some equity characteristics if they are linked to the performance of the organisation.

Investment and philanthropic capital (including grants) are mutually supportive

Both investment capital and philanthropic capital are complementary and necessary components in the social impact investment market. Some commentators say that to function effectively, the market requires 10% to 20% philanthropic capital and the rest can be investment capital. This ratio will need to be refined over time by independent data. The important principle to note is that their mutually supporting relationship is one of the market’s distinguishing features, which also help facilitate pluralism and diversity among providers of social impact investment capital and broaden the range of financing products.

Grants and other philanthropic capital will always be required; the availability of investment capital ensures that successful ventures started by grant funding can grow and expand – social investment capital leveraging the impact of grant funding.

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