Thursday is International Charity Day, a day in which giving is in the spotlight. But it is also worth considering whether there can be an intersection between philanthropy and investing which can make the charity self-sustaining.
That’s where philanthropic impact investing comes in. It’s a cross between charitable giving that must be repeated every year and impact investing that produces a social good while producing a financial return. For philanthropic impact investors, the charity comes in the form of being much more patient in receiving those financial returns, or perhaps not receiving them at all.
“Philanthropic impact investment aims to create impact by supporting social enterprises building viable organizations and unlocking sustainable social innovations,” writes Prof. Vanina Farber, the elea professor of social innovation and the director of elea Center for Social Innovation at IMD, an independent academic institute based in Lausanne, Switzerland.
“Rather than run the risk of distorting market mechanisms through unsustainable charitable gifts, the unique and differentiating mission of impact investors is to build better, more competitive markets by investing in businesses with potentially large social benefits, such as better livelihoods and perspectives for underprivileged people or a reduced ecological footprint on our planet,” she wrote.
In a primer on role of philanthropic impact investing on the institute’s website, Farber explained that new ventures trying to navigate from a stage of proven start-up to early growth face multiyear hurdles that can take substantial resources, in the hundreds rather than the tens of thousands of dollars often provided by traditional philanthropic gifts.
“Due to the many uncertainties combined with a lack of experience and resources at this early stage of enterprise development these commitments carry a high-risk profile,” she said. “A systematic expectation of positive financial return at this stage is simply not realistic: strategic and organizational viability is too uncertain, scale is too limited, and risk of failure is too high”
That doesn’t mean philanthropic impact investors fund a venture with no expectation of gain.
Unlike a charitable donation they are providing those resources with the goal of generating a cash-on-cash return, therefore an “investment.” However, as it does not systematically lead to positive financial net returns within a reasonable time frame, this patient form of impact investment can be considered “philanthropic.”
Farber said a typical philanthropic impact investment would be between $300,000 and $500,000.
Two key elements distinguish philanthropic impact investment from venture capital: a clear, explicit and measurable impact goal is pursued and capital follows more patient, longer-term financial return expectations.
It is also different from traditional charitable giving since a clear financial return expectation increases the focus on market solutions and hence a higher likelihood of longer-term sustainability.
IMD’s 4 keys to philanthropic impact investing success
- The business model should be sufficiently visible and allow for a ballpark estimation of the targeted social impact.
- There should be an element of bringing a non-traditional solution to market that unlocks social innovation.
- A medium term (3-5 years) path to economic sustainability must be plausibly articulated. This should capture the market potential and how future competitors affect growing revenue and gross margin projections. It also requires an analysis of both one-time investments and regular running cost that provide a plausible path to break-even within 3-5 years.
- Good ideas ultimately only become realized if combined with entrepreneurial energy and relevant skills: Therefore, the most critical criteria are the existence of either an individual entrepreneur or an entrepreneurial team that has the essential intrinsic entrepreneurial qualities and skills mix that are necessary to succeed.
Read more: Check out our Impact Funds by Theme page