Conventionally investors work on a model of risk and return which is being replaced by a model of risk, return and impact. The impact investing ecosystem is a novel innovation which oscillates between negative and positive selections based on environmental, social, and governance criteria on one side and financial returns on the other
Impact investing has been constructed around a legitimate logic based on a combination of various goals apart from the financial ones. These are social and environmental challenges coupled with personal values. Needless to say, the problems of depleting resources and a plethora of social issues form strong underpinnings for growing concentration in responsible investing. The impact investing ecosystem is a novel innovation across the financial world. It has always been contemplated if there is the willingness of accepting lower returns in exchange for the larger interest of society, and the investment decisions oscillate between negative and positive selections based on environmental, social, and governance criteria on one side and financial returns on the other. This binary view on the trade-off between profit and purpose, however, is misleading as impact investing adds both intrinsic and instrumental value. One key tenet is the introduction of newer actors, most notably private equity funds/VC funds to invest in responsible business.
As an expected starting point, it may be pointed that nearly 80% of global investors accept their increased focus on sustainability in the last five years. Beyond the buzz of impact investing in the recent years, a look at data also verifies the statement. Private equity investors have shown a special interest in the impact investing area in India. Private equity companies have successfully built the buy-to-sell model. The investors contribute money to provide strategic as well as financial input and exit after making a return of 20-25% in a period of 5-7 years.
With the Government announcing a target of 450 GW of non-fossil energy, there has been the infusion of investors focusing on impact investing in India. Conventionally investors worked on a model of risk and return which has been replaced by a model of risk, return and impact. Impact investments differ from pure philanthropy, which implied creating impact without expectation of any return.
The focus is now on sustainable investments which would help to achieve the Sustainable Development Goals (SDGs) by 2030. The UN estimates that for the same, there has to be an investment of $3.9 trillion annually by developing nations and $1.4 trillion by public and private sectors. The gap of $2.5 trillion is expected to be filled by the impact investments.
The sector has been in India since 2000, but it picked up after 2005 on the success of financial inclusion. With the microfinance crisis in 2010, the sector suffered a setback but since then it has grown by 8 times annually.
Agriculture, education, and healthcare have seen the highest number of investments by impact investors and return followed by financial services, housing, and skilling sectors. Agriculture employs 70% of India’s rural households out of which around 80% are small farmers and impact investment has helped to create sustainable business models for farmers helping them to increase their yields, reduce costs, and having better market linkages. The agri supply chain has become a prominent area for entrepreneurship and innovation. In 2019, the sector saw a 110% increase in deal amount to $10 mn. The healthcare sector has witnessed investments of $1.1 bn with a 173% increase in 2020 due to the pandemic and entry of online pharmacy and specialty clinics as well.
The majority of investments in the case of the Banking, Financial Services, and Insurance sector (BFSI) have been in microfinance, payment services, and NBFCs working in the areas of clean energy, financial services, rickshaw loans, and SME loans. The education industry has seen large investments in skill development, vocational training in the English language, financial services offered by companies such as Imarticus Learning, etc. Additionally, tutoring, coaching, and equipment, which include educational kits for maths and sciences, are also popular destinations for impact investments. In education, 43 mn youths are getting affordable and high-quality education from 93 startups. With online mode of education that offers a rapid increase in technology with the ability to move to more students at a low cost, the ed-tech sector saw a 225% increase in 2018 and 80% in 2019. There has been an equal contribution from the impact and the commercial investors in education. Waste management and water treatment are sought-after avenues in engineering and construction sector. With the plethora of IT-enabled services coming to the forefront, online services such as motel, B2B marketing portals specifically related to HR training, CSR management, logistics and online marketplace related to agri commodities, insurance, handicrafts consumer and educational loans have become popular with investors.
Venture capital has contributed to 75% of capital in the healthcare sector. Impact investors have focused on creating quality products in the above sectors to bring a sustainable impact to society. Though the investments have been small but high level of business and technological innovation has started and scaled by the impact investors to help the development challenges of India.
The above Table 1 shows the total contribution from the impact investors. In education, impact investors focus on filling the learning level gaps and improving the learning levels. Due to the change in the online mode of education in 2020, there have been 102 deals amounting to $ 515.99 million by impact investors.
The average deal size has increased from $ 5 million in 2010 to $ 17 million in 2019 and there have been follow-up rounds of financing for sectors that were initially funded by impact investors. Out of the complete $10.8 billion investment in this area, $3.5 billion of private equity and venture capital investment has been done, implying the success of impact investors in attracting commercial capital.
Impact investment has attracted venture capital which differs region-wise in India. In the southern region of India, there are a large number of deals but with less enterprise value. High enterprise value deals are less as the plot tapes at the top. Companies having high enterprise value are more in the west and the north compared to the south and the east.
Investments made particularly in the core impact areas such as agribusiness and BFSI happen primarily at the early stage and are a popular haven for investment even for foreign investors as well. Maximum India dedicated investments happen in the education sector at all stages -- early, growth and late. Another popular impact area for foreign investors is energy where the majority of financing happens at a later stage rather than early.
Several private equity funds have started purchasing impact investment platforms or have started their own impact investment arms. From 2011-2021, there have been private equity investments of $8700.67 million across 526 companies in India. Microfinance and NBFCs have been popular with investors for extending micro-credit to service a large chunk of rural communities and people in lower-income groups without collaterals. It sweeps the highest investment of nearly Rs 29,187 crore among all the industries. In the decade of mushrooming E-commerce websites and an ever-increasing pool of digital talent, the country’s core competencies have strengthened resulting in higher investment in the ITES industry.
Successful exits are an important component of a private equity deal. For impact investors, it is important to safeguard the company post the exit. When a private equity company exits, there are several risks associated like drifting from the mission and business failure. To mitigate these risks, the investors must exit responsibly. Impact investors incorporate various methods throughout the lifecycle to continue their impact even after they exit the investment. At the time of investment, aligning with the co-investors on the growth strategy of impact and usage of language emphasising impact should be incorporated in the legal documents. Instilling positive policies and practices like those of sourcing raw materials, customer service and governing employment should be taken care of. At the time of exit, it is important to select the right buyer so that the company can have continued access to the network, knowledge, and the right resources and keep growing along with a sustained impact. Every exit made by an impact investor is a step towards improving the impact investor model. In the last decade, microfinance saw the maximum exits demonstrating that it is possible to have attractive exits outside the financial services sector. Post-Covid era, technology-led impact investing has provided healthy financial returns. Though the sector has seen promising newer investments, the global Covid 19 pandemic saw a slump in the number of exits in 2020. Impact investors contribute the “patience capital” which can have an exit period more than the traditional Private Equity and Venture Capital investment. Exits saw a pause as valuations, projections, and assumptions during this period were questionable as companies had to exit at lesser multiples. Though the pandemic has given considerable value to core areas of impact investments like technology enablement, digital health, online education but the benefits would be seen in the form of revenue multiples in the next 4-5 years. Post-Covid, impact investing is expected to become mainstream, and more technology-led. Private Equity and Venture Capital investors have $5trillion of dry powder which would be deployed in impact investments as well.
As a promising tool for philanthropists and investors, impact investing intends to generate social and financial returns. Impact investing has become an important component towards the area of research in management, finance, human resources, etc.
The sustainable development goals launched in 2015 were a successor to the Millennium development goals to determine the social and environmental impact of an investment. The United Nations invited companies and financial institutions to contribute to achieving these goals. Impact investments support the SDG in providing social outcomes (reduction of environmental degradation, employee engagement, etc) and helping in the reduction of poverty and climate change.
Impact investing would help India in exporting its social enterprise models to countries that are developing as well help in poverty reduction and provide inclusive growth in an environmentally sustainable manner. An organisation can measure its impact investing status based on the output impact on the planet (environmental sustainability), impact on people (suppliers and customers), and if the purpose has been fulfilled.
Further, one of the components of impact investing can be investing and empowering women. Studies have found out that women-led companies find difficulty in having access to a traditional form of finances as well as gathering funds from venture capitalists. Impact investing can help women look for more opportunities to differentiate themselves by getting a good amount of finance. Impact investing not only helps in the reduction of poverty, impact investing model helps in training rural women in soft skills so that they can earn an income and live life with more confidence.This outlines the benefit of impact investing in reducing gender diversity and helping women to live a better life.
There are ethical dimensions to impact inveting as well. Impact investing has also given rise to a new concept “impact washing” where the investors doubt the integrity of the claims that are being made. Transparency, measurement, and impact are important concepts to establish the growth of impact investing. As many investment managers are making impact investing and ESG as an acronym to make potential financial returns than social returns. Another side is the importance of impact investing to fill the fund requirement gap created during the Covid 19 pandemic.
In the last ten years, India has raised $10.8 bn impacting 586 enterprises and 490 million people. There has been a jump of 26% CAGR from $32 million. to $2.7 bn. The average deal size for the impact investing area tripled from $5million to $17 million. India needs $2.64 trillion by 2030 to meet the targets of Sustainable Development Goals (SDGs). The pool of assets globally having impact investing funding is $35 trillion. Government, philanthropic capital is not enough to meet the need for funds so private equity and venture capital investors have to become an integral part to provide the requisite capital to such firms.
(Sakshi Sharma is Assistant Professor, Atal Bihari Vajpayee School of Management and Entrepreneurship, Jawaharlal Nehru University, New Delhi; and Kunjana Malik is Assistant Professor of Finance, Vijay Patil School of Management, DY Patil University, Mumbai)
