A Guide for Impact Investment Fund Managers

A step-by-step resource to creating and managing a private equity impact fund

Building a Fund Management Team

Structure

Only a very qualified team can effectively implement a fund’s strategy and produce both financial returns and impact for investors. A typical fund management team includes three core roles: senior deal team leaderassociate, and analyst. These roles can be expanded or collapsed as needed; for example, a fund may have multiple analysts or associates depending on its size and need. While advisors and experts are usually not considered part of the core fund management team, except for larger funds, they are regularly involved for specific deals, depending on their areas of expertise. The responsibilities of the fund manager include maintaining a roster of experts to consult when needed.

Impact Measurement and Management (IMM)

Impact fund managers also need to consider who will be responsible for measuring and managing the social and environmental impacts of their investments. Respondents to a GIIN survey, described in its report The State of Impact Measurement and Management Practice, most commonly assign the responsibility for impact measurement and management (IMM) to the broader investment team, often alongside dedicated staff:

Although impact investors employ various formal staffing structures, many respondents view IMM as a central component of their work, noting that all employees contribute to IMM. Most commonly, respondents assign the responsibility of IMM to the broader investment team (46%) or have both dedicated IMM staff and the broader investment team conduct IMM (42%). Fifteen percent of respondents contract IMM work out to external consultants, 9% rely only on staff members who are solely responsible for IMM, and 9% integrate IMM into the responsibilities of other staff members. … For the 71 respondents that have staff solely dedicated to IMM, the median is two staff members per organization.[1]

Staffing structure notwithstanding, building internal staff capacity is absolutely vital to plan and execute a thoughtful IMM strategy. As one fund manager who integrates IMM responsibilities commented, “Impact is at the core of our business, and therefore every staff member is responsible for its achievement.”[2]

Diversity of Skills

The fund management team should have a diversity of skills. PE investments particularly rely on relationships, which team members must manage, and require nuanced expertise. The fund manager must regularly interact with key fund stakeholders, namely entrepreneurs, the board, and the board’s committees. While LPs positively regard previous fund management experience, most equally weigh deal experience. So, while a manager needs skills in investing—both buying and selling—and operations management, they need not necessarily have achieved this experience as a fund manager. That is, LPs may also value experience as a direct investor or former entrepreneur. Depending on the fund’s industry target, domain expertise can be critical.

Similarly important is PE experience in investment selection, management, and exit. Such experience could involve direct fund management, but could also involve corporate, operational, or consulting experience. Because financial management and reporting are crucial aspects of successful fundraising and capital deployment, financial and accounting expertise are also valued.

Many investors look beyond traditional criteria to consider team diversity, including:

  • Expertise in the local environment;
  • Business-building or entrepreneurial experience; and
  • Demonstrated interest in and commitment to achieving social impact.

The Impact Investing 2.0 study offers the following perspective on impact fund management teams:

Founders and leaders of successful funds frequently come from varied backgrounds and have expertise in both the social and private sectors. This “cross-silo” experience enables leaders to communicate effectively with diverse sets of stakeholders and systematically approach the challenges of developing and executing an impact investing strategy. … In the traditional view of players operating in financial markets, performance is quite simply a function of assessing financial returns. Within impact investing, however, performance is better understood as a blend of financial returns and the creation of social and environmental impacts. Therefore, performance itself is a cross-sector concept and discipline; while effectively “doing the deal” is key, impact investing, by definition, is about much more than simply structuring and harvesting investment opportunities.[3]

Demonstrate Viable Deal Flow

Fund managers must demonstrate robust pipeline early in their fund design process to establish their ability to find good deals and deploy capital quickly. When evaluating funds for investment, one of LPs’ key concerns is the team’s ability to deploy capital immediately once a fund has closed. Over 60% of respondents to the GIIN’s 2017 Annual Impact Investor Survey cited ‘track record’ and ‘current pipeline’ as ‘very important.’[4] LPs evaluate the consistency between a fund’s ability to source deals and the promises it makes in the investment thesis. Developing pipeline in the early stage can be difficult, as a fund manager can make no capital commitments to companies until its investors are confirmed. Fund managers must balance the timing of investment from their LPs and the financing needs of their potential investees to avoid missing out on potential deals. This challenge is, unfortunately, unavoidable and must be managed effectively, as LPs need to see a real pipeline in which the fund manager can invest.

Though fund managers present their pipeline to investors in substantially different ways, a compelling presentation of an investment pipeline includes the following details:

  • How the company matches the investment thesis in terms of sector, stage of company, and size;
  • The company’s investment needs, impact thesis, and impact potential; and
  • The level or expected level of interaction between the fund manager and the business.

In addition to the core aspects of fund design laid out in the preceding section, many important aspects of a fund’s operational platform must be in place to successfully attract investors and make investments. Each of these topics is complex, and the right design will be unique to each fund. This guide makes note of these elements and provides additional resources for more detail at the end of this section.

  • Fund domiciliation and legal aspects: The choice of where the fund is registered should align with LP preferences and tax considerations. Navigating the options becomes more complex as differences among the geographies or national tax jurisdictions of LPs, GPs, and targeted investments increase. For example, tax treaties among various countries can yield different tax rates on individual investment reflows (principal, interest, dividends, etc.) depending on a foreign fund’s domicile. These differences in tax withholdings can significantly affect LP returns. In addition, most countries have strict securities laws to protect less knowledgeable investors from being taken advantage of, and while most GPs approach experienced LPs, GPs may wish to obtain legal advice to ensure compliance with these regulations. Restrictions on foreign direct investment (FDI) flows and repatriation of funds after exit can also influence the choice of fund domicile.
  • Currency risk: Of the several types of currency risk, the two primary types that concern funds are: (1) direct currency risk to LPs related to the fund’s currency, which is typically most significant if investors are from a developed economy (with hard currency), but the fund is domiciled in an emerging or developing market (with more volatile currency); and (2) indirect currency risk related to whether a fund’s investments are made in local or hard currency. Some funds might consider using hedging instruments to mitigate this risk.
  • Fund accounting: Professional accounting goes a long way to garner the trust of potential LPs and properly contributes to the management of the fund by (1) valuing portfolio investments and (2) generally reporting financial results along fund accounting guidelines. A good accountant is essential to support the fund, and should become familiar with the relevant regulations.
  • Terms of fund: Fund managers should be familiar with expectations for key terms in a fund’s limited partnership agreement in both the traditional and impact investing industries. The Institutional Limited Partners Association (ILPA) Private Equity Principles offer a standard that funds should know. In addition, many impact funds include impact considerations in their term sheets. For example, 81% of respondents to a GIIN survey, as described in the State of Impact Measurement and Management Practice report, rated as ‘very’ or ‘somewhat’ important standard term sheets that include impact targets or incentives.[5]
  • Governance: In devising fund governance, new GPs should be thoughtful. Some key questions are: What will the governance structure of the fund look like? Will the fund’s board act as a governing or advisory body, and why? How are investment decisions made, at both the ground and investment committee (IC) levels? What profile should IC members have? How can mission drift be prevented? Are interests aligned via incentive structures throughout the organization?

ADDITIONAL RESOURCES

  • Annual Impact Investor Survey 2017, The GIIN
  • The State of Impact Measurement and Management (First Edition), The GIIN
  • East Africa Legal Guide and Toolkit, ANDE Legal Working Group
  • Investor-Friendly Best Practices for Term Sheets In East Africa, ANDE Legal Working Group
  • Innovative Deal Structures for Impact Investments, a new project executed by Blue Dot Law (early findings)
  • Legal and Fiscal Guide (covering parts of West Africa), Investisseurs et Partenaires (I&P)
  • Impact Investing: Purpose-Driven Finance Finds Its Place in India, McKinsey & Company. This report offers insights into attracting and developing talent and compensation and performance incentives.
  • The resources below have been developed by the GIIN to help you integrate impact considerations into your investment management:
    • Set goals and expectations: The GIIN has coordinated with a variety of stakeholders through The Impact Management Project, facilitated by Bridges+, to identify shared fundamentals for understanding impact and more clearly articulating goals and expectations.
    • Define impact strategies and search for evidence: The GIIN’s Navigating Impact projectprovides a simple means to align impact goals and expectations to credible, evidence-backed investment strategies – such as those targeting housing, clean energy, or smallholder agriculture – and use metrics that indicate performance toward their goals.
    • Select metrics and set targets: IRIS is the GIIN’s catalog of generally accepted performance metricsthat the majority of leading impact investors use to measure and manage social, environmental, and financial performance and evaluate deals. The GIIN manages IRIS, and offers it as a free public good to support transparency, credibility, and accountability in impact measurement & management practices across the impact investment industry.
    • Measure, track, use the data, and report: The Impact Toolkitis a digital database designed to help impact investors identify otherwise fragmented supporting resources across the web that are fit-for-purpose to one's impact measurement and management (IMM) needs.
[1] Abhilash Mudaliar, Aliana Pineiro, Rachel Bass, and Hannah Dithrich, The State of Impact Measurement and Management Practice (New York: The GIIN, 2017), 49, https://thegiin.org/research/publication/imm-survey.
[2] Mudaliar et al., State of Impact Measurement and Management, 50.
[3] Cathy Clark, Jed Emerson, and Ben Thornley, Impact Investing 2.0: The Way Forward (San Francisco: Pacific Community Ventures, Inc., November 2013), 24, https://www.pacificcommunityventures.org/wp-content/uploads/sites/6/2015/07/2013FullReport_sngpg.v8.pdf.
[4] Mudaliar et al., Annual Impact Investor Survey 2017, 30.
[5] Mudaliar et al., State of Impact Measurement and Management, 18.

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