For decades, philanthropic investors have largely used two wallets for their capital: grants to support social causes, and investments designed to generate market-rate financial returns. But even when those market-rate investments are made through an impact lens, this approach often still leaves significant impact on the table.
Between a grant and a market-rate impact investment iss a third wallet: filled with a multitude of flexible, patient financial tools that have yet to be thoroughly explored or embraced by impact-focused funders.
Impact-first investing – what we like to call the third wallet – goes where the markets have failed. We cannot grant-make our way out of every problem, nor should every investible solution be expected to generate market-rate returns. Consider a small business building credit to hire returning citizens or a community lender converting predatory loans in low-income neighborhoods. Many such opportunities could benefit from the growth support of a traditional investment with the impact focus of grants.
If you are already investing for impact, then you might be familiar with the challenge of fitting the right capital to the right problem. Making those decisions requires making implicit assumptions about the trade-offs, whether around expected return, time horizon, risk tolerance, or the type of impact generated. Most of these assumptions are never made explicit because there has not been a framework for understanding how those trade-offs unfold across an entire portfolio: given the scope of your philanthropic capital and your impact and financial goals, what combination of grants, market-rate impact investments, and impact-first investments makes sense for generating the impact you’re trying to achieve?
Over the last two years, our teams have worked together to find an accessible way of providing this type of guidance. The result is the Impact-First Investing Tool, a free platform developed by the Social Finance Institute and the Rustandy Center for Social Sector Innovation at Chicago Booth to explore how integrating impact-first investments into a charitable capital strategy might affect both total impact and financial returns over time.
The IFI Tool turns an abstract guessing game into economic scenario modeling: if there is an investible solution to a given challenge, then what is the effect of moving some capital into that solution?
Capital fit
Take place-based wealth building in historically underserved communities. A two-wallet approach would offer a grant to a nonprofit organization supporting the community’s advocacy efforts and a market-rate impact investment to a successful locally owned business. The grant makes sense for critical work that is not revenue-generating, just as the market-rate impact investment may be most appropriate given the business’ growth projections.
But an organization helping first-time homebuyers in marginalized communities escape predatory mortgage loans is a different story: it has a business model, a growth trajectory, and loan repayments that could even be used to make another loan when they scale to a different state. The time horizon and return profile may be longer and lower than that of the local business, but the impact could be more significant. A grant could support short-term efforts but may make it harder to attract growth capital in the future.
The question is not which of these solutions is “better” or more important – they all serve clear and critical needs. It’s whether the right type of capital is being used for each. The IFI Tool lets you model what happens when you fund all three of these options, and see how applying the right tool to the right problem – through different allocations of grants, market-rate impact investments, and impact-first capital – shift the picture over time.
The IFI Tool can help make conversations about impact and return clearer. But its intent goes further – it’s a vehicle through which principals, boards, investment teams, programmatic teams, and advisors can align on the potential of impact-first investments for achieving philanthropic goals and seek out specific opportunities to unlock more capital for problem-solving. The problems we’re trying to solve are too urgent to settle for less impact than our capital can generate.
Robert Gertner is the Frank P. and Marianne R. Diassi distinguished service professor of economics and strategy and the John Edwardson faculty director of the Rustandy Center for Social Sector Innovation at Chicago Booth. Tracy Palandjian is the CEO and co-founder of Social Finance.
Guest posts on ImpactAlpha represent the opinions of their authors and do not necessarily reflect the views of ImpactAlpha.
