In just a few short years, “impact investing” – or “socially responsible investment” – has come into vogue as a way to encourage more firms to think about generating social good as well as financial returns.
Propelled by such high-profile ventures as the use of “social impact bonds” to finance preschool in Salt Lake County and “pay-for-success” experiments in several states, the nascent industry is already attracting hundreds of millions of dollars in capital. A 2009 study by the Monitor Institute predicted that impact investments could total as much as $500 billion by the end of this decade, both in America and overseas.
Most of this new capital, however, is finding its way to larger projects and firms. Salt Lake County’s program, for example, was funded by $7 million in loans from Goldman Sachs and J.B. Pritzker, and many projects are much larger. The New York City Acquisition Fund, a developer of affordable housing, began with $40 million in seed funding from private foundations and other investors.
To ensure that small businesses engaged in social impact also have access to capital, the Small Business Administration (SBA) announced in September 2014 that it was expanding its Impact Investment Fund, first launched in 2011.
The SBA’s Impact Investment Fund is part of the agency’s Small Business Investment Company (SBIC) Program, first created in 1958. Through this program, qualified investment companies can get access to government-guaranteed debt as a way to leverage the investments they make in small businesses. Since the program’s inception, SBICs have invested about $70 billion into American small businesses, including $13 billion in the last five years.
Under the expansion of the SBIC Impact Investment Fund, the SBA plans to help “impact SBICs” finance an average of $200 million a year in small business impact investments.
Three firms currently qualify as “impact SBICs” that put at least 50 percent of their portfolio into impact investments: Michigan Growth Capital Partners, based in Detroit; SJF Ventures III, based in Durham, North Carolina; and Bridges US Sustainable Growth Fund, based in New York.
Javier Saade, Associate Administrator of the SBA’s Office of Investment and Innovation, says he hopes this expansion will grow the number of firms making impact investments in small business.
R3.0: Why are you expanding the SBIC Impact Investment Fund?
Saade: The SBIC program was first enacted by the agency when there was no such thing as venture capital or private equity. Back then, there were gaps in capital formation – so-called “patient capital” didn’t exist. There was no pathway for small companies to raise money.
The SBIC program helped change that and is credited with being instrumental in forming the institutions and pathways from which [the venture capital] industry was born.
Fast forward to today.
There is now a vibrant market for impact investing around the world but there are still gaps. What happened after the [financial crisis] is that assets became consolidated – for example, banks have gotten very big. And with big pools of capital come big checks, which don’t typically go to small companies.
Small companies are having a hard time raising money, and the government should be there to address gaps. By guaranteeing debt for some of the funds that do invest [in small companies], it enables more capital to flow to these places.
R3.0: How does the SBA define “impact” investments?
Saade: There are three buckets [of investments] we consider “impact.”
The first is geographic – if a company or its employees are based in low or moderate income areas or in zones that qualify for the New Market Tax Credit, [an investment in that company] would be considered “impact.”
The second is by sector, and this is driven by areas of national priority. There are three sectors we consider “impact” – one is clean energy, and the second is education. The third is advanced manufacturing, and the idea behind that one is pretty simple: if it gets invented here, we should also make it here. So we want investment in that sector.[The third category of investments defined as “impact” fall under] fund-identified strategies. For example, if there’s a fund that’s looking to invest in clean water strategies, that is not a sector defined by us as “impact,” but we can probably all agree that clean water is something important to the nation.
But if you choose to define your own strategy, you have to be measured under a third-party standard.
R3.0: How is the Impact Investment Fund paid for?
Saade: Overall, the SBIC program runs at a zero-subsidy cost to the taxpayer – It doesn’t cost taxpayers anything. The fees and interest that we charge offset all of the costs of the programs, including defaults.
From a taxpayer standpoint, it’s a great program. We don’t have to go to Congress to appropriate funds to subsidize the leverage. It’s self-sustaining, and we mean to keep it that way even when more impact investment funds apply.
R3.0: What is the signal that the SBA wants to send about the value of impact investment by expanding this program?
Saade: We want investors to put more money to work in the places where they are needed the most and can create the most impact.
One of the reasons the program has worked so well for 56 years is that the people who actually manage the money – the fund managers – actually make all of the investment decisions. We’re not involved at all in what SBICs are investing in. We agree on their strategies upfront, but they make all the investment decisions, and they make all the exit decisions.
It’s a true public-private partnership. We use a fund manager’s drive to create returns on investment to foster economic development. In the case of impact funds, that includes intentional social returns too.