Impact investing, at its core, aims to solve at-scale problems in unserved and underserved segments while building commercially viable businesses. Unlike conventional funds, which focus mainly on financial returns, impact investors provide risk capital to early or growth-stage entrepreneurs who aim to tackle challenges affecting disadvantaged end-customers in broken ecosystems.
Entrepreneurs, typically first-generation, solving for these problems are armed with disruptive ideas but don’t have adequate capital support to tide over both innovation and execution risks. By supporting enterprises that, among other things, facilitate affordable access to essential products and services, create direct and indirect livelihood opportunities, and focus on environmental sustainability, impact funds can play a catalytic role for businesses and ecosystems.
Entrepreneurial Problems In Emerging Markets
Entrepreneurs in emerging economies, home to 80% of the global population, face larger business risks compared to their counterparts in developed nations. The lack of an evolved business ecosystem in such markets creates obstacles like unfair trade practices, the unavailability of skilled talent and below-par governance structures. These challenges have become more pronounced after the pandemic and are present across sectors like agriculture, financial inclusion, climate, education, and healthcare.
Entrepreneurs in such markets are more than capable of building innovative and geographically relevant solutions to the aforementioned problems. However, they are constrained by capital since funds typically choose not to take on the risks associated with investing in such markets.
This paucity of capital creates roadblocks in the enterprise’s growth and generates a vicious cycle, leading to sub-optimally scaled businesses. This creates a case for risk capital to support entrepreneurs with unique value propositions in emerging markets. Impact investors, with the ability and willingness to support these entrepreneurs, are aptly positioned to lend such support.
Benefits Of Deploying Impact Capital In Emerging Economies
By mobilising capital and providing strategic guidance, impact investors can help entrepreneurs in emerging markets create significant social and economic benefits. Immediate advantages include the availability of products and solutions that can benefit the end customer through income generation opportunities (quality agri inputs to farmers, loans to self-help groups), or a reduction in vulnerability (better healthcare facilities, educational solutions). Longer-term benefits for impact-backed enterprises include sustainable operations, institutionalisation, better governance, and economic freedom for further innovation.
Supporting entrepreneurship and innovation in emerging markets can also have positive spill-over effects. Solving for problems in populous and price-sensitive markets can lead to solutions that can be deployed in any other market, both developing and developed, with relative ease.
Attracting Follow-On Capital Through Demonstration Of Scale And Exits
Conventional capital has traditionally been cautious when investing in emerging economies. By facilitating sustainable and scalable businesses that are solving for broader societal challenges in such countries, impact investors enable validation for these business models and confidence for follow-on capital. In India, the confluence of impact and conventional investing has been recorded in recent years across sectors. In particular, areas like financial inclusion (especially in areas like microfinance and agritech) have seen fundraises from both impact and conventional funds.
Similar acceptance from global capital pools also comes through demonstrated exits by impact investors in emerging markets. The increasing ability of impact funds to return capital along with market returns has generated confidence for conventional capital to follow or co-participate with impact investors. Improving the depth of capital markets and increasing the interest of strategic investors in emerging economies add to this confidence. In recent years, established growth funds have also raised large pools of impact-focused capital aimed at areas like climate change.
Bottom Line: Impact Capital = Transformative Capital
Global impact assets under management today are in excess of $1 Tn, a significant portion of which has been invested in recent years. For instance, in India, the volume of impact investments jumped by 135% to $6.8 Bn in 2021 vis-à-vis 2020.
However, much work remains to be done to address the growth capital requirements of entrepreneurs solving for the needs of over 6 Bn people living in these markets. With their ability to catalyse consequential value creation, impact investors can mend broken ecosystems and drive real business change in emerging economies.
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