Catalyzing new markets with early-stage impact investments

Guest Author

Matt Bannick

This post is part of ImpactAlpha’sFrontiers in Social Innovation” series with Stanford GSB Center for Social Innovation. The posts in the series are adapted excerpts from the book, “Frontiers in Social Innovation,” edited by Neil Malhotra of the Stanford Graduate School of Business.


Economists have long understood that while individual firms come and go, the markets that they help spawn continue to grow and evolve, generating a “total impact” on the economy that is a substantial multiple of the impact of any individual pioneering firm.

Though commercial capital markets, particularly the venture capital community, do an excellent job of supporting market-creating firms, impact investors have the potential to create market innovation above and beyond what is currently supported by commercial capital markets. Impact investors can accomplish this by either:

  • Investing in high returns companies that are overlooked and/or “mispriced” by traditional early stage investors. Because such investments are not typically “validated” by the existence of commercial co-investors, these investments may be referred to as “non market validated impact investments.” In many ways, the existence of these investments – particularly in emerging and frontier markets – has been a reflection of the historical focus of VC firms on relatively prosperous and well-developed markets such as the US and Europe.
  • Making so-called “sub-commercial” investments, where the impact investor is willing to accept higher risk or lower expected returns in order to jump-start a market by investing in an innovative, high potential firm that may be operating in a particularly challenging environment. By providing early stage capital, the impact investor enables the promising firm to demonstrate the financial potential that attracts follow-on capital from commercial investors. As the firm scales, it attracts additional innovative competitors, accelerating a flywheel of innovation and market creation.

Catalyzing markets

Examples of market-catalyzing impact investments abound. Perhaps the most well known example of an early stage catalytic investment is MPesa, which received its initial funding in the form of a grant from DFID, the UK development agency, and went on to spawn not only a entirely new global sector of mobile payments but also provided a payment platform on which multiple other innovations could thrive. MPesa’s market-creating dynamism is not a one-off. 

The chapter, “Catalyzing New Markets through Early Stage Impact Investments,” highlights multiple examples of market creation from the portfolio of just one impact investor, the Omidyar Network. Whether sparking new markets for home solar systems, (d.light), democratizing education in India (Doubtnut) or providing affordable health care to lower income patients in Brazil (Dr. Consulta), early stage investments can catalyze the development of high-impact markets.

Encouragingly, many traditional VCs have recognized the potential for high returns in emerging and frontier markets and have dramatically increased their activity. This trend has spread from India to Latin America, Southeast Asia and Africa, among other regions. Entrepreneurs who just a few years ago struggled to get funding are sometimes receiving multiple term sheets. Though current economic challenges and market contraction may dampen this increased enthusiasm, it is likely that emerging and frontier markets will continue to see substantially more investment capital than they have in the past, driving increased market creation. 

While robust flow of VC money into emerging and frontier markets is good for entrepreneurs and for market creation, it is indeed making it more difficult for early stage philanthropic investors to find the “diamond in the rough” of high return/high impact businesses in previously underappreciated markets.

Another positive trend is the increased recognition of the potential of subsidized investments among philanthropists and impact-oriented fund managers. A recent report by the Bridgespan group highlights some of the innovators in “impact-first” philanthropic investing while also noting the substantial structural, cultural and financial impediments that remain.

Increasing concern over climate change has been a major driver of a growing willingness to sacrifice return, as many philanthropists and investors recognize that existing returns-driven capital markets consider many critical climate related investments as too risky, too capital intensive and/or too slow to reach commercial scale. Among the most prominent impact-first environmental funds are Breakthrough Energy Ventures and Generation Capital’s Just Climate fund.

Overcoming challenges

Notwithstanding the momentum behind market-creating impact investments, significant challenges remain. Chief among these are: an excessive focus on commercial rates of return; insufficient impact measurement and a lack of clarity about whether specific investments drive impact above and beyond what would have occurred without them (a concept referred to as “additionality”). These market shortcomings not only lead to systemic under-investment in market creating ventures; they also undermine the credibility and health of the impact investing movement.

A fixation on commercial rates of return. Many impact investors and promoters of the sector argue adamantly that impact investments must generate market rates of return in order for the sector to thrive. Anything less, they argue, might suggest that impact investors – however well-intentioned – may just be poor investors who might even distort healthy markets by subsidizing inefficient players. The implication that some impact investors are sloppy and/or ineffective has hindered fundraising for new impact investing funds and the deployment of more philanthropic capital. 

The returns fixation has also distracted from the more important and clarifying question of the conditions under which one should be willing to sacrifice return in service to impact. Indeed, being clear about why (and how much) one is subsidizing an investment tends to yield to more disciplined discussions about – and commitment to – true impact. One framework for consideration of when to consider lower-return investments is Omidyar Network’s “Return Continuum.” 

Insufficient impact measurement. Even as most impact investors focus on returns, relatively few impact investors have put in place the rigorous metrics, processes and systems to effectively measure impact. Ironically, however, more self-declared impact investors in a recent GIIN survey said they were meeting their typically superficial-defined impact objectives (98%) than reported meeting their financial objectives (70%). 

The same survey group, meanwhile noted that issues related to poor impact measurement threatened the vibrancy of the sector. Indeed, the four most cited impediments (impact washing, inability to demonstrate and compare impact results and lack of common impact language) relate to inadequate impact measurement challenges. Inadequate measurement also reinforces the instinct of many impact investors to focus on what they CAN measure—financial returns—thereby reinforcing an overweighted focus on financial measures of success. 

Fortunately, there is increased attention to this issue, with standards such as IRIS being increasingly supplemented by tools such as RCTs and innovative frameworks such as TPG Rise’s Impact Multiple of Money and 60 Decibels’ “lean data” survey methodology. To be most effective in helping to drive market creation, these tools need to be supplemented by a greater commitment to measuring not only at a firm level, but also at a sector level. 

If impact investors are drawn to the highest possible financial returns and if they count only those impacts that are both measurable and attributable to their individual investments, then they will systematically under-invest in companies – particularly early-stage, high-risk innovative firms – that have the potential to create entire new markets for social change. 

Insufficient attention to incremental impact/“additionality.” The concept of creating value beyond what would be generated in commercial capital markets is called “additionality” and has gained increased currency in the field. The issue of additionality continues to be the subject of substantial debate, with many arguing that impact investors can only generate true additionality if they provide either a financial subsidy or add value in other ways such as governance, networks and strategic knowledge or acumen. 

The existence of additionality has important implications. If a self-declared impact investor is not generating additionality, then accusations of “impact washing” become more relevant as suspicion grows that returns-maximizing investors are not really creating incremental impact and in some cases are merely donning the impact investing moniker to attract additional capital. Tellingly, impact washing is mentioned by 66% of respondents to the GIIN survey as one of the three largest impediments to the healthy development of the impact investing sector. 

An increased emphasis on additionality, meanwhile, would shine a brighter light on impact-first investments as they typically have high levels of financial and non-financial additionality. This increased appreciation of the role of such investments would help drive increased capital into these segments.

These challenges are not insurmountable. With increased impact of climate change and the partial reversal of decades-long poverty due to the pandemic, there is increased urgency for impact investments to create new markets and drive systemic change. 

There is also abundant capital that remains on the sidelines, most glaringly among ultra high net worth individuals, many of whom have continued to amass wealth despite the pandemic. 


Matt Bannick is the former managing partner of Omidyar Network.