Newsflash! The intent of the entrepreneur does not matter. What matters is the social impact of the enterprise. This was the breaking news at a recent conference on impact investing sponsored by the Centre for Strategic and International Studies in Washington DC.
This view was put forward by Elizabeth Littlefield, president and CEO of the Overseas Private Investment Corporation, supported by Julie Katzman, executive vice-president and chief operating officer of the Inter-American Development Bank, two of the largest development finance institutions involved in impact investing in emerging markets.
Their view is probably not accepted by wide swathes of the impact investing community – at least not yet. There are still many impact investors who focus on investing in social enterprises where the entrepreneur has a clear social mission – even if he or she does not have a strong commercial track record.
Their remarks reminded me of Scottish economist Adam Smith’s observation in his book The Wealth of Nations: “It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own self-interest.”
The genius of private enterprise is that it motivates producers to meet consumer needs out of their own interests, not because they are on a social mission. So why do so many impact investors limit themselves to investing in social enterprises? Does it really matter what motivates the entrepreneur?
What is more important is the track record and ability of the entrepreneur – that is the best predictor of commercial success. And without commercial success, the social impact will be transitory and unlikely to reach scale.
But social entrepreneurs are often inexperienced at running a business, and are usually starting their enterprises from scratch. That means that investors are adding additional risk to their investment – early-venture risk and unproven-management risk. That makes it harder to earn a commercial return, or even to ensure the enterprise becomes financially sustainable.
The IFC’s experience in financing enterprises with a big impact on the base of the pyramid in emerging markets shows that working with large-scale commercial enterprises creates greater impact than working with early-stage startups led by social entrepreneurs.
Filtering for social intent not only adds risk, it also restricts the range of investments that you will consider. The big challenge facing impact investing today, by common consent, is lack of dealflow. That is not surprising when impact investors put so many restrictions on the deals they will back – environmental standards, certain sectors such as agriculture, certain products such as microfinance. So if more investors relax the constraint that the entrepreneur must be on a social mission, that can only help increase the dealflow. But this is only the start – impact investors should also rethink their assumptions about what sectors and products have social impact.
Investors may not all agree to drop intent as a selection criterion, but maybe they can agree with Elizabeth Littlefield’s follow-on suggestion – instead of worrying about intent, let’s double down on measuring impact, as the IFC does with all our investments. However, let’s do it in a way to avoid imposing heavy costs on the enterprise – something that can be especially difficult for smaller enterprises.
For our own clients, the IFC is piloting the embedding of impact measurements in the business model itself, so that we create surveys that capture important customer or supplier feedback, often segmented by income, that is useful to the company in its commercial operations. Aligning impact and business metrics also makes it more likely that the entrepreneur will manage the business with an eye on metrics that matter for impact, whether he or she has a social intent or not.
This is an edited version of an article first published on Medium