How is impact investing different from the traditional model of funding for non-profit ventures?
The mission of any non-profit organization (NPO) always involves a social impact and therefore impact investing in Non Profit Organizations represents ‘a social impact with a financial return.
A need for getting more value out of investments in social ventures to attain sustainable long term financing, makes impact investing a trending topic these days. While in the private corporate sector, a financial return is required on any investment in order to keep investors in the business (e.g.the dividends that are paid out on shares are the return on equity ), impact investing it is all about investing in ventures which in addition to social impact will generate a return on investment as well.
The concept of impact investing revolves around an idea that once investments generate a return, these returns can be reinvested back into the Non-Profit Organization to further social impact. By generating returns, Non Profit Organizations continue to fund themselves in the long term. Microfinance, for example, is a type of such impact investing. Initially donated funds are loaned by Non Profit Organizations to the disadvantaged who have no previous access to credit, for small business ventures. Over the loan period the borrowers repay the loan with interest but also generate enough revenue for themselves to escape poverty. The social impact of microfinance is helping people out of poverty, whilst at the same time, using the funds repaid by the borrowers to cover the NPO’s operational cost and to be lent out again to other disadvantaged individuals for other business ventures which generate a return.
How is impact investing different from the traditional model of funding?
In the traditional funding model for NPOs, donors donate funds towards a NPO’s mission. For that, they hold the NPO accountable to achieve certain measures of performance in relation to their mission. The funds are used towards expenses to fulfill the mission and the donors continue to donate annually to the NPO. Since the NPO is dependent on the donor’s funding, it can be said that donors drive the results by dictating the expectations of the NPO’s performance through the funding contract.
After the injection of funds by donors, the social venture begins to generate revenue or a return which can then be utilized to fund the NPO’s expenses and social programs into the future, eventually leading to financial sustainability for the NPO. By having a financially viable social venture, the NPO can drive its own performance as they are the people who are involved in the day to day running of the program and therefore are best placed to stipulate the results or return. In this way, there is little waste of resources in trying to satisfy the often numerous and sometimes irrelevant measures of performance specified by donors to hold NPOs accountable.
In impact investments, the risks, the returns, the social impacts and the performance measures are all envisioned by the venture specialists. Once those are laid out, they enable investors to choose a competitive social investment similar to choosing a profitable investment in the private sector.
Does this mean that the social impact investing model allows better performance monitoring and revenue generation mechanism than it is the case in the traditional model of NPO financing?
The answer is not that simple because of the nuances and many variables involved and that we are not comparing apples with apples. But in a way that might be true because the NPO is run like a business venture. Therefore, when the returns are positive, it means the business is doing well and vice versa. In traditional funding model, because there is no intention to generate a return or revenue, the performance measures have to be detailed and specified and the result is only the provision of the service- but if the intention is return, then automatically all systems within the organizations will be geared to trying to achieve a return in addition to providing a service.
The advantages of impact investing in non-profit ventures
Seeking a ‘return’ per se makes for good business sense whether the venture is profit making or not, because this enables funds to be used efficiently. Even in NPO’s, where traditionally profit is not the motive, funds used efficiently can extend the impact of the services the organization provides. Due to limited resources and increasing demand for services, we live in times where even essential services gets regular funding cuts, which makes resource allocation extremely challenging and calls for acute financial management. Impact investing in non-profits has been very effective in securing both institutional and individual funding for environmental projects and for economic development ventures in poor regions of the globe, such as microfinance.
The downside of impact investing in non-profit ventures
The downside of impact investing is in estimating the social impact and in creating financial returns, since This is not always a straightforward task. For example, what specific measure of return can be estimated for a service that improves the quality of life of a disabled child by providing attendant care support to enable the child to play in the park for an hour?
The impact is solely to the disabled child who may or may not be able to express what the value of the service is to him or her. Or what return and impact can be estimated when funds are invested in defending the sexual or reproductive rights of a woman against religious government authorities? Even in a field like education, where quantitative and qualitative measures for impact already exist, there are still gaps in measuring the quality of education, which is the more desired result.
If impact investing becomes the standard, would there be investments in NPO’s fighting on behalf of political prisoners or human rights defenders? Would there be investments in programs to end gun violence, when simultaneously both gun sales and gun deaths are rising? Would there be investment in rehabilitation for victims of rape or domestic violence? In all these scenarios it is hard to fathom a financial return or measure the social impact of these investments due to the nature of the problem and partly to due to the lengthy investment of time and resources required for a resolution, with or without the possibility of a future desirable result.
The Outlook of Impact Investing
There is a space for impact investing in non-profit ventures which can lead to effective and efficient resource utilization. However, Non Profit Organizations and governments essentially provide services that in their very essence do not necessarily generate a return but are indispensable to any responsibly functioning society which values accountability to its most vulnerable members, services which generate returns that are often immeasurable and non-financial.
If impact investing becomes the standard for these types of services, there will be increased efforts to come up with ‘creative’ social impacts and returns in order to attract donors and increase NPO’s accountability, something the traditional funding model is guilty of in the first place.