This document discusses factors that drive the financial and impact performance of impact investments. It presents a framework that identifies five key factors: 1) the operating environment, 2) the business model and technology, 3) management values, 4) the financing environment, and 5) financing incentives and requirements. These factors influence how management allocates resources and ultimately the risk-adjusted financial returns and social impact generated by an investment. The document uses examples to illustrate how each factor can create synergies or conflicts between financial and impact objectives.

1. Op#mizing
the
Investment
Process
for
Returns
and
Impact
Madeleine
Evans
Please
contact
the
author
before
ci1ng
this
presenta1on
or
using
the
material
in
other
works.

2. Impact
inves#ng
and
the
big
ques#ons

3. An
introduc#on
§ An
impact
investor
has
a
financial
and
a
non-­‐financial
objec6ve,
with
certain
performance
requirements
for
a
given
level
of
risk1
§ These
investors
face
a
unique
strategic
challenge:
simultaneously
managing
these
two
objec6ves
to
produce
an
investment
with
“shared”
or
“blended”
value2
§ This
presenta6on
offers:
§ A
framework
for
understanding
the
drivers
of
blended
value
§ A
strategic
toolbox
for
cul6va6ng
impact
and
desirable
risk-­‐adjusted
financial
returns
in
one’s
own
porGolio
§ Insight
is
drawn
from
DFIs
and
funds
inves6ng
in
for-­‐profit
or
social
enterprises
Entrepreneur
proposes
an
idea
Entrepreneur
goes
a@er
profit
Investor
wonders
what
happened
to
impact
Accep#ng
below-­‐market
returns
for
a
given
risk
in
exchange
for
greater
impact
Requiring
market
risk-­‐adjusted
returns
on
impact
investments
Social-­‐first
Finance-­‐first

4. The
big
ques#on
What
drives
an
investment’s
impact
and
financial
returns?
How
can
investors
manage
these
drivers
to
produce
blended
value?

5. 5
factors
that
maIer
for
performance

6. The
big
ques#on
What
drives
an
investment’s
impact
and
financial
returns?

7. Opera6ng
environment
The
building
blocks
of
performance
Financing
environment
Management
&
stakeholder
values
Business
model
&
technology
Decision
by
management
Financing
incen6ves
&
requirements
The
building
blocks
of
performance
§ A
simplified
view
of
performance
drivers,
grounded
in
incen6ve
theory
and
expanded
in
light
of
impact
inves6ng
prac6ce

8. Opera6ng
environment
The
building
blocks
of
performance
Financing
environment
Management
&
stakeholder
values
Business
model
&
technology
$$
i
Decision
by
management
Financing
incen6ves
&
requirements
$
i
The
building
blocks
of
performance
§ A
simplified
view
of
performance
drivers,
grounded
in
incen6ve
theory
and
expanded
in
light
of
impact
inves6ng
prac6ce
§ Five
“factors
that
maTer”
drive
resource
alloca6on,
impact
&
financial
returns
PorGolio
results

9. Core
opera#onal
synergies
§ The
business
model
&
technology
define
whether
profitability
and
impact
are
easy
to
jointly
achieve
§ Cross-­‐subsidy
models
rely
heavily
on
management
ini#a#ve
to
generate
impact
from
profitable
opera#on
§ The
fact
of
profitable
opera#on
can
ensure
impact
in
“lock-­‐step”
§ Conflicts
limit
value
for
the
investor
by
forcing
management
to
trade-­‐off
profitability
for
impact
§ Synergies
maximize
value
as
impact
enhances
expected
profitability
and
vice
versa
1.
Business
models
maIer
§ Prac6cal
examples:
§ So@ware
business
funds
founda#on
that
develops
charter
schools
in
the
Bronx
§ Solar-­‐powered
water
pump
is
sold
in
Kenya
§ Tex#le
factory
converts
to
more
costly
wind
power
§ Leather
tanning
opera#on
in
Bolivia
invests
in
technical
training
and
primary
educa#on
for
workers,
developing
posi#ve
rela#onships
that
reduce
risk
of
costly
strikes
or
boycoIs
$$
i
Decision
by
management
Business
model
&
technology

10. Opera6ng
environment
$$
i
Decision
by
management
§ The
opera6ng
environment
affects
the
cost
and
revenues
of
business
ac6vi6es,
making
certain
business
models
more
likely
or
feasible
§ Consumer
preferences
§ Supply
chain
dynamics
§ Regula#on
&
government
programs
§ NGO
ac#vism
§ Beliefs
about
the
environment
need
to
be
consistently
updated
§ Changes
in
the
opera#ng
environment
may
turn
complementari#es
into
conflict
or
vice
versa
Business
model
&
technology
2.
The
opera#ng
environment
maIers
§ Prac6cal
examples:
§ European
customers
pay
premium
for
“Fair
Trade”
label
on
flowers
à
aIen#on
to
labor
health
&
safety
standards
creates
value
despite
costs
by
boos#ng
revenue
§ NGOs
protest
community
impact
of
Ugandan
power
plant
à
ac#ve
engagement
and
reseIlement
premiums
creates
value
by
reducing
risk
of
associated
cost-­‐overruns

11. Opera6ng
environment
Management
&
stakeholder
values
$$
i
Decision
by
management
§ Management
values
influence
resource
alloca6on
by
shaping
intrinsic
rewards
§ Prac6cal
examples
§ Turn
a
tradi#onal
for-­‐profit
business
into
a
business
subsidizing
separate
impact
ac#vi#es
§ Create
profitable
businesses
in
high-­‐impact
areas
§ Generate
impact
at
expense
of
profitability
or
return
when
objec#ves
are
in
conflict
Business
model
&
technology
3.
Management
values
maIer

12. Incen6ves
&
requirements
Incen#ves
&
requirements
$$
i
Decision
by
management
§ External
rewards
or
punishments
contained
in
financing
payoff
structure
can
guide
resources
toward
op6mal
performance
§ Maximize
both
profit
and
impact
under
lock-­‐step
or
synergy
model
§ Enhance
impact
when
management
pursues
profit
at
expense
of
impact
4.
Incen#ves
and
requirements
maIer
§ Requirements
in
terms
and
condi6ons
enhance
and
complement
incen6ves
§ Ensure
investor
has
ability
to
monitor
performance
and
correctly
apply
incen#ves
§ Control
level
of
impact
or
financial
performance
prior
to
investment
§ Prac6cal
examples
§ Marginal
cash
payoff
structure
of
equity
or
debt
incen#vizes
beIer
financial
performance
§ Share
bonus
for
hi^ng
certain
impact
targets
un#l
investor
exit
directly
incen#vizes
impact
§ Minimum
impact
requirements
callable
as
event
of
default
let
investor
and
management
bargain
over
punishment
for
low
impact
later
§ Offer
of
financing
condi#onal
on
demonstra#ng
certain
observable
impact
or
financial
metrics

13. Conducive
financing
environment
Financing
environment
$$
i
Decision
by
management
Incen6ves
&
requirements
$
i
Contract
&
rela6onship
§ The
financing
environment
affects
the
scope
for
crea6ve
contract
structuring
and
long-­‐term
financing
rela6onships,
constraining
external
incen6ves
and
requirements
§ Funding
op#ons
§ Legal
requirements
on
por_olio
§ Forces
of
compe##on
§ Beliefs
about
the
environment
need
to
be
consistently
updated
§ Changes
in
the
financing
environment
may
undermine
the
power
of
implicit
incen#ves
§ Prac6cal
examples
§ Compe##on
from
solely
for-­‐profit
lenders
constrained
environmental
impact
objec#ves
pursued
by
DFIs
un#l
financial
value
of
such
objec#ves
was
widely
accepted
§ Rising
compe##on
can
undermine
implicit
incen#ves
for
impact
as
value
of
financing
rela#onship
diminishes
from
investee’s
perspec#ve
5.
Financing
environment
maIers

14. The
impact
investor’s
toolbox

15. The
big
ques#on
How
can
investors
manage
these
drivers
to
produce
blended
value?

16. § These
building
blocks
can
be
adjusted
as
part
of
investment
strategy
in
order
to
improve
expected
returns
for
a
given
level
of
impact,
or
vice
versa
§ Arrangements
that
align
management’s
incen6ves
with
the
investor’s
objec6ves
help
minimize
the
fric6ons
that
limit
or
distort
performance
§ Three
simple
tools,
already
used
by
many
investors
for
different
objec6ves
§ Selec#on
and
screening
for
conducive
business
models
and
investment
environment
§ Structure
of
the
investment
contract
§ Long-­‐term
financing
rela#onship
and
(condi#onal)
offers
of
future
financing
§ Incen6ve
theory
and
investor
experience
suggest
how
to
use
these
tools
to
achieve
or
enhance
the
blended
value
of
investments
Blended
value
The
investor’s
role
Smart
acquisi6on
Smart
financing

17. Opera6ng
environment
A
Management
&
stakeholder
values
Business
model
&
technology
1.
Selec#on
and
screening
§ Investors
can
focus
screens
on
compa6ble
business
models,
opera6ng
environments
and
management
values
§ Invest
in
profitable
businesses
whose
fact
of
opera#on
produces
a
definable
&
jus#fiable
impact
(e.g.
providing
life-­‐
enhancing
services
to
underserved
loca#ons
or
popula#ons)
§ Iden#fy
and
invest
in
businesses
that
exhibit
underlying
synergies
between
profitability
and
measurable
dimensions
of
impact
of
interest
to
stakeholders
the
investor
§ Invest
in
businesses
in
opera#ng
environments
where
preferences
of
customer/stakeholders
are
increasingly
aIaching
a
financial
value
to
posi#ve
impact
§ Insights
from
interviews
§ Screening
for
“social
entrepreneurs”
is
popular
in
new
early-­‐stage
funds
but
is
not
a
silver
bullet;
conflicts
can
remain
in
the
business
that
undermine
returns
for
a
given
impact
§ Shi@s
in
consumer
values
and
NGO
agendas
to
reward
strong
labor
standards
and
punish
poor
environmental
standards
provided
cri#cal
support
for
these
standards
in
DFI
por_olios
§ Management
who
personally
values
impact
is
cri#cal
to
maintaining
impact-­‐oriented
policies
within
the
business
when
the
opera#ng
or
financing
environment
reduces
the
desirability
of
impact
ac#vi#es
(e.g.
standards,
abatement,
community-­‐engagement
ac#vi#es)

18. Opera#ng
models
in
detail
What
rela6onship
between
profitability
and
impact
should
I
expect
to
see?
Separate
ac6vi6es?
Impact
feedback?
Separate
and
subsidize
A
core
ac#vity
generates
profit,
and
impact
is
created
through
separate
ac#vi#es
funded
by
a
por#on
of
profits
from
the
core
business
Y
None
Lock-­‐step
Impact
is
generated
by
the
simple
fact
of
profitable
opera#ons
N
N/A
Synergy
Greater
impact
enhances
profitability
of
core
business
(reduces
expected
costs
or
enhances
expected
revenues)
and
vice
versa
Y
Enhances
profitability
Trade-­‐off
The
two
ac#vi#es
conflict,
and
management
is
forced
to
allocate
resources
to
either
profit-­‐
genera#ng
ac#vi#es
or
impact-­‐genera#ng
ac#vi#es
Y
Drags
on
profitability
§ Management
allocates
resources
toward
profit-­‐genera6ng
and
impact-­‐genera6ng
opera6ons,
which
may
be
separate
or
integrated
§ Impact
may
“feed
back”
and
affect
revenue
and
cost
structure
of
profit-­‐genera6ng
ac6vi6es
§ Posi#ve
feedback
enhances
profitability,
while
nega#ve
feedback
drags
on
profitability
Screening
opera#onal
models

19. Opera#ng
environment
in
detail
§ Customers
will
pay
a
premium
for
the
business’s
products
or
services
if
the
business
aIains
posi#ve
social
impact
or
mi#gates
nega#ve
impact
§ Nega#ve
impact
carries
a
direct
cost
(cost
of
complying
with
mi#ga#on
rules,
etc.)
§ Nega#ve
impact
carries
an
expected
cost
to
the
business
(NGO
demonstra#ons
damage
reputa#on,
etc.),
such
that
mi#ga#ng
risk
enhances
expected
financial
performance
§ The
investee’s
supply
chain,
distributors
etc.
reward
impact
§ Posi#ve
impact
opens
up
new
higher-­‐revenue
or
lower-­‐cost
business
opportuni#es
Conducive
to
synergies
Likely
to
cause
trade-­‐offs
Selec#ng
a
conducive
opera#ng
environment
§ High
impact
is
highly
costly
rela#ve
to
altera#ve
low-­‐impact
scenario
§ High-­‐
impact
goes
unrewarded
by
customers,
supply
chain
etc.
rela#ve
to
low-­‐impact
business
§ Nega#ve
impact
goes
unpunished
by
regula#on,
NGO
ac#vism,
etc.

20. Incen#ves
explicit
in
the
contract
§ Apply
crea6ve
contract
structuring
to
ensure
incen6ves
and
requirements
are
op6mized
to
produce
desired
porGolio
results
§ Think
beyond
contracts
that
purely
incen#vize
profit
maximiza#on
in
cases
where
the
underlying
business
model
exhibits
trade-­‐offs
or
follows
a
separate
and
subsidize
model,
and
management
cannot
necessarily
be
trusted
to
pursue
impact
as
the
investor
would
like
§ Incorporate
explicit
incen#ves
for
impact
into
the
investment
contract
in
the
form
of
e.g.
equity
share
bonuses
or
step-­‐downs
in
interest
rates
in
order
to
alter
cost-­‐benefit
calculus
of
genera#ng
impact
2.
Crea#ve
contract
structuring
Investment
contract
Incen6ves
&
requirements
§ Insight
from
investor
interviews
§ Investment
contracts
always
incorporate
strong
incen#ves
for
financial
performance
(e.g.
simple
debt
or
equity
investment
contract)
but
seldom
for
impact
(save
one
investor)
§ Control
rights
generated
by
minimum
impact
requirements
are
frequently
used
by
development
finance
ins#tu#ons
to
incen#vize
pursuit
of
very
important
impact
objec#ves
§ Control
rights
let
investors
gauge
the
driver
of
devia#ons
from
expected
impact
and
respond
in
order
to
maximize
financial
performance
and
impact
in
the
longer-­‐term

21. Incen#ves
explicit
in
the
contract
§ Develop
a
valuable,
long-­‐term
financing
rela6onship
that
offers
addi6onal
implicit
incen6ves
for
the
investee
to
pursue
desired
impact
standards
or
outcomes
§ Addi#onal
financing
(implicitly)
condi#onal
on
mee#ng
impact
targets
can
alter
cost-­‐benefit
calculus
to
management
of
pursuing
impact
§ A
financing
rela#onship
must
provide
value
rela#ve
to
compe#ng
for-­‐
profit
investors
in
order
to
create
incen#ves:
lower
financing
cost,
technical
exper#se
or
market
connec#ons
(especially
as
necessary
to
enable
impact
that
brings
financial
value),
or
poli#cal
risk
mi#ga#on
3.
Long-­‐term
financing
rela#onship
Financing
rela6onship
Incen6ves
&
requirements
§ Insights
from
investor
interviews
§ Implicit
incen#ves
for
both
impact
and
financial
performance
common
§ Offer
of
future
financing
condi#onal
on
impact
is
a
cri#cal
tool
for
encouraging
management
teams
to
pursue
impact
objec#ves
to
investor’s
sa#sfac#on
§ The
value
of
the
financing
rela#onship
is
o@en
resourced
by
impact
investors
as
a
bargaining
chip
when
deciding
how
to
take
ac#on
in
response
to
a
devia#on
from
expected
impact
§ For
DFIs,
leveraging
value
of
rela#onship
as
incen#ve
for
management
to
return
to
compliance
o@en
takes
precedence
over
enforcement
of
legal
rights

22. Opera6ng
environment
Financing
environment
Assess
the
big
picture
Business
model
&
technology
Applying
the
intui6on
to
improve
porGolio
performance
and
minimize
trade-­‐offs
§ Assess
building
blocks
of
performance
for
compa#bility
or
fric#on
among
performance
drivers
§ Apply
impact
investor’s
toolbox:
Smart
selec#on
and
smart
financing
Management
&
stakeholder
values
Incen6ves
&
requirements
Compa#ble
or
fric#on?
Compa#ble
or
fric#on?
Compa#ble
or
fric#on?
The
big
picture
for
investors

23. Madeleine
Evans
is
a
direct
equity
investor
with
research
and
advisory
experience
in
both
impact
inves6ng
strategy
and
tac6cs
as
well
as
impact
measurement.
Madeleine
is
also
the
co-­‐founder
of
Finance
MaIers,
a
London-­‐
based
organiza#on
bridging
the
gap
in
knowledge
and
networks
between
mainstream
finance
and
the
UK’s
growing
impact
investment
sector.
She
received
an
Master
of
Public
Administra#on
with
Dis#nc#on
from
the
London
School
of
Economics,
where
she
aIended
as
a
Thouron
Scholar
and
focused
on
development
economics
and
policy.
Madeleine
holds
her
undergraduate
degrees
from
the
University
of
Pennsylvania’s
Huntsman
Program,
with
a
B.S.
from
the
Wharton
School
and
a
B.A.
in
Interna#onal
Studies
from
the
College
of
Arts
and
Sciences.
She
speaks
English,
Spanish,
and
German.
About
the
author

24. The
content
in
this
presenta#on
is
the
product
of
a
year
of
inves#ga#on,
culmina#ng
in
a
Masters’
disserta#on
en#tled:
“Mee1ng
the
challenge
of
impact
inves1ng:
How
can
contrac1ng
prac1ces
secure
social
impact
without
sacrificing
performance?”
The
disserta#on
presents
a
strategic
toolbox
for
investors
with
financial
and
non-­‐
financial
objec#ves.
Content
is
based
on
lessons
from
economic
theory
of
contracts
and
from
in-­‐depth
interviews
with
sixteen
Bri#sh,
German,
and
U.S.
impact
investors.
The
relevance
of
each
strategic
tool
will
depend
on
the
investor’s
control
over
the
underlying
por_olio,
the
legal
and
funding
constraints
on
contracts,
the
degree
of
ac#ve
management
pursued
by
the
investor,
and
the
objec#ves
of
compe#ng
investors.
The
toolbox
is
meant
as
a
direct
resource
for
investors
in
a
por_olio
of
companies
or
projects,
but
the
intui#on
should
be
valuable
for
funds-­‐of-­‐funds
as
well.
Copies
of
the
paper
or
details
of
methodology
are
available
from
the
author.
About
the
research

25. Assess
the
big
picture
Get
in
touch.
Evans.madeleine@gmail.com