3.2 Investment Deal-Making

The purpose of an impact investment is to generate positive benefits alongside a financial return (or return of the principal). It follows then that alongside financial constraints and attention to how the investment will be repaid, the investment deal considers also how the organisation will deliver on its proposed impact.

There are three key questions:

3.2.1 Objectives

What are the impact objectives for the organisation and the investment, and how will these be measured?

High-level impact aims are, almost by definition, at the heart of mission-driven organisations, and it is important that the investor and the investment itself is well-aligned to these (see alignment between the investor’s mission, developed through impact investment planning, and the organisation’s mission, detailed in the impact plan). However for the making and ongoing monitoring of an investment deal, it is essential also to have concrete objectives.

The objectives are typically crystallised in the form of a set of key performance indicators (KPIs). It is agreed the organisation will report on the KPIs, and appropriate targets are put in place.

The KPIs themselves naturally draw on the indicators used within the impact measurement system of the organisation. The KPIs should likewise accord to the same standards, and therefore seek to be specific, measurable, attainable, relevant, time-bound, standard, and stakeholder-inclusive, including in particular the perspective of target beneficiaries. Ideally KPIs gather information on outputs and outcomes. When the latter are longer-term or more difficult to follow, investor attention may focus on the outputs that can best be used as proxies for subsequent outcomes. In such cases, the need for the link between them to be strong, and the surrounding conditions for change properly detailed in the impact plan, is that much greater. Where it is anticipated that the organisation will develop its measurement system over the term of the investment, the initial KPIs may focus on outputs, but with defined expectations as to when outcome indicators will come into use, and start to produce results.

With an investment where the immediate aim is to secure the growth and strength of the organisation (an aspect of investor impact), the primary KPIs may relate less to outcomes than to business measures (for example, indicators tracking progress toward operating financial sustainability, or the achievement of defined balance sheet ratios). These quantitative measures should be supported by strong communicative feedback, and it is important that investors ask their investee organisations about their experience of the investment (what investees feel the effect has been, what has been useful, what they have found difficult, what could be helpful etc.), potentially using formal surveys. This ensures the organisation’s perspective is incorporated into the investor’s understanding. While communicating with the organisation, awareness of the ultimate beneficiaries must be retained. Though the main objectives may be around investor impact, with measurements focusing on demonstrating the increasing resilience of the organisation, to be meaningful in terms of social impact, investors will still need to satisfy themselves that this increased resilience is of a genuinely impact-generating organisation, and will ultimately lead to positive real change.

In the interests of compatibility — and comparability — across the portfolio, and for portfolio management, the investor may have a prepared list of KPIs that it prefers organisations to use and report against. At the same time, as noted elsewhere (see use of indicators in measurement system), it is often the organisation itself, with its unique knowledge of its activities and beneficiaries, that is best placed to select meaningful and appropriate indicators. Investing with a prescriptive list may feel constrictive to investee organisations, and may also serve to limit the investor to activities that fit its list, rather than allowing for flexibility as to where the outcomes and impact may in fact be forthcoming.

It is often best to approach the setting of KPIs, and corresponding impact objectives for the investment, as a dialogue between the investor and the organisation. The question is: given the outcomes the investor is interested in, and the activities that the investee organisation is proposing in its impact plan, what are the best indicators that relate materially to both?

The use of standard indicator sets wherever possible greatly facilitates the selection of KPIs, as they provide both the investor and the organisation with indicators of commonly-acknowledged quality and compatibility. It also improves the potential for alignment among different investors and funders, reducing the burden on investee organisations (who can thus measure and report against the same KPIs to different sources of capital), and facilitating the sharing of results among investors.

The outcomes matrix makes available a bank of recommended indicators for use by investors and social purpose organisations.

3.2.2 Oversight

How will performance against the set objectives be monitored? What are the reporting requirements, and how will the reporting be used?

The setting of KPIs and targets and objectives naturally requires the organisation to report against them, and it follows that reporting requirements be integrated into the investment deal. Typically these include specifics as to when and how frequently the organisation reports on its impact, and possibly details as to the format (e.g. for software requirements) and any relevant additional information.

In tandem with setting requirements, it is important the investor ensure the organisation is capable of fulfilling its reporting obligations — i.e. that it has the processes, human resources and necessary funds in place. The investment may include a special provision to cover the costs of impact reporting, or specify additional grant funding (either packaged with the investment or to be sought from elsewhere). Alternatively the investor may regard impact measurement and reporting as an integral part of operations for a social purpose organisation (much as financial accounting is for any business that deals with money), and therefore expect related costs to be part of normal operating expenses. Either way, it should be anticipated and verified that impact measurement and reporting is an acknowledged expense within the organisation’s business plan.

Reporting requirements and oversight are inevitably laid down by the investor side. However, as much as the investor expects transparency from the investee organisation, it is fitting to exhibit reciprocal transparency regarding how the reporting is going to be used. It is important the organisation does not feel that reporting demands are arbitrary or obscure, or that reports, once delivered, will disappear meaninglessly into a drawer in the investor’s offices. Investor transparency on this front means that the organisation is made aware of:

  • why the reported information is important to the investor
  • how the investor will assess the reported information, and use it in managing the investment and the ongoing relationship
  • how the investor will use the information in understanding its own impact, and for its own impact reporting

3.2.3 Protection Measures

What are the ways in which the organisation may underperform or fail with respect to impact, and what measures can be built into the investment deal to enable an address to such problems?

Protection processes commence in the event of the investment failing with respect to its impact.

Types of potential failure include:

  • the organisation is failing to report on or evidence its impact
  • reporting is forthcoming, but the organisation has not achieved the scale outlined in the impact plan, and results do not meet the set objectives
  • reporting is forthcoming, but the results suggest the impact plan is not working (i.e. activities are not producing the anticipated outcomes and impact)
  • the organisation is not carrying out the plan (either the investment capital has not been drawn down, or has been used for something else)
  • the organisation has lost a form of accreditation that is deemed to be critical to its impact (e.g. organic or fairtrade status, charitable status)
  • the investment is being bought out, and the organisation is discontinuing its social mission

At the point of making the investment, it is sensible for the investor to consider the various types of failure that may occur, and to ask what it would be able to do about them, and if it is necessary to build any protection measures into the investment deal.

For the investor, it can be useful to have explicit processes in place if a failure does occur. For example, if an investee organisation falls behind on submitting its reports, the situation is easier to manage for a loan officer, and clearer and more transparent for the investee organisation, if there are guidelines setting out what the next steps are (e.g. how follow-up is managed, how pressure may be applied, what penalties may be incurred). Depending on the nature of the relationship, and the type of potential failure, the investor may seek explicit contractual provisions, or something closer to an assurance of intentions, and a means to apply pressure if the investor becomes concerned. A degree of flexibility, as opposed to clauses that kick in automatically, may be useful. In the event of a failure, the first resort is naturally for the investor to ask for an explanation, and it may be that external factors beyond the organisation’s control (e.g. weakness in the economy, changes in policy) have negatively effected impact performance. If so, the failure may be understandable, but the investor will still want to know what the organisation is planning to do about it, and how it will respond and, if need be, change.

Measures relating to potential failures should ensure there is clarity as to what would constitute a failure, what this would mean for the investor, and what it would mean for the investment and the organisation. Protection measures that can be built-in at the time of making the investment include:

  • covenants within the investment agreement relating to reporting requirements, social targets, maintaining accreditation etc., with the investor reserving the right to call the investment or loan in the event of an “impact default”
  • variable credit rates, or the application of credit penalties and credit holidays according to impact performance (i.e. high levels of reported impact are rewarded with favourable credit treatment, low levels of reported impact incur higher credit rates or other forms of financial penalty)
  • the investor takes a position on the board or on an advisory board through which it is able to apply pressure on management if it becomes concerned regarding the impact being reported (or not reported), or the use of capital
  • exit restrictions which stipulate a mission-aligned exit, obliging follow-on investors to continue the social mission
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