Coming from a corporate fortune 500 setting, I will be the first to admit that I typically fall into the trap of looking at the same standard criteria when assessing the feasibility of a new social impact investment program [i]: market need, market size, business model, financial model and strategic fit. Don’t get me wrong, a lot of effort and intelligence goes into developing each of the above.
However, after attending the IIX Impact Institute Executive Certificate Program: Financing the SDGs, I came to realize one large blind spot: Risk.
We, of course, talk about risk in our ‘large- strategic -all-hands-on-deck–every-stakeholder-represented’ internal leadership meetings. In fact all sorts of risks: FX exchange risk, brand risks, market risks, etc. But everything changes when we take our internal beautiful strategic slide deck and start thinking about gaining external investor support. What investors care about are vastly different from what we internally care about.
So, I would like to shed some light on the Five Types of Risk and more importantly the Seven ways to de-risk we should all consider for our next impact investment project, as outlined in the report Shifting the Lens: A De-risking Toolkit for Impact Investment by Bank of America Merrill Lynch and Bridges Ventures [ii].
Five Types of Risk
1. Capital Risk
Losing any portion of the investment (or principal) amount. Before a company even thinks about making a return on their investment, they may be doubtful of even getting their principal back.
2. Transaction Cost Risk
This is the time and money needed to complete your due diligence, deal structuring and ongoing monitoring of the asset.
3. Exit Risk
Is it impact investing or impatient investing? Impact investing by nature takes longer to mature, leaving investors with less options to sell, transfer or liquidate their assets.
4. Impact Risk
How do we know that this product will achieve its intended impact just as well if not better than an alternative product? How can we be sure this product will have the benefit we intend? Or worse, will not create a negative benefit?
5. Unquantifiable Risk
We don’t know what we don’t know…especially in new chartered territory such as impact investing. Investors have lumped all of the possibilities into one ‘unquantifiable’ category.
Now that we understand Bridge Venture’s categories of risks, what are the
Seven ways to de-risk?
1. Downside Protection
Especially helpful with capital risk, downside protection limits the amount of capital loss in the event of poor investment performance.
2. Bundling
Useful in capital risk and transaction cost risk, bundling intentionally combines dissimilar underlying investments into one product to diversify risk
3. Track Record
A proven track record is going to come in handy for those unquantifiable risks. A track record both socially and financially can help to alleviate the unknown. Some firms hire impact investing consultants or ‘bolt on’ their social impact investment product onto an already existing platform.
4. Liquidity
“Be Like Water” and make a quick exit like Jackie Chan. Liquidity helps with exit risks. By providing more information on the asset, this can allow for exchange on platforms. Liquidity is influenced by the quality and type of legal documentation, the number of trading platforms and market-makers, transaction costs and overall market transparency.
5. Technical Assistance
Again helpful for unquantifiable risk, technical assistance addresses complex or performance gaps that an impact lens may add to an investment strategy. (Huh? What does that mean?) Well, for example, improving financial controls, upgrading management information systems, training staff, improving corporate governance, financing riskier business development activities, providing impact investment assessment training etc. are the types of improvements that can help with the unknown risks.
6. Placement & Distribution
What if there was a spokesman who could contextualize and put the product into a framework your investors are familiar with? Using comparators, strong marketing brand names, and connected to distributors? This would probably make your investors feel more comfortable and relieve some of that unquantifiable risk.
7. Impact Evidence
Can you take a guess at what Impact Evidence will de-risk? Yep, Impact Risk. Impact Evidence works best when you work with your stakeholders to collaboratively develop a methodology to track the progress of your investment against your expectations, supported by a randomized controlled trial.
The next time you are considering developing a new impact investment venture, I hope you take into consideration the types of risks you may face with investors. Think of how you much faster you can gain investor support by already being prepared with responses to their fears and concerns.
Think of how much faster you can make an impact.
No risks, no gain!
Rupa Bhojraj, Spring 2018 Executive Certificate Program Alumnus
References:
[i] This is only with regards to impact service programs, and does not include healthcare technology and products which undergo thorough analysis of patient health risks and are subject to the approval of FDA, CE-Mark etc.
[ii] https://thegiin.org/research/publication/shifting-the-lens-a-de-risking-toolkit-for-impact-investment