Impact Investing 101: what is it and how does it work?

Development is a term that is thrown around to describe everything from the creation of new medicine, the mental capacity of a child, the construction of roads in rural areas, and the conception of new technologies. To me, development means empowering people who would otherwise be trapped in the poverty cycle. It means giving people, particularly in poor countries, the opportunity to not only become consumers in the very same economic market that drives the “developed world”, but also to play a meaningful role in that market. Muhammad Yunus proved to the world that poor people, especially women, could be very successful business-people if they are just given the opportunity. The Grameen Bank and Microfinance changed the lives of millions of impoverished people around the world.

So what does all of this have to do with impact investing? Microfinance targets the poorest of the poor and provides them with very small loans to lift them out of poverty.  Once out of life-threatening poverty, these people are able to imagine a future. Many of them become entrepreneurs and start small, community-focused businesses. If these businesses are successful, they look to expand. However, they need more money than can be provided through microfinance but either they do not have the collateral necessary to take out a loan from a traditional bank or they cannot take on the debt because their business is in such an early stage of development. That is where impact investing steps in. Impact Investing “involves making investments that generate social and environmental value as well as financial return” (monitor 2009). Impact investors target these small, growing businesses, “social enterprises” that are making a social impact. They fill the gaping “missing middle” by providing the necessary support (both financial and non-financial) so these entrepreneurs can develop, refine, and test their business models, stimulate demand, develop supply chains, build organizational capacity, and ultimately reach scale. (Monitor report).

How does impact investing work? The field of impact investing is very new and is rapidly growing and innovating. The two impact investing organizations I am most familiar with, Village Capital, and Agora Partnerships, go about it in different ways. Village Capital uses a “peer review” model in which 15 carefully selected social enterprises pay a small fee and enter into a 10-week peer review process. Each week all 15 entrepreneurs meet and work together to help each other develop their businesses. At the end of the 10 weeks, two entrepreneurs are selected by their peers to receive a $50,000 investment to start their businesses. Although the remaining 13 do not receive any money, they all leave with investment-ready business models. Agora takes a different approach to impact investing. They are an incubator, which means they find the social enterprises, work with the entrepreneurs to develop their businesses and then they match them with investors. Both Village Capital and Agora have been very successful with their methods and have become influential in the impact investing world.

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