Increasingly, GPs secure commitments from LPs of the many different organizational types in the impact investment community. This example highlights the Africa Agricultural Capital Fund (AACF), managed by Pearl Capital Partners. Investors in this fund comprise a bank and three foundations. An aid agency provides a guarantee to the bank and invests in a technical assistance pool. In fact, one of the most powerful aspects of the impact investment industry is its ability to attract a wide range of actors and encourage them to work together in unprecedented ways. Blended finance, a promising strategy gaining traction among impact investors, combines capital with different levels of risk in order to catalyze risk-adjusted, market-rate-seeking capital into impact investments.
The following are typical types of investors that make investments into impact investing funds:
- Development Finance Institutions (DFIs): A development finance institution is a multilateral, bilateral, or quasi-government institution that invests in the private sector for development purposes.
- Foundations: Foundations are increasing their impact investing mandate and moving increasingly from pure philanthropy to Program-Related Investments (PRIs) or Mission-Related Investments (MRIs).
- Independent Investors: This group includes high-net-worth individuals (HNWI) and small family offices that manage investments for wealthy individuals or families.
- International Development Agencies: Aid agencies can be multilateral, bilateral, government, or quasi-government. Aid agencies are most often sources of grant capital but do occasionally provide investment.
- Institutional Investors: This group can include international banks with a social finance arm or wealth management functions, corporations, pension funds, and insurance companies.
Capital Stacking and Co-investment Opportunities
The diversity of investor types interested in impact investing provides an opportunity for complementary co-investing with different types of capital. GPs should understand how they can curate a set of co-investors from various organizational types to fill out their fund. It is rare for first-time funds to get their full initial investment from one investor.
A diversity of investment capital can also help a fund increase its operational flexibility by incorporating different tiers or classes of equity to allow repayment of more flexible investors later than their co-investors. In principle, a fund could have at least four different types of investors: (1) senior lenders; (2) junior lenders; (3) preferred investors; and (4) common equity, as well as grant funding provided for TAFs.
LPs themselves may seek out co-investors to mobilize more capital towards a fund. Capital can be invested in a way that is complementary to the different roles investors hope to play, allowing each to participate according to their interests. Combining capital based on impact interests and risk tolerance allows investors to participate that might not otherwise be able to, thereby enabling capital deployment into investments that might not otherwise be possible. Co-investment also provides opportunities to share the costs of performing due diligence and impact measurement and assessment, which are typically high transaction costs for any one LP.
In the example of Equity for Tanzania, a tiered capital stack is used. Flexible investors take on more of the financial and timing risk, adopting first-loss positions, in order to entice more risk-averse LPs to participate.
This is a relatively small fund, with assets under management totaling less than USD five million. The fund has three tiers of capital, with Class C (equity) on the bottom taking any first losses, Class B (also equity) taking a second round of losses, and Class A (debt) on top taking priority on fund returns.
Capital stacking has two related implications for fund managers to consider. First, when considering who to target as potential investors, GPs should first consider their potential role in the capital stack. For example, if a fund manager needs additional equity capital in the stack, it should target investors likely to place equity. Second, a capital stack has numerous possible combinations, which fund managers should take the time to explore, as these options provide significant flexibility for funds looking to combine co-investors.
- Model RFPs, CFA Institute
- The State of Blended Finance, Business & Sustainable Development Commission and Convergence
- Blended Finance Working Group, a project of the GIIN
- Private Market Fundraising, PEI
- Donor-Advised Funds, Microvest
- MRIs and PRIs for Private Foundations, The Practical Tax Lawyer
- Diverse Perspectives, Shared Objective, a GIIN report that examines the process of how a series of diverse investors came together to co-invest in the AACF fund.
- Catalytic First-Loss Capital, the GIIN
- Scaling the Use of Guarantees in U.S. Community Investing, the GIIN
- 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 project provides 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 metrics that 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 Toolkit is 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.
Understanding Investors: A Deeper Dive
Fund managers responding to the GIIN’s Annual Impact Investor Survey noted that they manage capital from a range of sources. Almost 75% (100) reported raising capital from family offices or HNWIs, and more than 60% (84) reported raising capital from foundations. More than a third also reported raising capital from banks, pension funds, or insurance companies, as well as DFIs. The largest sources of capital by percentage of funds raised were pension funds and insurance companies (24%, excluding outliers) and family offices or HWNIs (18%). This section examines more deeply how each of these common impact investor types typically relate to three key parameters of investment: (1) risk appetite; (2) impact mission; and (3) size in market (Figure 15).
Development Finance Institutions, or DFIs, are hard to ignore given the large capital commitments they make and their influence in the market. The GIIN’s 2017 Annual Impact Investor Survey found that pension funds or insurance companies and DFIs manage the largest amount of impact investing assets, at USD 576 million and USD 463 million, respectively. Given their large size, the minimum investment sizes for DFIs can be too large for a small fund, but fund managers of smaller funds should not dismiss DFIs outright, as some are working on innovative projects to create new investment possibilities. For example, IFC has dramatically increased its capital allocation to SME investments (both direct and indirect) from a total portfolio investment of USD 200 million in 2000 to nearly USD one billion in 2013.
Like foundations or aid agencies, DFIs place impact at the core of their mission, but different institutions can define impact in very different ways, which results in different investment-screening behaviors. DFIs have a strong focus on ESG factors besides their general purpose to catalyze economic development. Their ESG policies can constrain their flexibility, as they may not be able to invest in a fund that does not meet their specific ESG requirements. In addition, many DFIs are required to invest in a particular region or achieve particular impact objectives. DFIs tend to have strong expectations for financial returns, because they depend on profits from their investments to ensure they have the resources they need for their ongoing engagements. They do, however, have a mandate to promote markets and create additionality, that is, to produce social benefits that would not have occurred without their investments.
Despite their similarities, fund managers should evaluate DFIs on an individual basis, as they are increasing their engagement with impact investing at varying degrees of depth and speed. DFIs can also vary in other important aspects, including whether or not they support the development of first-time fund managers, their preference for investment instrument, and whether or not they finance TAFs. Importantly, DFIs may also vary in their degree of involvement in the running of the fund. As experienced investors in emerging markets, DFIs have significant expertise to impart; those involved in setting up funds often have significant shareholder representation and tend to be more involved with strategy as members of the board or as participants on advisory committees with oversight roles.
Before approaching DFIs, fund managers should consider the following:
- Decisions about investments are influenced by complex factors, including shareholder targets, the economic and social impact of the sector and geography, the additionality of the opportunity, the comparative advantage of the DFI versus other investors, and the specific commercial interests of any home-country firms.
- DFIs’ due diligence and investment decisions tend to take a long time due to extensive review processes, including the investment officer’s supervisor, credit department, the investment committee, and the board of directors. Compounding this process are often-rigorous due diligence processes and significant compliance requirements for ESG prior to committing capital.
Foundations come in all shapes and sizes. Several larger institutions that are active and well-known in the impact investing industry are far out-numbered by the many smaller, lesser-known foundations. As with DFIs, some generalizations can be made about foundations’ impact investing characteristics. First, they may have explicit environmental or social missions that can translate to narrow impact objectives, which may be difficult to align precisely with those of a fund. Because of their mission focus, some foundations may be willing to take higher risk in the capital stacks of any fund, for example by providing first-loss capital or common equity (after debtor and preferred investors). In the GIIN’s 2017 Annual Impact Investor Survey, 12 foundations noted that they have acted as a guarantor in at least one investment. Foundations are often more flexible in terms of the type of capital they provide and in terms of their financial return expectations. Beyond providing capital, foundations can also (1) provide first-loss capital to encourage investment from more risk averse co-investors, (2) help develop markets, (3) establish or incubate fund managers, and (4) provide TAF financing, either alongside a capital investment or separately.
The Shell Foundation is one example of an organization that played a large role in helping several impact fund managers get started. They provided capacity-building support, networking support, and grant funding to help get the fund, Grofin off the ground. Today, Grofin is one of the industry’s larger fund managers in sub-Saharan Africa (SSA), now attracting various investors, including DFIs.
Foundations are beginning to play a larger role in the impact investing space and see potential to grow their commitments in the future. By organizational type, the two largest categories of respondents to the GIIN’s 2017 Annual Impact Investor survey were fund managers (67%) and foundations (11%). Foundations project over 30% growth in the amount of capital invested in the coming year.
Like DFIs, fund managers must evaluate foundations on an individual basis. Foundations are bound by their own governance structures, as well as local legal restrictions that vary significantly based on their geography. A foundation’s ability to make impact investments may come down to its institutional flexibility and the laws in the country where it is based. High-Net-Worth Individuals (HNWIs) are important LP targets for impact investing funds. A study by Grant Thornton on raising capital from HNWIs described several common characteristics of independent investors:
- They rely on their relationships, network, and gatekeepers or advisors to find funds.
- Cold-calling generally will not work. Less than 5% of the HNWIs surveyed respond to unsolicited approaches or proposals.
- They care about seniority. Eighty-percent want involvement of senior management in the relationship.
- They are looking for an investment fund that suits their unique needs in terms of risk–return profile and impact objectives.
According to a joint 2014 study from the GIIN and J.P. Morgan, almost three-quarters of HNWI capital (72%) comes from HNWIs investing independently. Private banking platforms (9%) and investing clubs or deal networks (2%) have yet to contribute significantly to the capital allocated to impact investing fund managers. Capital from independent investors is typically accessed either through direct engagement with the individual or family, or through an advisor or wealth management platform. Once a fund manager makes contact, independent investors respond best to a consultative approach that helps them dig deeper to understand if an investment is appropriate for their overall portfolio. Fund managers should be prepared to answer many questions from HNWIs and work to build a strong relationship.
These last points may seem counterintuitive. Why would one of the smallest investor types need the most involvement and ask more questions compared to larger investors? There are three principal reasons for this. First, the investment is personal for them, and such individuals are both personally attracted to impact investing and mission-driven. Second, the investment may represent a significant portion of their net worth. Finally, many HNWIs have experience as successful entrepreneurs or leaders and are eager to share their wisdom. GPs can make a good impression by becoming thought leaders who are out in the industry by speaking at conferences, attending events, being quoted in industry publications, and developing a robust website and marketing materials.
HNWIs will often look critically at financial returns, but their target returns can vary drastically. Individual investors tend to provide smaller capital allotments than other investment organizations, but this is not always the case. They can be particularly powerful allies for new fund managers because of their flexibility. Often facing fewer guidelines and institutional constraints, HNWIs have strategies that can remain nimble.
ADDITIONAL RESOURCES ON INVESTOR TARGETING:
Finding an Anchor Investor or Sponsor
An anchor investor or sponsor, can make all the difference to a successful fundraise especially for a first-time fund manager. In the impact investing industry, mission-driven investors will often play these roles, because they recognize the challenges that new funds face in getting started. Although sponsors and anchor investors are somewhat different, one investor can play both roles, and all the types of investors described above have played both roles.
An anchor investor is generally the first investor to make a substantial capital commitment to a fund. They help gather momentum for the fund and, through their credibility and network, attract other investors. As in the commercial PE world, anchor investors are often identified through existing relationships the GP may have from their successful investment experience, serving as a syndicator of investors or simply as a champion gathering others from their own network. In the impact investing world, anchor investors can have various motives. Some are explicitly mission-driven investors, such as foundations or donors, that are willing to incur significant risk and expense to help launch a fund, to build a market. Several impact funds have been supported at first by a foundation, donor, or non-profit. These impact funds have used their capital to develop a track record through initial investments and create a deal pipeline that can eventually be converted into a full investment portfolio.
First-time managers often lack track records sufficient to attract capital. Partnerships with sponsors can help them surmount this initial hurdle through the following potential benefits:
- Improved brand and credibility: As anchor investors encourage the trust of other investors by declaring their own confidence in the fund manager, a sponsor also increases trust by associating their investment track record or brand with the new fund. This role is often played by a more mature and experienced fund management company.
- Improved network: A sponsor will also often commit to working through its own network to identify potential investors. Some funds will bring a well-known individual with strong political capital to sit on their board and provide significant networking capacity to the fundraising process.
- Working capital to carry fund manager through fundraising: Beyond an actual capital commitment to the fund, many sponsors provide much-needed working capital to carry the fund manager through the stressful and cash-intensive fundraising period. This allows them to build their team more quickly and execute transactions to prove deal flow and their fund’s strategy.
- Capacity building for the fund manager: Sponsors can also provide valuable capacity-building services to help the fund manager, for example, create deal flow, evaluate and structure investments, and gain due diligence insights. Such support is often provided by staff from more experienced funds or long-time professionals in the industry who are recruited as advisors. Models for support include embedding staff in the new fund or providing mentorship by sharing office space or taking a role on the investment or advisory committees.
- Back-office operations: In some cases, a sponsor that is an experienced fund manager will allow a new fund to piggyback on its robust back-office operations to reduce the newer fund’s operational expenses.
Bringing on a sponsor clearly has many benefits, and funds should work diligently to find the right partner. Fund managers must consider both the tangible and intangible costs of doing so, as bringing a sponsor on board may mean any of the following:
- Sharing the carried interest: Most relationships with sponsors, especially when they provide operating capital, require the fund manager to share a portion of the carried interest generated by the fund. This makes fewer resources available for incentive payments to fund staff who are responsible for generating returns.
- Control of the fund management company: Various issues are raised by ceding some control of the management company, the largest of which is the potential ability of the sponsor to fire members of fund management. This can be especially troubling when the interests of other investors and the sponsor diverge.
- Investment committee participation: In certain instances, sponsors require formal participation on the fund’s investment committee, which raises potential conflicts of interest between the sponsor and other investors.
- Investment size, influence, and potential conflicts of interest: Other investors may perceive the potential for conflicts of interest if the amount committed by the sponsor exceeds 25% or more of the fund.
Deciding on the Use of a Placement Agent
New fund managers looking to establish themselves will often consider enlisting the services of a placement agent (PA). PAs help fund managers find investors, develop their marketing materials, negotiate fund terms, and provide insight on positioning a fund within given market conditions. PAs help fund managers widen their investor base, open doors to institutional investors, and offload significant operational and logistical loads during the fundraising process.
On the other hand, PAs can be expensive, typically taking a percentage of total capital commitments to the fund that were made by LPs as a result of the PA’s services. PAs can also be difficult to find in the impact investing industry, given the wide diversity of potential investor types and the relative nascence of the industry.
Morgan Stanley’s Desktop Series, “Working with Placement Agents,” suggests the following aspects to consider when engaging a PA:
- Exclusivity: Many PAs will request engagement on an exclusive basis, the appropriateness of which depends on the situation. Exclusivity may be appropriate when a PA and GP are confident that the PA will be able to raise significantly more than the fund manager would have on their own or when the PA is willing to take ownership of the entire fundraising process, beyond providing introductions to investors. Exclusivity may not be appropriate if a fund is seeking significantly more capital than a particular PA will be able to raise or if the PA has a particular client list in a niche market.
- Determining credit: Because PAs are typically compensated based on a percentage of the total capital commitments made to a fund through PA contacts, it is important to clearly establish the rules for determining which investors will be attributed to the PA. The fund manager may have existing relationships that overlap with those that a PA has or proposes to develop.
- Control over process: Also important is an overarching covenant that the PA will act in accordance with the instructions of the fund manager. A PA can delegate its duties to other actors without the fund manager’s consent. The agreement between the PA and the fund manager should clearly state that the PA remains liable for all of its own activities. In addition, the PA must agree that all its activities will be in accordance with the Placement Agreement.
- Defining the functions: As noted above, PA engagements can vary widely in scope and responsibility. Therefore, the functions of the PA must be clearly set forth in the Placement Agreement in order to remove any ambiguity regarding its duties, which may include any combination of:
- Consulting on strategy and tactics for initiating discussions with prospective investors;
- Drafting marketing materials (e.g., PPMs and slide presentations);
- Identifying and making initial contact with prospective investors, keeping a list of all prospective investors contacted by the PA, and, to the extent feasible, recording the level of interest of those investors contacted;
- Arranging and attending meetings between prospective investors;
- Forwarding to the fund manager any requests for additional information by prospective investors and assisting the fund manager in responding to such requests;
- Advising with respect to market terms and conditions in fund agreements; and
- Maintaining a master investor log and marketing records for the placement of interests under the Placement Agreement and regularly reporting to the fund manager regarding contacts made with prospective investors.
- Fee payments: Some PAs will seek payment sooner than a fund’s final closing. Payment to the PA should, at a minimum, be timed such that the fund manager can make and receive capital calls from the LPs before being obliged to make payments to the PA. In some circumstances, a PA may agree to payment by promissory notes until capital is called from the investors in the fund.
- Sequel funds: PAs sometimes request the right to act as PA for any subsequent funds that a fund manager may form. Fund managers should resist this request, as the facts and circumstances that will exist when raising any additional funds are very difficult to predict. At most, a fund manager should agree only to notify the PA of any sequel funds and to meet with the PA to discuss, without any obligation or inference.
- Compliance with securities laws: Fund managers should seek appropriate representations in the Placement Agreement to ensure that the PA and any associated professionals are registered and licensed. A separate issue of compliance with securities laws concerns the way the PA engages in its activities. The PA must not engage in any general solicitation or advertising of the fund, and it must only make offers to investors it believes are suitable and with whom the PA has preexisting relationships. In addition, the fund manager should retain complete control over the information provided to prospective investors and the format in which such information is provided.
 The GIIN, “Blended Finance Working Group,” http://thegiin.org/blended-finance-working-group.
 Amit Bouri and Abhilash Mudaliar, Catalytic First-Loss Capital (New York: The GIIN, October 2013), 14, https://thegiin.org/assets/documents/pub/CatalyticFirstLossCapital.pdf.
 Mudaliar et al., Annual Impact Investor Survey 2017, xv.
 Mudaliar et al., Annual Impact Investor Survey 2017, 19.
 Mudaliar et al., Annual Impact Investor Survey 2017, 26.
 Mudaliar et al., Annual Impact Investor Survey 2017, 3.
 Mudaliar et al., Annual Impact Investor Survey 2017, 1.
 Mudaliar et al., Annual Impact Investor Survey 2017, 4.
 Raising capital from single-family offices: Perspectives for private equity firms and investment bankers (New York: Grant Thornton, Russ Alan Prince, 2012).
 Yasemin Saltuk, Ali El Idrissi, Amit Bouri, Abhilash Mudaliar, and Hannah Schiff, Spotlight on the Market: The Impact Investor Survey (New York: J.P. Morgan and the GIIN, 2014), 39, https://thegiin.org/research/publication/spotlight-on-the-market-the-impact-investor-survey.