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A new paradigm for scaling early stage impact investing in SA

The world is facing diminishing natural resources, a growing population and an increasing economic inequality. But impact investing can help solve these issues.

Impact investing seeks to create both a financial return, alongside a positive social or environmental impact.

As governments and civil society struggle to achieve the UN’s Social Development Goals (SDGs), the trillions of dollars in the financial system, could be put to better use, in the hands of capable entrepreneurs, trying to solve these issues.

In addition, early stage impact investing, geared towards small growing businesses (SGBs), has the potential of providing funding to the “missing middle”, ie companies with capital requirements, that are too big for micro finance, angel investors and grant funders, but too small for private equity, or too risky for traditional debt funders.

These SGBs are critical growth drivers of the economy, not only in terms of job creation, but also in terms of positively impacting rising inequality, spiraling social issues (like health, education, energy, water and food security) and the increasing effects of climate change.

In South Africa, there are only a limited number of players, in this ecosystem. At an event in January hosted by the Impact Amplifier and Edge Growth discussions were held on three key areas, which require focus from all early stage impact investing ecosystem participants, to catalyse improved funding and performance.

The forum was fortunate to include partners from Capria (a global accelerator for emerging market impact investing fund managers) who provided valuable learnings and insights from their experience in early stage impact investing across several emerging markets.

The three required focus areas discussed include:

1. Create an investor community – By engaging downstream funders

Investors are encouraged to engage extensively, with next stage funders, to better understand their investment appetite and key decision-making criteria before making investments.

This will optimally position SGB investments for follow-on funding or exits, mitigate liquidity risk and potentially crowd in more capital into this space.

By working together with different ecosystem funders and actors, it will reduce the risk profile, mature the market, and potentially enhance returns.

2. Disrupt the traditional fund management model – Investing early stage is not cheap

When investing into SGBs, fund sizes are smaller than private equity structures and require additional resource intensive pre-and- post investment support.

This means that traditional private equity business models, simply do not work for early-stage investing.

Capital providers that want to invest in these exciting missing middle funds, should consider the actual effort it takes to make early stage deals work, and allow for higher overall average fees, to enable the best possible value creation and net fund returns.

3. Tighten up the system – Bring more venture capital rigor and discipline into early stage impact investing

Given the requirement for financial and social or environmental impact, the investment process should be even more rigorous and disciplined, in early stage impact investing than traditional venture capital or private equity investments.

Fund managers should implement global best practice in deal-sourcing, investment analysis, selection criteria processes and impact measurement and reporting.

High quality investment committee advisors are also required to enhance the process, and ensure that all aspects of the investments are considered.

Why is it important for the ecosystem as a whole to pull in the same direction?

Simply put, success breeds success, and there is still very little evidence in South Africa, to date.

Noteworthy performance from a variety of local participants, is the best way to create significant momentum, and attract additional capital, particularly from the more commercially driven investors, such as pension funds and retail asset managers, into this essential SGB asset class.

Early stage impact investing has the potential to address some fundamental social and environmental challenges at scale, however given the complex and nascent industry, a collaborative ecosystem approach will be a key success factor!

*Janice Johnston is investment head at Edge Growth. Edge Growth provides funding for high-growth SMEs.

This piece was co-written with Max Pichulik, a partner at Impact Amplifier which supports high-growth impact businesses to access funding from both local and international investors.

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