Our Take: Philanthropy Meets Returns – Innovative Strategies for Impactful Investments

Written by Julie Witherspoon, Principal Consultant

In the face of a massive climate finance shortage to address the rapidly growing climate crisis, the role of impactful financial tools to trigger positive change grows more critical.

There is a spectrum of financial instruments available to help manage the multifaceted challenges of global warming, environmental protection, and biodiversity loss. Chief among these is philanthropic capital and impact investing.

The strategic deployment of philanthropic funds and impact investments can catalyze significant environmental actions, support innovative solutions, and foster a collaborative approach toward achieving sustainable outcomes. To go a step further, when possible, blending philanthropy and impact investing strategies can be a powerful way to achieve even greater outcomes.

By examining the synergy between philanthropy and impact investment, we can better understand how these financial mechanisms can be optimized to propel the global environmental agenda forward, highlighting the potential for these tools to drive change and contribute to a more resilient and equitable planet.

Philanthropy and Philanthropic Tools

Philanthropy involves the act of donating money, resources, or time to support causes, organizations, or individuals in need, to improve welfare and solve societal problems such as climate change. The essence of philanthropy lies in its focus on the common good. Philanthropic investments do not seek financial returns.

Philanthropic tools serve as essential methods for championing a cause or supporting an initiative within a community or via a non-profit partner organization, especially when financial returns are not feasible. These instruments are particularly valuable in fostering growth in sectors where market opportunities are minimal or absent, a concept highlighted by Kristin Hull from Nia Impact Capital as a strategy “to grow something new.” Key philanthropic tools encompass:

Distributing grants to projects, non-profits, or businesses that are not in a position to repay the invested funds
Investing in research, gap analyses, and other evaluations to guide future investment decisions or to facilitate market evolution
Offering fiscal sponsorships to enable mission-oriented enterprises to secure additional grant financing
Enhancing initiatives through engaging stakeholders, building coalitions, and orchestrating communication efforts

Impact Investing

Another climate finance tool available is impact investing.

Impact investing is an investment strategy that seeks to generate positive social and environmental outcomes alongside financial returns. Impact investors actively seek out opportunities that can make a difference, aiming to use their capital to drive social and environmental progress without sacrificing profit.

This strategy stands apart from conventional investment methodologies by focusing on supporting businesses, organizations, and funds dedicated to tackling worldwide issues. Impact investments facilitate ongoing contributions to positive change by generating returns for the investor. Such tools are perfectly suited for scenarios where repayment is possible, yet the prospects might not attract traditional investors or creditors looking for pedestrian investment opportunities with standard market returns.

Impact investments have the potential to create a catalytic effect by shifting the balance between risk and return for investors. Impact investing tools include:

“Concessionary” or low-interest loans or lines of credit to non-profit or for-profit borrowers
Recoverable grants, which are essentially zero-interest loans
Loan guarantees or bank deposits provide surety to lenders that their funding will be repaid
Volume guarantees to purchase a specified quantity of a good or service if the producer is unable to sell it and thus provides the confidence necessary for the producer to start a new venture or product line
Direct equity investments or convertible debt investments in for-profit enterprises; can be structured as “first loss” capital to help mission-driven enterprises raise capital from market-rate investors or lenders
Market-rate equity investments or loans to mission-driven enterprises that are financially competitive and serve the mission and impact initiatives of the investor

Impact investment tools employed by forward thinking philanthropies and foundations are often categorized into two groups:

Program-Related Investments (PRIs) – a categorization in the US IRS tax code that allows foundations to make investments where the pursuit of profit is not the significant purpose; such investments often seek a sub-market rate of return
Mission-Related Investments (MRIs) – these more often seek a market rate of return but are also interested in mission-related impact

Every instrument has its unique function. The Bridgespan Group created the following illustration to explain the diverse tools and their potential usefulness.

Ways That Investing Can Improve Impact

Beyond just offering a return of capital – and possibly a profit – impact investment instruments stand out from grants via their applicability in more commercial settings and the potential for granting ownership and control rights. Owing to these features, they can sometimes be more effective in fulfilling impact objectives. Here are a few examples:

Equity investments, loans, and guarantees can all serve as endorsements of a viable business proposition to other investors and creditors, thus helping the project catalyze additional funding
These investment mechanisms also set different expectations for the recipient, potentially motivating project leaders to exercise greater financial discipline than they might with grant funding
Impact investments offer investors a more robust platform for advocacy and achieving their impact goals. The Redstone Strategy Group’s analysis of the Packard Foundation’s mission investments highlighted three distinct ways impact investing enhanced the foundation’s ability to effect change in ways grants alone could not:
- Investments may enable participation in policy discussions by allowing a charitable entity to engage in economic or trade contexts
- They can serve as a proving ground for market-driven policies by offering below-market capital to validate a concept before it attracts investment at market rates
- They can establish a fund (such as an economic development fund or a fixed-income mutual fund) around which allies, and additional financiers can be mobilized. These funds might directly invest in businesses or other funds or financial intermediaries.

The Power of Linking Philanthropic and Investment Agendas

While a philanthropic program and an impact investing program can operate independently, such an approach runs the risks of redundant strategy development and overlooks the chance for mutual reinforcement and synergy creation.

When possible, there are many benefits to integrating philanthropic and impact investment initiatives including:

Certain impact goals necessitate a combination of philanthropic contributions and investment capital to be realized
The use of philanthropic and investment mechanisms in conjunction can generate synergies, either within a single deal or across different growth phases, contributing to the success of the overall strategy; hence, their joint consideration is beneficial
Efforts in philanthropy and investment can each uncover opportunities that are well-suited for the other approach, thereby enhancing the flow of viable projects or investments in both realms
Coordinating the operational facets of both philanthropic giving and impact investing – including the processes for identifying, evaluating, and overseeing investments or projects – enables more efficient execution of both sets of activities through the shared use of skills, tools, methodologies, and insights.

Blending Tools to Achieve a Single Outcome

As previously mentioned, philanthropic and investment instruments fulfill distinct roles. Therefore, when a philanthropy or investor outlines a specific strategic goal or desired outcome, realizing this outcome might necessitate the use of a combination of these tools. If a philanthropic grant program or its impact investment program set separate priorities, there could be competition for resources, diminishing the likelihood of accessing the comprehensive array of tools necessary for success.

Philanthropic grants, especially within foundations that engage in impact investing (PRIs and MRIs), can be effectively coupled with equity investments to support a project during its initial development. This combination can occur either simultaneously or in phases. The Bridgespan Group noted that this is “a familiar situation for early-stage companies with a lot of promise. A grant can help to keep the organization financially afloat during its vital proof-of-concept stage. An equity investment fuels growth and sends a positive signal to other investors.”

Philanthropic funding can play a pivotal role in strategic contexts, facilitating the initiation or success of an investment round. For example:

Philanthropic funding can fill a capital stack gap – such as meeting a borrower capital match requirement – that allows a loan investment to proceed
Philanthropic funding can fill a performance gap – such as a temporary debt-service shortfall or loan covenant requirement – to provide more time for an enterprise to achieve stabilization and not default on a loan
Philanthropic funding can enable an intermediary – such as a CDFI – to establish structures to allow for future impact investments
Philanthropic funding in the market “ecosystem” – such as funding for stakeholder engagement or workforce training – can make an investment sector more viable

Synergistic Deal Sourcing

Another way in which philanthropy and investment efforts complement each other is through the cultivation of a pipeline for potential projects. When objectives and strategies are in harmony, the likelihood of identifying and subsequently cultivating such opportunities increases.

The groundwork of philanthropic initiatives can contribute to building an investment pipeline in various ways. Primarily, investors engaged in specific program areas often have established networks and are well-informed about key players and organizations within those sectors. Leveraging these connections – and especially if the investor openly communicates its interest in providing impact investments in these areas – can lead to the discovery of emerging business ideas, expansion opportunities, and financial needs that could benefit from impact investment solutions. Philanthropic grantmaking may also directly create investment opportunities by laying the research and development groundwork for new business ventures.

Conversely, impact investing can pave the way for grantmaking in several ways. As mentioned previously, certain impact investment initiatives might necessitate an initial grant, either as part of the closing transaction (like “matching funds”) or to enhance the performance of the investee. Moreover, impact investing can facilitate access to industry insights or foster relationships with businesses that enhance the effectiveness of grantmaking. Redstone’s analysis of the Packard Foundation’s mission investing provides a pertinent industry example:

Mission investments broaden networks and introduce new viewpoints that enhance grantmaking strategies. For instance, the Foundation’s biannual meetings with Afaxys yield valuable insights. During these sessions, program officers gather current data on trends within the pharmaceutical industry related to reproductive health products (such as the availability of contraceptives in key markets), benefiting from Afaxys’s private-sector outlook.

Integrating the objectives and teams across both philanthropic and investment initiatives enhances the chances of uncovering high-quality funding opportunities. It helps with a transition from grant funding to investment stages and contributes to the fulfillment of overarching impact objectives.

Suggested Strategies for Integrating Philanthropic and Investment Efforts

The recommendations provided below serve both as strategies to tap into the synergistic potential outlined above and as means to enhance operational efficiency in their own right.

1. Incorporate Impact Investment Instruments into Programmatic Approaches

An impact investment program might design its initiatives and strategies without predetermining the necessary tools for their implementation, whether philanthropic or investment-based and subsequently harmonize impact investing and programmatic efforts towards these collective objectives. The advantages of such integration are twofold: it enhances the potential to advance toward a program’s goals and optimizes the efficiency of the impact investment program’s time and resources. Adopting this approach could simplify the strategic planning process and allow the investment arm to concentrate staff efforts on a more focused set of clear, strategic directions.

2. Implement a Unified Sourcing and Standardized Evaluation Procedure for All Funding Prospects

The philanthropic and investment arms might adopt a unified approach to identifying and evaluating both philanthropic and impact investment prospects. While some funding mechanisms might necessitate unique due diligence requirements (like financial return forecasts for investments, which are irrelevant for grants), a shared foundational screening methodology can be applied. This unified approach aims to ensure uniformity and excellence in all undertakings, enhancing the effectiveness and impact of both philanthropic endeavors and impact investment initiatives.

The establishment of a single sourcing and screening process could also help the respective teams collaborate across philanthropic and investment work and better apply programmatic sector expertise to impact investment decisions. Program staff’s deep knowledge of a sector or industry is an important context for screening, due diligence, and investment assessment. This knowledge will allow the teams to better assess the nuances of the deal’s impact and its long-term viability. If all staff are familiar with the same sourcing and screening process, it will be easier and more efficient for program staff to help assess impact investments and for finance staff to lend insight into grant-making evaluations.

3. Create a Uniform System for Impact Measurement and Metrics Across All Funding Opportunities

The challenge of creating, tracking, and reporting “impact” metrics is a common issue encountered in both philanthropic grantmaking and impact investment efforts. By implementing a unified system for monitoring and reporting impact metrics across all initiatives, a foundation can simplify the process of developing these metrics and ensure that all efforts are aligned toward a collective goal. Consistent impact monitoring and metrics bring about efficiencies, standardization, and the accumulation of shared knowledge and continuous improvement. Moreover, involving the same program staff in overseeing the impact progress of grants and investments can enhance coherence in program evaluations, as exemplified by The Packard Foundation’s approach to including impact returns from investments in its program assessments.

4. Merge Programmatic and Investment Teams to Facilitate Skill-sharing

The central idea behind these suggestions is to integrate the programmatic and investment teams, encouraging a collaborative pursuit towards a collective goal. Practically, foundations and philanthropies can foster this integration by promoting shared objectives, mutual progress updates, and the deliberate exchange of skills and knowledge among team members.

Various foundations have highlighted the significance of enhancing investment understanding among their staff, bolstering collaboration between investment and programmatic teams, and improving communication across diverse skill sets.

In its research, The Bridgespan Group discovered that more than two-thirds of the foundations surveyed identified the divide between programmatic knowledge and investment expertise as an obstacle to achieving more impactful investments:

The split between programmatic/grant teams and investment teams often complicates the implementation of mission-related investments (MRIs) due to the absence of a clear organizational fit for such investing activities. Additionally, from a skill set perspective, MRIs demand competencies that span both traditional investment and programmatic realms (for example, underwriting and sector-specific knowledge). This challenge becomes more pronounced in small-to-medium-sized foundations, which might lack dedicated investment teams or specific impact investing units. In such contexts, the responsibility for impact investing is not assigned to any team, making it challenging for staff to engage in impact investing activities on top of their regular duties without appropriate incentives, thus hindering progress.

The Packard Foundation has identified challenges in bridging the gap between program and investment staff, attributing these difficulties to differing cultural norms and skill sets:

It has been observed that program staff often lack familiarity or comfort with financial and business concepts, which can hinder the implementation of Program-Related Investments (PRIs) despite their integration into programmatic efforts. Program officers who understand and are open to exploring PRIs can be crucial for seamlessly incorporating these investments into programs. Initiatives like case studies and workshops serve as an introductory measure to help program officers identify where PRIs can fill financing voids. However, it might also be necessary to pinpoint (or even recruit) specific program officers within each team who are tasked with seeking out PRI opportunities.

Conclusion

While it may not always be feasible for philanthropic grantmaking and impact investment programs to fully merge their objectives, financial strategies, and teams, seizing the opportunity to do so, when possible, can be incredibly advantageous. Embracing a holistic strategy for initiatives and impact objectives, which prioritizes a flexible approach to the tools used, can lead to more unified and effective outcomes. This involves coordinating impact investing, grant-making, and other efforts towards collective goals, ensuring a seamless progression towards the desired impact.

If a linkage between philanthropic efforts and impact investments is in the realm of possibility, there are some crucial considerations that could lead to potentially increased results.

First, establishing a unified process for identifying and evaluating potential investments and grants, complete with common criteria for screening and due diligence, could simplify the selection process and enhance the synergy between different types of investments toward the impact investment arm’s key goals. Moreover, a standardized system for tracking and reporting on the impact of all investments and grants facilitates a consistent assessment of progress, ensuring that every contribution is effectively advancing the overarching and collective objectives.

Crucially, building a cohesive culture that bridges the gap between philanthropic and impact investment teams is essential. The organization can significantly boost its internal collaboration and operational efficiency through shared goal-setting, regular updates on progress, and a deliberate effort to cross-pollinate skills and knowledge among members. Additionally, promoting deeper engagement and knowledge sharing between the management of both the impact investment and philanthropic teams enriches the strategic approach.

In conclusion, these methods could not only leverage resources more effectively but also amplify the impact potential in alignment with the philanthropy and the strategic goals of the impact investing program, ultimately improving the likelihood of success and impact.