October 18, 2012
By: Ashley Lee of International Financial Law Review
Why impact investing is the next corporate innovator

Oxfam’s £1 billion loan to Mongolia’s Xac Leasing blurs the line between private equity funds and not-for-profit organisations.

The transaction highlights the growing trend of impact investments, or utilising private equity strategies for investments focused on the greater good. It also signals environmental, social and governance (ESG) issues becoming more important for private equity funds.

However both trends raise questions about the for-profit and non-profit status of companies, and may signal the introduction of new corporate structures.

“Charities are excited about impact investing because regardless of budget, there are still billions of people in poverty and never enough resources,” said Matthew Kasdin, legal advisor for Impact Investment Exchange Asia (IIX), a platform for social enterprises to raise capital. “They see impact investing as a way to scale up their impact.”

Impact investments involve making investments in both for-profit and not-for-profit social enterprises which prioritise their missions over the business side.

But its exact definition is not settled. Some believe that impact investments should earn a pure market rate of return while others believe they should earn a so-called muted return – not as much as in a traditional investment.

“That isn’t necessarily settled in the industry, and I believe it never should be, as it is better to have a big tent servicing all investor appetites,” Kasdin.

New structures

It is essential that companies structure themselves for impact investments, and that investors are made aware of any of the company’s goals that differ from those of traditional corporations.

Social enterprise goals can be built into legal documentation. In a recent deal completed by IIX in the Philippines, the documentation included a investor representation that they recognized they were investing in an impact enterprise, and that management would be making decisions to advance the company’s social mission rather than to solely maximise profits.

“The company’s social mission was built into its articles of association and it was required to report on its social impact,” he said.

Traditional corporate or non-profit structures often do not fit a social enterprise’s needs, and there has been a push to introduce new corporate structures to encourage impact investors.

Kasdin said there has been a movement to form new legal structures and accommodate social enterprises. In the US, these take the form of benefit corporations and low-profit limited liability companies, called L3Cs. In the UK, there is the community interest company, while Korea has a special social enterprise law. The Philippines and other Asia-Pacific jurisdictions are following suit

What it means for private equity

Impact investments have taken off as ESG issues become more important to private equity firms. IFLR recently spoke with Kohlberg Kravis Roberts’ (KKR) director of European corporate affairs and head of sustainability about the firm’s focus on ESG issues.

But as the asset class becomes more prominent, counsel warn about blurring of the line between not-for-profit and for-profit organisations and activities.

A private equity lawyer agreed that ESG issues have come into focus in the last year as more investors require firms to disclose their social and corporate governance policies. These factors have long been a concern for multilateral investors such as the Asia Development Bank and the International Financial Corporation.

However maintaining charitable status in some jurisdictions prohibits firms from participating in any activity for profit. “It’s untested ground for a lot of countries,” the counsel said.

A level playing field for private equity firms and impact investors is also a concern as the investment process is nearly the same for impact and private equity investments. Private equity firms are especially wary of tax breaks charities receive, although they are participating in similar investment activity.

For US charities non-charitable activity such as impact investments will be taxable, though it is still unclear how taxation will work in other jurisdictions.

Some private equity funds are looking into impact investing. India’s Motilal Oswal Private Equity recently established a Rs 250-300 crore fund for investments in social enterprises. As impact investing becomes more popular and private equity further focuses on ESG issues, there may be more competition ahead for investment into well-run companies focused on social issues.


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