Finance first or impact first? Neither!

Daniel Madhavan, the CEO of Impact Investment Group, discusses what bothers him about oversimplifying impact investing into either finance first or impact first, and explains why we should let go of all the names and frames and just see the resources we have as a set of tools.

Lots of things bother me. And yes, at times I can get on my own little soap box and have a good whinge with the best of ‘em. For this column that I write for the Pro Bono News community, I’m the guy from the world of finance. Sure, finance for good, but still. In the finance for good/impact investing world one thing that bothers me is the idea that every problem can be solved with a market-based solution that produces wonderful returns for investors. I think it’s a dangerous idea. I’m also troubled by the idea that no problem should ever be solved with a market-based solution. Equally dangerous idea.  

So how do we tell the difference? Sorry to disappoint, but that’s not this week’s topic! 

I want to tackle a more subtle idea in impact investing, and talk about something else that bothers me. But I think it might be powerful. This is the discussion about your starting point. 

Our community has developed an idea that some impact investments are “finance first” and some are “impact-first”. In finance-first you get the same financial returns you would have got if you were an a***hole, but you get to feel good about not being an a****hole because impact sits atop of your investment as a glorious cherry crown. (Sorry about the cussing, but please see my last article which hopefully provides context to ease your discomfort). Or, you can have an “impact first” investment born of DNA grafted from Gordon Gekko and one of the Saints (take your pick). These investors happily take lower financial returns because of the wonderful impact baked into the investment like the cherry in the cherry pie. I hate these ideas.

Why? Oh, so many reasons! But before I tell you why I hate them, I will acknowledge some things about their usefulness. Yes, they challenge the standard assumption that you must always compromise returns. Yes, they help people make sense of impact investing’s broad church. Yes, they reduce complexity to provide short-cuts. Have I personally used these as frames in conversations or in developing investment ideas? Absolutely (despite my shame). 

But what bothers me a lot are the limitations of using a crude method for oversimplifying the world.

Limitations of a “finance first” mindset

So, we’re aiming for “market returns”. What is the mythical “market” we are comparing ourselves to and in particular how do we avoid comparing ourselves to something we don’t want to be? Am I succeeding if I tell the truth more often than Donald Trump? Am I failing if I earn less than the CEO of Phillip Morris? I’m not sure these should be my benchmarks. I’m not sure “market” should be the benchmark, if the “market” includes a bunch of activities I really don’t want to be benchmarked against. 

Okay, this is going to freak every finance person out. In some corners of impact investing (treading very carefully here), say like lending to a social enterprise, maybe there’s a better way to have a conversation about what “financial return” could and should be? 

What about if we started with what is “fair” not what is “market”? I have always been intrigued by RSF Social Finance and their Community Pricing Gatherings that set interest rates for all the enterprises they lend to. Every quarter they bring a group of their stakeholders (borrowers, investors and staff) together to talk about what the interest rate should be for that quarter. This includes a conversation about what a higher or lower interest rate would mean for the various stakeholders. 

Limitations of an “impact first” mindset

There are some investments that will not meet the aforementioned hurdle of “market rate” so when baking the cherry pie the investor chooses to “take less” than they would normally expect if there wasn’t the impact. I’m in no way against the concept. I love it. It allows us to think really creatively (which is sometimes a very dangerous exercise in the finance world) about how finance can be used for good. 

In theory if you are taking less then it’s the same as giving something. So, it is often argued that “impact first” investing involves a type of philanthropy. I think that’s interesting, but I also wonder why then we have to approach this from the perspective of investing. It seems limiting to me that “impact first” investing sounds like “giving something up” investing, when another mindset could be “potential to stretch further” philanthropy. 

When I was on the board of Sanfilippo Children’s Foundation we were going to make a large grant to a research organisation to run a clinical trial, but we ended up negotiating a piece of equity. It had the same milestones and outcome expectations as the grant was going to have. If I was wearing an “investor” hat I would have thought it a very poor investment decision. It would have seemed super risky, with a business model that was difficult to understand. But with a “grant funder” hat on it was a great decision. 

We didn’t compromise the impact we were seeking but instead of giving the money away, we gave ourselves the opportunity to get it back and re-use it. As it turned out we made about 10 times our money and the researchers got the clinical trial up and running, so it was a big win/win but that’s not the point. Framing the decision differently allowed us to think of this as smart philanthropy instead of risky investment. 

So even after all that, I argue that what I just outlined is still limiting in itself. What I really think we should do is let go of all the names and frames and just see all the resources we have (financial and otherwise) as a set of tools we have to build/rebuild, create/recreate and shape/reshape the world we want to live in. 

If we remain unattached to names and frames we can start with the world we want to create, or the problem we want to solve, and then figure out what tools we have to bring it about. We could first examine our tool box and then build the best possible house based on the tools we have. But that sounds dumb. It would seem smarter to decide what we want the house look like before we decide what tools we should use to build it.