Place-Based Impact Investing 101: How local dollars can be deployed to benefit local communitiesJuly 17, 2018 Category: Column, Featured, Funding, Long
Solving the world’s greatest challenges requires determination, innovation, collaboration and capital.
While we have historically looked to government and philanthropy for solutions, there has been growing recognition of the vital role that traditional capital markets and private sector actors can and must play in tackling our most entrenched social and environmental crises. At the Wharton Social Impact Initiative, we focus on how businesses and finance can be leveraged to drive inclusive economic development.
Over the last decade, we have noticed a dramatic increase in the number of investors seeking to achieve financial returns as well as measurable social or environmental impact across their investable assets. This approach to investment — generally known as “impact investing” — takes many forms across asset classes, impact sectors, industries and geographies. And, the growth in impact investing is leading to a range of partnerships, approaches and funding strategies.
Place-based investing — a focus on specific local or regional communities — is seeing renewed interest. Place-based initiatives for poverty alleviation and economic development are not new, yet decades of philanthropic and public policy initiatives have rarely yielded the scope and scale of impact needed.
Part of the appeal of place-based investing is that it involves diverse, coordinated sources of capital, which inherently also require multi-stakeholder engagement and collaboration. And, this coordinated approach is consistent with a focus on industry clusters (closely related and interconnected industries in a specific geography), which ICIC highlights as a worthwhile approach for job growth, innovation and business development.
In this article, we highlight opportunities for asset owners and intermediaries to deploy capital into their local communities — both in the United States and in our backyard of Philadelphia.
Place-based investing in action: Community Development Finance Institutions (CDFIs) and private debt
For decades, community development finance has led pioneering efforts in place-based investing. In the 1950s, policymakers and community activists began noticing the startling trend of “community disinvestment,” or the notion that commercial retail banks were lending less and less to the poorer communities in which they were taking in deposits.
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Specifically, this meant that money deposited into banks by local community residents was diverted to more lucrative credit markets, leaving local urban and rural communities without sufficient lending resources, even though the local community had generated that money.
To address this issue, the U.S. Congress passed the Community Reinvestment Act (CRA) in 1977, “which was intended to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods.” Later revisions of CRA legislation emphasized the Community Development Financial Institution (CDFI) as a creative vehicle for CRA compliance by banks. According to the CDFI industry group, Opportunity Finance Network (OFN), CDFIs are financial intermediaries “that exist to align capital with financial, social, and political justice, bringing low-income, low-wealth communities left behind by mainstream finance.”
Public funding and retail banks seeking to fulfill their CRA mandates have been the primary source of investment capital for CDFIs. More recently, however, CDFIs — out of necessity but also opportunity due to growing interest in impact investing from mainstream investors – have diversified their investor base. As Nonprofit Finance Fund CEO Antony Bugg-Levine puts it, “CDFIs are poised to be an important partner for impact investors, bringing their decades of knowledge in financing the organizations that tackle social issues.”
Specifically, CDFIs help local businesses create jobs and help nonprofits access financing where commercial banks are unwilling to lend. That does not necessarily mean a concession on financial return. One industry study found that of 209 OFN members, the collection of CDFIs had deployed $35 billion in cumulative financing and averaged a 1.5 percent net loan loss rate, on par with FDIC-insured institutions. While one would certainly want to do his or her due diligence, for the foundations, private banks or family offices looking for place-based investment opportunities, CDFIs may be one area they may want to look.
Example: Reinvestment Fund is one of the most well-known CDFIs in the country. Over the last 32 years, the organization has deployed $1.9 billion into local communities, helping finance diverse projects from high-quality grocery stores and affordable housing to schools and health centers.
Affordable housing and real assets
More than 11 million low-income families pay more than half their monthly income in rent, and approximately 2.5 million are evicted each year. Compare that to the 25 to 30 percent monthly housing expenditure suggested by most experts, and it is easy to see that the U.S. is facing an affordable housing crisis. This problem will only be compounded as people continue to converge on urban centers and folks 65 or older begin to represent a larger portion of the US population.
Investments in Low-Income Housing Tax Credit (LIHTC) funds may prove one viable option for place-based investors. The LIHTC was developed by the U.S. Department of Housing and Urban Development in 1986 and remains an important resource for creating affordable housing today. LIHTCs allow housing developers to receive federal income tax credits that they can pass on to private investors — the developers get funding for their projects, and investors get a reduced tax bill.
Example: Enterprise Community Partners is a nonprofit real estate developer that has made nearly $29 billion investments since 1982. The organization offers a variety of investment tools — from asset management of LIHTC-financed homes to their community loan fund and conventional equity fund. Its investment areas spans affordable housing, charter schools, commercial and retail centers, and even federally-qualified health centers, among others.
Innovation and job creation: private equity and venture capital
Some place-based investors may choose to drive innovation and job creation in their communities by investing directly in companies. Many cities have regional angel investing groups or impact investing venture capital funds that help early-stage enterprises get off the ground.
People who qualify as an accredited angel investor make $200,000 or more in base salary every year or maintain a net worth of more than $1 million. While angel investing has been mostly relegated to these accredited investors, recent policy changes with Title III of the JOBS Act allows non-accredited investors to participate in early-stage investing through online equity crowdfunding platforms.
Individual accredited angel investors generally invest in a company’s “seed round,” investing between $25,000 and $250,000 in the round. Non-accredited investors are allowed to invest through intermediaries between 5 to 10 percent of their annual income, depending on whether they make less or more than $100,000. Angel investors who provide this start-up capital to companies do so in exchange for convertible debt or equity ownership in the company. As is true with other types of impact investors, impact angels generally invest across the spectrum of impact theses, sectors and industries.
If place-based investors are unable to expend resources to invest in companies directly, they may look to pool their resources through local angel groups or find intermediaries like fund managers in community development venture capital (CDVC) or other types of impact investing private equity/VC fund managers.
Research shows that traditional venture capital is rarely accessible to entrepreneurs and small businesses in economically distressed communities in the United States — which can be a challenge for place-based approaches in these areas. Despite these challenges, the potential of venture capital as a tool to enhance the economic development of these communities has garnered increased attention over the last two decades.
CDVC is the use of venture capital to do just that: CDVC funds provide equity and near-equity investments (e.g., convertible debt) to small and growing businesses in a similar fashion to other VC funds, but focus investments in economically distressed communities to “create good jobs for people who would otherwise have limited employment opportunities.”
Example: Investors’ Circle is one of the most prominent impact investing angel networks. IC’s explicit mission is to bring together committed investors and cutting-edge entrepreneurs to scale solutions to the world’s most pressing challenges. Their network has invested over $200 million over the last 25 years, and they have regional chapters all over the United States, with a very strong Philadelphia chapter.
Innovative financing structures: social impact bonds and pay for success
While investing in traditional municipal bonds can be a way to invest locally, innovative bond-like structures have emerged over the last several years as a way to drive more capital to social and environmental impact.
Social impact bonds (SIBs) — or pay for success financing (PFS) — are contracts where private investors agree to lend capital to social service providers to scale their operations (typically more capital than they could otherwise receive at one time through government grants and philanthropy).
In this model, however, the service provider is not liable for repaying the investors. Instead, a third-party payer — generally a government entity or a foundation — agrees to pay back the investors if the service provider reaches specific outcomes metrics mutually agreed upon at the outset of the contract.
SIBs and PFS contracts have been used in states as far and wide as Massachusetts and New York to Oklahoma and South Carolina. These mechanisms have also been used to finance a diverse range of projects, including eliminating parental substance abuse to keep families together; outpatient alternatives to reduce the number of women in prison; and workforce development and housing opportunities for veterans.
Example: Groups like Social Finance US develop these instruments. They help communities identify which promising programs and services could benefit from an infusion of investment capital to scale, find investors and manage the projects to ensure positive results.
Place-based investing is a promising approach for impact investors who seek to increase their impact in a specific geography. Creating opportunities for coordinated investments with shared impact goals can bring together a range of private investment and philanthropic capital. There are a number of investable opportunities with strong track records available to place-based investors.
There is also plenty of room to innovate. As an anchor institution in Philadelphia, we look forward to engaging more in this area.