The next challenge for impact investing: Scaling up support to early stage social enterprises
The growth and success of green and inclusive business models with high impact potential are central to the challenges many emerging economies are facing. These enterprises not only spur development and market growth but also ensure the preservation of the very base of our global economy – environmental and social resources. Thus, these small and medium-sized enterprises (SMEs) may just be the backbone of tomorrow’s global economy.
The considerable political and economic momentum that has been built around social entrepreneurial activity is therefore not surprising. And yet, a lack of access to finance for SMEs - described as “one of the greater challenges” by the World Economic Forum - has not yet been sufficiently addressed.
This financing gap is particularly problematic for social enterprises, as they not only find themselves stuck in the “missing middle” gap of the ‘post-startup pre-scale-up’ phase with other SMEs, but moreover, struggle to find an investor equally committed to their social mission.
Impact investing has become a hot topic and is increasingly being explored by the investor community. Numerous calls to action have spurred promising initiatives, but essential challenges remain: Firstly, high transaction costs prevent both investors and entrepreneurs from finding fruitful partnerships. Secondly, even promising new impact investing structures and vehicles still exclude a large group of investors and businesses focusing on early-stage ventures.
Investors often associate impact investing with high risk, unaware that a large number of social enterprises are profitable and have great potential. Moreover, research, due diligence and monitoring costs are high for a single investor. Even where venture capital could be mobilized, many still fear exiting may be a problem, as potential buyers are hard to find - especially when investing in social enterprises.
Struggle to find deals
Similarly, investors struggle to identify matching and promising ventures. In this emerging global market with very diverse actors, the likelihood of finding a mission and finance product match through one-on-one pitches is especially low. Currently, huge potential is lost, making the “missing middle” gap and lack of low-scale, globally accessible impact investment structures a considerable drain for growth.
To tackle these issues initiatives for impact investor and entrepreneurial networks are valuable progress. Forums such as the Global Impact Investing Network, the Aspen Network, the Investors’ Circle and Toniic aggregate expertise, provide space to share knowledge, best practices and potential deals - mostly among investors, and offer valuable tools. Namely, the impact base online directory of investment vehicles, and a global deal flow platform.
However, barriers to entering these organizations are high: be it in financing targets, membership fees or level of formalization. Financing targets of members exceed what many entrepreneurs can offer, despite their growth potential (which again showcases the “missing middle” gap). On the supply side, small actors who are just starting to consider becoming part of the impact investment space may find the costs of joining these groups too high. This is certainly the case for small business ventures.
Thus, existing structures are valuable, but not effective enough in facilitating much-needed partnerships at scale. Both small investors and businesses are especially in need of stronger facilitation and yet thus far left out of impact investment networking we see thus far. Geographically, existing structures, though building global networks and branching out to some extent, are thus far largely centred in North America and Europe, leaving other potential areas largely untapped.
Early stage finance and support
Networks should spread wider globally, and above all, a low-cost, easy entrance network including both parties is needed. Serving as a knowledge, best practice and deal flow platform like existing forums, it should focus especially on early-stage social enterprises and investors. It is this group that needs the most facilitation and support.
The emerging angel networks such as the Intellecap Impact Investment Network in India and the new African Business Angel Network (ABAN) to support the development of early-stage investor networks across the continent are examples of promising initiatives in this direction. With their knowledge of the local markets, angel investors will be able to play a crucial role in the development of starting inclusive business entrepreneurs as they offer both hard and soft capital. The angel-funded startup companies that are able to scale up fast then become interesting for the larger impact funds, which creates an exit possibility for the first investors.
In addition, the interaction between early-stage social enterprises and investors cannot only spur co-investment but also allows both sides to get to better understand the needs of potential partners. Even the development of new finance vehicles at small scale and common impact measurement standards - each currently a key topic in addressing the “missing middle” gap - could be spurred by such a forum. A small-scale, better accessibility and a higher level of interaction are key. Innovatively addressing these needs may just be the decisive step in scaling up impact investment, unlocking the potential of tomorrows flourishing SMEs.
This blog was also published on The Practioner Blog for Inclusive Business.