Catalytic Capital | October 24, 2023

Embracing the Spectrum: Investors of catalytic capital seek outperformance – on impact 

Maoz (Michael) Brown

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Guest Author

Maoz (Michael) Brown

Profit and purpose, mission and money, values and value creation – the synergy of financial return and social benefit is the animating principle of impact investing. 

This happy interplay has been essential to field-building, but it has always been unclear how we apply the “doing well by doing good” mantra to those impact investors targeting subcommercial returns for the sake of social mission. If we can make the world a better place and get rich at the same time, why should such investors exist?

Rather than get stuck on this question, the field has seemed largely content with centering market-rate-seeking financial vehicles to grow the movement of impact investing and to differentiate impact investors from philanthropic analogs. 

Lately there have been stirrings of a shift in norms.

Katie and Brian Boland of the Delta Fund have urged their colleagues to “stop using the term ‘concessionary’ when describing impact-first returns.” Trimtab Impact, a fund of funds incubated by The ImPact and Blue Haven Initiative, describes itself as “unapologetically impact-first.” A recent Bridgespan report declares “now is the time for impact-first.”

Adding further momentum to this change in language and sentiment, the Catalytic Capital Consortium—led by the MacArthur Foundation and supported by the Rockefeller Foundation and Omidyar Network—has made major investments in demonstration pilots, research reports, and educational programs to prove and scale the value of catalytic capital, often treated as a synonym for impact-first. 

An ImpactAlpha article notes that “‘Catalytic capital’ is edging out disparaging terms such as ‘concessionary’ or ‘below-market.’”

One might get the impression that an impact investing turf war is underway. But a recent report on catalytic capital published by the Impact Finance Research Consortium paints a more nuanced picture. Based on survey responses from over 200 impact investing fund managers across the world, the report presents numerous findings on the forms, features, and functions of catalytic capital. 

One particularly interesting finding is that although there are large portions of the field that are “all out” or “all in” when it comes to catalytic capital, a substantial segment falls on a spectrum in between those poles. More specifically, my colleagues and I found that 40% of respondents classified none of their committed capital as catalytic, while 19% classified all of it as catalytic. That leaves 41% of funds that fall somewhere in the middle. In short, our survey data point to a range of diversified funds that blur the boundary between the finance-first and impact-first archetypes.

We should keep this continuum in mind as impact-first investors assert their value proposition more boldly. It is certainly high time to more fully recognize the unique impact that such vehicles can create. We also must remember that this impact often depends heavily on the co-investors that impact-first actors recruit into deals.

Connections and coordination

The impact thesis underlying catalytic capital is not that it furnishes a perpetual subsidy, but rather that, ideally, it incubates technologies, businesses, and markets to the point that they are ready for investment on more conventional terms. The impact inherent in this model entails not only the trailblazing role of impact-first investors, but also partnership with a broader capital market ecosystem.

In practice, however, we find that catalytic investors often struggle to attract and collaborate with co-investors. This finding surfaces in all three of the excellent guidance notes on catalytic capital published by FSG and Courageous Capital Advisors. As explained in the guidance note on catalytic capital’s role in scaling enterprises, the problem of misaligned incentives and confusion over objectives is particularly acute in blended finance transactions “where different capital layers often pursue different interests.” 

This challenge is the reason that our finding of a spectrum of catalytic funds is not only interesting but also exciting. Impact-first fund managers should know that there is a range of other impact investors in their ecosystem with various types of catalytic carve-outs that can help to bridge the chasm with “purely commercial” capital. As we learned in the 2018 Impact in Alpha report by Tideline and Impact Capital Managers, one of the unique ways in which impact investors drive value is by sourcing investments through mission-aligned networks.

Building out and spotlighting such mission-aligned investment networks should be a critical priority for our field if we hope to realize the full potential of catalytic capital. As impact-first investors make a compelling case for the outsized impact they can achieve, it is incumbent on the broader community of impact capital owners and managers to respond by strengthening connections and coordination. 

As for those impact investors who do not yet utilize catalytic capital, field-builders and thought leaders should make clear that there is a menu of strategic options for experimentation, rather than going full tilt into an all-catalytic approach.

Bridges already exist, but more are needed. Creative deal structures that align interests and incentives will be essential, as will transparent communication, patient relationship-building, and a shared commitment to expanding quality investment opportunities. 

If we get this right, catalytic capital can achieve exponentially greater impact.