Pushing for greater impact investment to and impact incentives for small and growing businesses

30. Jun 2018

Nudging the investment ecosystem by incentivizing impact

• 26 pages • : Intellecap, Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH

This paper aims to foster a conversation around impact measurement and management 2.0 and actively integrating impact incentivization in investment processes. It builds on the results of the Conference Financing Global Development – Leveraging Impact Investing for the SDGs hosted by the German Federal Ministry for Economic Cooperation and Development (BMZ) in Berlin on 21st November 2017.

GIZ, Intellecap, and the Swiss Agency for Development and Cooperation (SDC) are working with impact investors and impact-oriented businesses to better articulate, measure, benchmark, and incentivize impact achievement, and channel greater investment to high impact small and growing businesses (SGBs). According to impact investment chain actors - fund managers, development finance institutions, intermediaries, entrepreneurs, governments, civil society stakeholders, and other experts - there are five crucial factors to improving impact incentives and increasing impact investments that capital providers, fund managers, and businesses/enterprises should focus on:


  1. Leadership towards internal change and impact alignment within investing companies.
    Future innovations in impact management will be pioneered by organizations that apply smart incentives oriented towards internal change. Leadership and organizational culture are crucial to align internal ecosystems with impact.
  2. Promoting transparency across the investment chain.
    Future innovations in impact management will be nurtured by increased transparency along the investment chain including at government, capital provider, fund manager, and enterprise levels.
  3. Standardization or common articulation of impact to allow comparative impact performance evaluation overtime, and across investments.
    Future innovations in impact management – no matter if market places, auctions or rankings – require more common articulation of impact. Working towards a more common language forms the basis for better mutual understanding and enables effective impact benchmarking.
  4. Emerging technologies such as big data, blockchain and cryptocurrencies.
    Future innovations in impact management will likely build on emerging technologies such as big data, blockchain and cryptocurrencies that can enable innovative incentivization approaches. The characteristics inherent to those technologies respond to the need for lean, transparent, and peer-to-peer mechanisms with the potential to increase effectiveness and efficiency.
  5. Building reward mechanisms for impact performance and achievement.
    Future innovations in impact management will likely be built on market-based mechanisms that help reward impact performance and, hence, ‘nudge’ the overall system towards more impact orientation. Regulators and policy makers will play an important role to create relevant framework conditions.

With the adoption of the SDGs and the Addis Ababa Action Agenda (AAAA)—the global policy framework for financing sustainable development—there is increasing global interest in developing innovative financing mechanisms that align private capital with impact. The debate goes beyond the idea of mobilizing more capital; stakeholders across the spectrum realize the need to look at how to achieve better outcomes and impact, e.g. to more actively pursue and manage for quality. Impact investing cannot only provide models for mobilizing private investments for the SDGs but, more importantly, it should also provide frameworks for articulating, measuring, benchmarking and incentivizing impact in value chains.

While impact investing has gained momentum internationally, the amount of capital going into small and growing businesses (SGBs) remain marginal; of the USD200 trillion private equity funding available globally, only 1% is available through venture capital. Due to high perceived risk, disproportionate due diligence cost, lower potential returns, longer time horizons, and unfamiliarity with new business models in unknown markets, capital providers and fund managers are hesitant to place capital into SGBs. Once capital has been acquired for these ventures, the financial objectives of investors often eclipse impact objectives set by implementers because current impact investing models are geared towards lessening risks for investors/capital providers, and reconciling competing interests within organizations. Impact investment firms have also largely targeted and preferred to support bigger and more mature enterprises rather than small ones, including startups.

This report highlights key ideas from 50 impact investment chain stakeholders—fund managers, development finance institutions, intermediaries, entrepreneurs, governments, civil society stakeholders, and other experts—on how to 1) incentivize mobilization of capital for impact investment, and 2) incentivize the scaling of impact along the investment chain. Stakeholders across the spectrum agree that impact needs to be further engrained in investment and enterprise development strategies. To channel more capital into impact, governments can offer guarantees and other de-risking mechanisms to capital providers and high impact enterprises, and craft tax incentives (i.e., tax relief mechanisms) to mainstream investments into small and medium enterprises (SMEs), while capital providers and fund managers can design financing schemes that distribute returns based on impact and additionalities (e.g., technical assistance, market linkages) provided, and open funds that allow for long-term investments without time limits for fundraising or fund liquidation. To scale impact creation, impact performance-based revenue, paying for impact premiums, and outcome-based funding, i.e., results-based financing (RBF) and pay for success (PFS) instruments, can be utilized by governments, philanthropists, and other donors to reward enterprises and intermediaries that deliver specific outcomes and impact. Other funders are providing reimbursable grants with discounts based on impact created to reduce repayments by grantee-enterprises, protective provisions to secure impact by creating classes of capital providers and giving special rights to “impact-first investors”, and recoverable grants, soft capital, and convertible debts to early-stage enterprises and meet the needs of unproven business models. Capital providers, financial intermediaries, and enterprises are being challenged to shift organizational culture towards impact creation by aligning performance appraisal systems to impact and underscoring the link between long-term wealth creation with social development and environmental sustainability.

Five innovative mechanisms are already being developed and piloted by some funders: online marketplaces and impact auctioning, set up using blockchain technology, where governments or donor agencies can define challenges and have enterprises pitch/bid with their solutions; impact currency using blockchain and cryptocurrencies to allow individuals and consumers to “purchase impact”; impact reward system to monetize impact, create an “impact economy”, and incentivize purchasing of impact products and services; impact indices that can benchmark and rank enterprises and investors according to their impact performance; and give-back distribution that will reinvest profit into the impact ecosystem.