Impact for Decision-Making, Part 2
In part 1 of Impact for Decision-Making, Impact Frontiers and Impact Capital Managers made the case for “impact-financial integration.” Dive deeper into impact ratings with module two of the open-access course.
What is an impact rating?
One of the most fundamental questions facing any impact investors is, which investments have more impact?
That question can be approached from a variety of perspectives. ‘Impact’ is multi-dimensional: what kind(s) of impact will these investments create? How much impact will they create? Who will experience those impacts? Would those impacts have occurred in the absence of our investments?
An impact rating is a tool that investors use to organize all of the information they have (and don’t have) about these and other dimensions of impact in order to assess the relative fit between the impact profiles of different investments and an investor’s impact goals.
Why does it matter?
Impact ratings can help investors improve their impact performance over time.
They do so by helping investors move beyond screening-based approaches to impact, and begin to distinguish between investments with ‘good’, ‘great’, and ‘exceptional’ impact. Drawing these kinds of distinctions can help investors allocate resources towards as many of the highest impact opportunities as possible.
It might seem abstract, but investors make decisions every day that reflect value judgments about impact. Impact ratings are just a way to make those implicit or intuitive value judgments explicit and transparent.
This process also helps organizations align around a shared understanding of their impact goals, and coordinate their efforts to pursue those goals. It is often the case that different members of the same investment team conceptualize impact differently. Building an impact rating is one way to get everyone on the same page about what they mean by ‘impact,’ and which investments have most of it.
There is no one ‘right’ way to build an impact rating. In Module 2, we introduce two different approaches – a simple version and an advanced version – and invite you to consider whether either would make sense for your organization.
For those who are interested in exploring the simple version, we include a worksheet that you can use to set up a quick, High / Medium / Low impact rating. Investors have used this exercise in brown bag lunches with their teams.
For those who are interested in exploring the more advanced version, Modules 6-13 provide a step-by-step guide organized around the Five Dimensions of Impact.
The view from Impact Capital Managers
Private capital funds can have vastly different approaches to developing an impact rating depending on investing stage and other factors, which is why Module 2 offers two approaches.
It’s worth noting that while giving your investments a High/Medium/Low impact rating might seem like a simple exercise, in our experience, this can actually be a challenging and thought-provoking process.
Let’s go back to grad school. If you were required to grade your portfolio companies’ impact on a curve: who gets the top spot, who gets the bottom, and why? And can you make that case with your colleagues? What about your LPs?
Developing an impact rating can also help a fund manager determine whether the fund has a “hurdle” or bar for different kinds of actual or potential impact based on contextual factors. Ideally this requires grappling with the question of whether the good being created by the company as it scales is making a meaningful difference based on the size of the problem it is seeking to address and the efficacy of the solution.
Risk comes into play here, too. Some managers intentionally seek companies where they can add additional impact value over time – so they might accept a lower initial impact rating, but develop targets for how they will enhance impact value creation over the holding period.
Earlier stage investors may use a rating to develop an impact pro-forma to help them compare prospective investments and identify which KPIs will be the most meaningful for tracking. Later stage investors may look for more developed evidence of actual impact and a more sophisticated understanding of impact as a business driver, on the part of the management team.
At ICM, we come across many funds that claim they simply know impact when they see it. But if we know we wouldn’t invest in something without a hurdle rate of X, or a potential gross IRR of Y, then we should be able to develop a similar rule of thumb for impact. In cases where impact can be a driver of financial return, developing an impact rating and socializing it with the investment team is an essential tool in the toolkit.
The good news is that this doesn’t have to be an overly complicated process, thanks to Module 2.
Integration Insights Challenge:
The first 50 people to share a link to the online curriculum with one thing they learned on LinkedIn will receive three unreleased impact management memes, like…