A Guide for Impact Investment Fund Managers

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

Deal Sourcing and Selection

Deal Sourcing

In order to source deals, funds must (1) effectively market themselves and present their unique value proposition for potential investees and (2) have a thoughtful strategy for identifying future investments. 

On the first point, a fund’s profile in the market and reputation greatly impacts the quality of its incoming inquiries and referrals. Having a strong local presence and business network is essential. Relationships with local business leaders, bankers, accountants, financial advisors, and those involved in supply chain management can all be important sources of deal flow.

On the second point, funds can take various approaches to pursuing potential deals. Some may pay for referrals or create formal partnerships with local incubators. The fund management team must be able to articulate a clear and sustainable strategy for identifying investees.

In total, a fund should plan to spend 12 months sourcing all deal, including time spent with the enterprise to ensure they are investment-ready. To maintain its pipeline, one fund, for example, records every conversation it has with a potential investable enterprise in an internal fund database. At the end of each month, a report is sent to the entire team detailing how many touch points each person on the team has had. The team member with the highest number of touch points receives a reward. While this is only one potential approach, all funds should find a model for tracking their deal sourcing and pipeline development that fits their corporate DNA.

 

Deal Selection 

Networks, relationships, and partnerships with local intermediaries are all essential for developing a robust investment pipeline. Equally important is a well-established process for evaluating potential investments thoroughly and efficiently (Figure 11). Fund managers must also evaluate the impact potential of their investee companies and how that potential aligns with their own impact objectives. Approximately three-quarters of respondents to the GIIN’s 2017 study, The State of Impact Measurement and Management Practice, use impact data to pre-screen investments or inform due diligence (76%) and to inform investment selection or portfolio allocations (74%). Forty-five percent use these data to inform portfolio modeling and strategy.[1]

Figure 11: Filtering the Investee Pipeline

Ultimately, most critical, regardless of process, is that a fund manager maintains a robust pipeline that matches its clearly defined investment strategy and impact objectives and includes a large universe of potential companies—and that it pursues a clear process to identify future opportunities and track current relationships.

Regarding deal selection, there are two key questions to answer. (1) What criteria are used to select a company? (2) What are the characteristics of an ideal company? Factors to consider include the following:

  • For sponsors or owners, who are the driving forces and what are their motivations for managing the business?
  • What is the market opportunity for the business?
  • Can the company deliver its products or services efficiently?
  • How is the company organized?
  • Does the company operate transparently?
  • Does this investment align with fund mission or impact objectives (ideally grounded in an organizational theory of change)?
  • How is the company currently performing toward impact goals? Can it optimize for higher impact?

Funds narrow down their investment opportunities differently depending upon factors that are specific to fund strategy, impact objectives, and risk–return expectations. All team members of a fund must clearly understand how its deals are sourced, which filters are used at each stage, and how its due diligence processes ultimately lead to final selection of a portfolio company for investment. How a fund sources deals can differentiate funds in the market for potential investors; documenting the criteria used will demonstrate a disciplined approach.


Role of the Investment Committee

Figure 12: Investee Selection: Using an investment committee

Each fund has a different relationship with its investment committee (IC), and each investment committee has different expectations its involvement in the fund. The IC helps the fund make decisions about deal selection, ultimately authorizing the final process for due diligence and budgeting (Figure 18). The IC commonly requests more information than a fund puts together at first. Some ICs may want to see mostly already formulated deals, while others may want to see more options so they have room for feedback. Fund managers should know in advance what their fund’s IC wants, so the IC can effectively advise on the details of a transaction and approve the final capital commitment.

[1] Mudaliar et al., State of Impact Measurement and Management, 41.

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