The screening process yields a refined pipeline of investment opportunities that fall within the investor’s field of interest. The next step toward actual investing is to embark upon the in-depth analysis and due diligence that will determine if the investment is both financially sound and truly impact generating.
Impact-driven investing implies paying an equal amount of attention to analysis of the impact aspects of the investment as to the financial analysis and due diligence. Rigorous impact analysis provides investors with tangible knowledge as to what impact an investment can be expected to generate, and the risk that this impact will not be achieved. This knowledge forms the basis for integrating impact into investment decision-making, and ensures that impact concerns, alongside financial ones, are informing and guiding the use of capital in an effective manner.
It is important to perform impact analysis alongside the financial due diligence (and if not done by the same team or individual, the two should be in close communication). This is due to the inevitable extent to which the two are bound together. Most obviously, if an organisation falters financially, this will have a negative effect on impact-generating activities. Conversely, if the business model and impacts are well-aligned, then financial sustainability and impact generation will go hand in hand.
Financial analysis and due diligence is outside the scope of this guide, and it is assumed investors will have developed their own processes on this front (addressing in detail the organisation’s finances, management and key personnel, operations, business plan and so on). Yet while a potential investee organisation may be financially extremely sound, this does not in itself provide assurance that it will deliver the impact it proposes to.
Any investment poses both a financial return, and a risk around whether or not that return (and potentially the investment capital), will indeed come back to the investor. An impact investment in addition presents both a potential impact to be generated, and the risk that the strategy may not work, and the impact fail. And so, as an investor’s financial interests focus on risk and return, in parallel, the two main parameters regarding impact are:
- impact risk: what is the risk that the impact will not be achieved?
- impact generation: what is the volume of impact the investment or investee organisation proposes to generate?
In order to address these questions, it is essential for investors to “get inside” the investee organisation — including getting to know the management or entrepreneur in question, and the vision that is driving operations. Equally, as any outcomes-based analysis will need to relate to the problem being addressed, and how beneficiaries are responding, it is equally essential for the investor to ensure they have a good understanding of how the impact processes will work in context, and, where possible, to get to know the beneficiaries and their lives too.
First-hand exposure to the organisation, its activities and its beneficiaries, gives excellent depth to the impact research, as well as providing assurance that the organisation is doing what it says it is, and that this is having the reported effect. Ultimately investors will rely upon such reports from the organisation, and so verifying that what is being reported is meaningful for beneficiaries, and validating the organisation’s measurement and reporting systems, is a crucial part of building confidence in the proposed impact.
The effectiveness of the personal approach however is greatly increased through the simultaneous use of a systematic process. An explicit framework for analysis, with a defined checklist of points or questions, ensures that the research done is not only deep, but also thorough and complete. It further supports a common procedure for analysing different organisations (and for use by different analysts, e.g. loan officers operating in different regions), thus establishing a plane of consistency among results, allowing for meaningful comparison, and for this to feed into the investment decision.
The analytical process may take the form of a scorecard, with points awarded on various lines to produce an aggregated result. Alternatively a more qualitative approach may be preferred, with evaluations of e.g. “high”, “medium” and “low” on different sections of the analysis. For the process to be effective, it must meet four key conditions:
- the presence of an explicit methodology
The process must be laid out in a clear form, breaking the analysis into modular parts, with a methodical means to work through these parts, and guidance as to how to understand the terms and processes involved. The methodology must be distributed internally, with both analysts and investment committee members being aware of its structure and main points, and be in active use.
- the use of standard forms
The methodology itself must be standardised and suitable for consistent application across different potential (and existing) investee organisations. The adoption of external standards where available will further increase consistency, compatibility, and the extent to which results can draw on and contribute to common best practice.
- evaluation and performance levels
In addition to being investigative, the methodology must also be evaluative, yielding not only a descriptive understanding of the impact, but an assessment. Performance levels must therefore be built into the modular parts of the methodology, allowing analysis to determine if the performance (or prospective performance) of the organisation on any particular part is comparatively higher, lower or similar to that of other organisations.
- objectivity and independence
The methodology’s design must ensure objectivity such that evaluative results are not conditional upon the individual who is conducting the analysis. Multiple individuals, given the same information, should produce the same analytical results, regardless of their own views or preferences. The analysts must also be independent of the organisations they analyse, and able to perform analysis free of any conflicts of interest.
The purpose of this section on analysis is not to provide a pan-methodology for use by all investors. Differing areas of focus among investors will necessarily place differing needs upon their methodologies. Moreover the strategy and balance of interests of a particular investor will play into the weighting of the various parts within the analysis, with more or less depth and importance placed on one area or another accordingly.
However, while emphasis may shift, the key questions and issues at stake when performing impact analysis are common. This section presents an essential framework for organising these questions, and accommodating the sets of considerations they each imply. For investors, it may be used as something like a library of parts. Investors may wish to compare their own approaches and methodologies to ensure they are covering the things they need to cover, and are doing so using the structure, order and balance that is right for them.
The framework is built around the two key parameters of impact risk and impact generation. However, before analysis proper can start, it is necessary to draw out in full what the proposed impact is, and what the investee organisation is doing to generate it. This involves a close working through of the organisation’s impact plan. In addition, as the impact analysis inevitably requires an input of time and resources from both the investor and investee organisation, it is necessary to ensure adequate attention is paid to managing the analysis process.