Stanford professor Sean Foote’s microfinance class, which reaches thousands of undergraduates through a web broadcast, including a small group at Michigan State, introduces students to a range of microfinance structures. From the extreme profit-driven organization to the most altruistic nonprofit, his class challenges students to think about each organization’s effects on the world, financial and beyond, and create a framework to measure these effects.
When Foote’s MSU class set out to define the measurements, they began by examining financial statements. Financial records proved to give a clear picture of an organization’s revenues and expenditures, but they stopped short at what happened to the expenditures after they were disbursed.
As students driven by a humanitarian impulse, the class wanted to know more about how a company affected the world in terms of health, material, and psychological change. Although the online class, including Foote, found themselves unable to come up with an end-all set of measurements that captured a company’s total impact, they learned to examine an organization with both financial and social questions in mind.
These two variables—financial and social—make up the analytical framework called Impact Investing. It’s a way to generate a more complete understanding of the value of a company, and its implications range from individual decisions about where to work and how to invest to the global economy.
To introduce the concept of Impact Investing, Foote offered a question that many of his students face after graduation: “Do I want to work at Wall Street, or would I rather work at a Wall Street type job, where instead of just making money for some company’s secondary offering, I could do the same job that somehow would be helping a social problem?”
This question captures an emerging trend in today’s market: in our 21st century economy, new companies continue to form that operate under a hybrid structure combining savvy fiscal investment with social change. For the socially minded entrepreneur, there are places to work that run like a top financial company, but also deliver the services of a world-changing nonprofit.
One of the most interesting examples in this field is Compartamos, an organization that makes microloans to Mexico’s poor. With a value of roughly $6 million in 2000, the bank raised the value of its shares to $126 million in 2006. By the time the organization went public in April 2007, the company’s market value was over $1.5 billion. The company generated such astronomical investment because it was making huge profits from its above-average interest rates, an annual rate of roughly 90 percent. As investment rose, so did the scale of the loan giving, which currently reaches more than 2.5 million customers with net profits of about $69 million this year.
Despite its gargantuan scale and profit, the company’s financial success raises ethical questions about microlending—namely, what is an appropriate amount of profit to be made on loans to the poor? Although many microfinance institutions generate a profit, Compartamos makes triple the average of Mexican commercial banks, taking in an estimated 23.6% of their interest income for profit.
As Impact Investing evolves, it will force for-profit enterprises like Compartamos to balance the interests of their customers and their investors. Critics of Compartamos’ market-driven model point out the risk of “mission drift,” where the social mission of a company is sacrificed for financial gain. Compartamos’ founders maintain that their microfinance has the potential to reach more people by appealing to investor capital, which vastly outweighs the limited pool of donations and grants.
As, according to Foote, “it seems that the people who traditionally give grants now want to get some of their money back,” companies are changing their business models to appeal to investors. Not all socially-minded companies appeal to investor capital with the allure of solid returns, however. Some simply offer a balance of return on investment and investment back into the company. Companies in the nonprofit sector, which by definition do not have to return profit to investors, are offering extended lives on their donors’ investments and grants, which helps their credibility. Instead of spending money on social programming that, however noble, yields no financial return, these nonprofits generate revenue that gets recycled back into the program.
At the far end of the socially minded scale, but with an added appreciation for finance, Spartan Global offers interest-free loans, which get paid back at a rate of 98.7%. Although our donors will not see a return on their investment, we make the case that their money will perpetuate loans long after the first credit is given out.
Without valuing one model over the other, Foote’s class upholds that Impact Investing falls on a continuum. Its scope ranges from a nonprofit like Spartan Global that expends its entire revenue on social programming, to a for-profit organization that collects large profits on its loans. For all its range, Impact Investing manages to capture two traditionally competitive arenas in the market. Drawing upon the strength of finance to leverage investor capital and social initiatives to provide solutions to the world’s problems, Impact Investing creates change for investors and customers.