All you need to know about investing in social impact startups

Investing from a social impact angle has a big myth attached to it from a long time. There is a misconception that the returns are sub-par when compared to other similar investments made. Historically, social impact investing has made multi bagger exits, defying the myth of lower returns.

Social impact investing is unlike any other investment with an additional checkbox of social good carrying a decent weightage. A section of the investment fraternity also believes that impact investing has taken a longer time to exit than other investments, but the same is not true.

Studies have shown impact investments to exit at around five years, which is approximately the same as other startup investments. Impact Investing is also gaining ground across private and public investing, and crossed $500 billion in 2019, the highest so far.

Typically, social impact investing would look like a normal startup investment, with the addition of the impact evaluation it makes on the society, environment, weaker sections of the society, conserving natural resources, etc.

The negative list for impact investing is also long enough, and it doesn’t promote sectors like tobacco and alcohol, weapons and nuclear energy, gambling and pornography, etc.

Below are the aspects to keep in mind while investing in social impact startups.

The impact it intends to create

Social impact investing evaluation starts with the impact it intends to create, and the scale on which the same can be created. Social development goals are the parameters through which funds and investors measure the goals and intended impact. The funds look at bifurcating the investments across various goals like poverty, hunger, and affordable healthcare.

Let’s take the example of an agri research startup that advises farmers on crops to choose, inputs to use, timing for farming activities, and other aspects related to farming. These inputs result in a 20-30 percent improvement in per acre produce. The startup has advised 5,000 farmers in the first three years, and has improved their farm productivity and livelihood. There is a significant impact the startup has created in order to improve the livelihood of thousands of farmers.

Market size

Secondly, market size is a very critical element to any startup funding, including social impact investing. The target market should be such that a heavy investment should not cater only to few people’s problems.

Once a famous impact investor said to me “rather than spending a few crores to improve lives of a few thousands in a niche sector (non-life threatening), spend that money in such a manner that it impacts lakhs of lives.

That’s another way of saying that the segment should have a large market and a capital efficient business model. The problem being solved should be a large enough market and a problem for lakhs of people to make it a viable social impact investing.

Founding team and their passion for the idea

Thirdly, founders need to have a deep conviction for the impact required and the skills to make it happen. In many cases, I have come across founders who have faced the problem first-hand they are trying to solve. This adds an advantage because they come with a deeper understanding of the problem, and the gap they are trying to fill in.

To give you an example, an agritech entrepreneur with a background in farming comes with a knowledge about the problems faced by farmers in terms of market lobby in pricing, reasons behind farmer suicides, and other issues plaguing the farming community.

When an individual with in-depth understanding about the market decides to start an agritech platform to eliminate the above mentioned problems, there is a natural conviction and passion to solve it at scale.

Scalability

In addition to the above mentioned factors, the financial aspects of the company to be evaluated include traction achieved, product-market fit, current and future unit economics, capital structure, marketing spend, burn rate, etc. These are similar to non-social impact investments, and are focussed on the cash generation capacity of the business with scale.

For example, affordable healthcare and education is the space which typically has very low gross margins initially, and can achieve better numbers only after scale. So, the projected unit economics and scale are very critical to the overall success of the business. To create a sizable impact, it has to scale and reach millions of people and few thousands would not really help.

Competition

Another aspect to consider is competition. It has to be evaluated so that the monetary part is taken care of. Ideally, the social impact is better with more competition in the space, but it makes the exit difficult. This is a dilemma that needs to be balanced while evaluating the competitive landscape of the sector/sub segment.

For a country like India, a large scale problem needs more than a single player to cater to different geographies, and that needs proper evaluation with respect to India’s demography.

A lot of people don’t believe yet that a viable business can be made out of a social impact startup. The reality, however, is that it can be done at scale, and the money it generates can be reinvested into creating more impact, and investor returns can be given so that investors can reinvest in another social impact elsewhere to further magnify the impact.

Social impact investments are making money, and that’s how more funds are being raised and allocated to this space in the last few years.

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All investors can allocate a portion of their overall portfolio towards investing in social startups, and participate in the societal good it takes care of. Investing in socially driven companies gives better satisfaction than an exit from another investment. Those that are making money out of this are engaged more in societal good in their life. So, effectively, it helps create a better world for our future generations and the world at large.