This article was originally published on World Resources Institute's Insights blog. Read it here.
The long-held maxim of "what gets measured, gets done" holds true for any entrepreneur and is especially true for those who seek to advance the UN Sustainable Development Goals (SDGs) while making a financial return. For transformative partnerships with an SDG-focused business model — in other words, multistakeholder collaborations between businesses (or "impact entrepreneurs") and governments and civil society actors that seek to advance the SDGs — measurements can also provide a pathway for setting goals that will attract impact investors.
Impact entrepreneurs are the businesses at the core of these multistakeholder partnerships that aim to disrupt the status quo and build long-lasting and innovative solutions through, for example, launching or scaling a new commercial product or service or developing a new financial instrument. Their aim is to achieve "impact returns": financial returns that advance the SDGs and climate action. Only by increasing the number of successful impact-based business models can we capture the level of private sector investment needed to close the SDG financing gap — which stands at a whopping $4.2 trillion per year.
Impact acceleration can also help businesses and their partnerships overcome the "missing middle," or the transitory period in which the partnership has outgrown small-scale grant funding but is still considered too early for commercial investment.
Many impact entrepreneurs and their partnerships fail to overcome the missing middle because they have not had a long enough runway to prove their business model. These partnerships face the challenge of crafting their business innovation to provide a positive social and environmental impact in a manner that is profitable. An added challenge is demonstrating these impact results in a standard way and satisfying potential investors that are looking to fulfill environmental, social and governance (ESG) goals. Crossing this rarified space to become a successful impact entrepreneur is extremely challenging and requires exceptional business and impact acumen, monitoring and evaluation skills and a strong support network.
Only by increasing the number of successful impact-based business models can we capture the level of private sector investment needed.
In this article, we discuss the distinction between the widely used ESG integration versus impact measuring and management (IMM) from both the partnership and funder perspectives. If partnerships can understand ESG vs IMM, then they can better position themselves to attract more investment by showing they’ve accounted for internal and external risks and opportunities. If investors can better understand ESG vs IMM and the challenges they pose for partnerships, then they can also better identify promising investees that can achieve financial, environmental and social impacts. Achieving these impacts can then reduce perceptions around impact washing and accelerate the SDGs.
The partnership perspective
Impact entrepreneurs (and their partnerships) must have a foot solidly in both the worlds of investment finance and SDG impact and understand how to develop both an "investment" thesis and an "impact" thesis, which requires navigating the worlds of ESG and MM. ESG and IMM are often used interchangeably but there are important distinctions.
ESG focuses on an impact entrepreneur’s environmental, social and governance practices to ensure the business will survive, thrive and realize a financial return. The overall capital markets are justifiably concerned with whether companies are including ESG issues in their corporate and investment decisions, that is, "ESG integration."
In other words, ESG integration is inward-looking and very positive in the sense that companies and investors are recognizing, for example, the ever-increasing risk of climate change and environmental degradation to the value of an investible entity. An impact entrepreneur’s "investment" thesis thus should be based on the underlying business plan and must be tested against ESG inward-looking risk factors and disclosure requirements.
Impact entrepreneurs (and their partnerships) must have a foot solidly in both the worlds of investment finance and SDG impact and understand how to develop both an 'investment' thesis and an 'impact' thesis.
Impact measurement and management, on the other hand, considers the outward impact of companies’ and investors’ performances on social and environmental development goal at large, specifically with the dual intention of driving both financial and impact returns. An impact entrepreneur’s "impact" thesis must be based on the business model, but also tested using outward-looking IMM standards that articulate the positive social and environmental change they aim to effect — the impact. Both must then be monitored, measured and managed, enabling an adaptive management approach to run the business and yield positive financial and SDG returns over time (that is, impact integration).
Both ESG integration and impact integration are important for the success of partnerships — indeed, the processes can live comfortably side-by-side to provide crucial management information that informs executive action and decision-making. The Partnering for Green Growth and the Global Goals (P4G) initiative, for example, is moving to an approach that requires its partnerships to use both ESG factors and IMM systems. This is because the impact investors who may invest in these partnerships also require both because both are central to their investment goals.
Beyond the floor of ESG integration to meet risk and compliance baselines, impact integration should add significant value to understanding if the partnership is meeting its transformative impact goals, as well as managing unintended impacts.
Once the parties in the partnership understand this crucial difference in what they are measuring, then the frameworks to support an impact thesis are clear. The Operating Principles of Impact Management (OPIM) can guide partnerships and investors on the ideal process to follow The IRIS+ system provides frameworks to help set goals within the context of a theory of change and measure outcomes in light of a handful of core metrics within each impact theme, such that investments can be managed toward their conclusion along the lifecycle of the investment.
Get the right partners on board who can successfully draft both an investment and impact thesis and ensure that all parties agree on which impact outcomes to prioritize.
In the end, the challenge of what to measure and the standards to use may be less of a headwind than initially anticipated. Perhaps the bigger trick for partnerships is to get the right partners on board who can successfully draft both an investment and impact thesis, and to ensure that all parties agree on which impact outcomes to prioritize.
The investor perspective
Investors are, in effect, a key partner in helping impact entrepreneurs cross the missing middle. Whether they are early-stage, first-close investors or those that come in at later stages of business maturity, understanding how they see ESG vs. IMM can aid the funding transition.
In essence, the principles of ESG considerations are age-old — most investors are concerned with the potential for negative externalities to affect the value of their investment. They either develop strategies to minimize the implications or make alternative investment choices.
Only recently have climate degradation, poverty and exclusion caused investors to narrow their investment universe because these challenges are pervasive and not easily mitigated. Thus, the demand of impact entrepreneurs is to factor into their investment prospectus consideration of ESG factors, alongside demonstrable impact outcomes using comparable standards.
For an investor, requiring and helping their impact entrepreneur investees to understand these distinct but crucial lenses (an "investment" thesis and an "impact" thesis) will go a long way to avoid confusion. The inward-looking factors may affect the value of the investment, and the outward-looking results of the investment may, add value to people and planet. Understanding and measuring both are key.
Uniform standards for businesses are making significant progress to account for the ESG risks that may affect an investment thesis.
Uniform standards for businesses are making significant progress to account for the ESG risks that may affect an investment thesis. The IFRS Foundation and their standard-setting boards, the International Accounting Standards Board (IASB) and International Sustainability Standards Board (ISSB) are formulating "high-quality, understandable, enforceable and globally accepted accounting and sustainability disclosure standards."
Fortunately for impact entrepreneurs, most investors in the impact thesis space have shifted over the past decade. Instead of proprietary methods of measuring and managing the impact results of their investments, investors coalesce mainly around the SDGs and the use of the IRIS+ system to measure, manage and optimize their impact performance.
These shifts mean that investors are less likely to ask impact entrepreneurs to use different ESG and IMM frameworks, leading to more cost-effective management practices. Further, standardized accounting, disclosure and IMM practices are ways for investors to trust the ESG and impact claims, thus reducing the potential for impact washing.
Over and above accounting and sustainability disclosures, IMM amalgamation means that investors are more likely to derive more meaningful insights on progress against the SDGs. At the very least, they have a common, focused language for measurement. In recent years, investors have realized that measuring their own impact performance using a common language is one thing, but seeing how they stack up relative to peers, or what progress is required to achieve a specific SDG, is quite another.
Performance comparisons are even more meaningful to investment management — providing the insight for investors to make informed decisions throughout the life of an investment.
Performance comparisons are even more meaningful to investment management — providing the insight for investors to make informed decisions throughout the life of an investment, to adjust course, to know if and where more effective impact is likely or to intervene if necessary to keep the desired impact outcomes on track.
A year ago, the impact industry welcomed the release of COMPASS, which laid out for the first time a broadly accepted way to compare impact performance in a standardized way. COMPASS paved the way for the development of crucial impact performance infrastructure, such as benchmarks. These developments, together with ESG integration into accounting practices, are important tailwinds for impact entrepreneurs that seek investors’ capital.
In all cases, having the systems in place — to both account for and disclose potential negative externalities and to measure progress and manage targeted positive impact outcomes that are aligned to an agreed investment and impact thesis — are welcome steps forward. Leveraging strong ESG and IMM practices can beneficially serve impact entrepreneurs in their quest to attract funding and, over the long term, may make crossing the “missing middle” challenge just a little easier.
An upcoming report led by WRI, the Global Impact Investing Network and P4G, "Unlocking Early-Stage Financing for SDG Partnerships," takes a deeper dive into partnership financing challenges — including IMM challenges — and provides tangible recommendations for partnerships and funders to overcome the missing middle and better drive SDG impact.
We encourage grant funders, investors and SDG-focused partnerships to download the report and attend the report’s launch webinar Sept. 9 to learn more.