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    While deal-making has exploded, impact investors are struggling to differentiate themselves

    Synopsis

    While deal-making has exploded, impact investors are struggling to differentiate themselves.

    Investor
    The limited partners who invest in such funds are wary of accepting lower returns, the terms these funds offer entrepreneurs in turn are sometimes not markedly different from traditional investors.
    The premise and promise of impact investing has always been clear. This is capital that avowedly cares about the triple bottomline— people, planet and profits. The idea is that there are opportunities in the social sector and towards the bottom of the income pyramid that needs innovation in the way the business models are funded.

    The traditional venture capital expectation of high and quick returns, the argument goes, are singularly unsuited when you are not just building a business, but often willing a new sector into existence, working in unorganized segments and rural areas. It takes time, patience, networks and rolodex of a different nature, links with the government and regulators, and so on.

    But some two decades after the pioneer fund Aavishkaar made the first Indian deals in the space, while the players and money in the space have grown by leaps and bounds, the industry appears to suffer from an identity crisis.

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    Because the limited partners who invest in such funds are wary of accepting lower returns, the terms these funds offer entrepreneurs in turn are sometimes not markedly different from traditional investors.

    Mainstream funds have also recently muscled their way into this space, inspired partly by the early success impact funds had in microfinance in India. The net result — the distinction between impact funds and others feel increas-ingly diluted, a number of entrepreneurs, many of whom declined to be named for fear of alienating investors, told ET Magazine.

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    Vishal Mehta, the founder of Lok Capital, is an impact investor in ventures as varied as Drishti Eye Care (low-cost eye treatment) and Ummeed (housing finance for informal sector workers).

    “Given the force and direction the market is moving towards, the distinguishing characteristics between impact funds and others are hardly visible,” says Mehta, who has raised three funds and made 30 investments in 14 years.

    He is referring to the entry of marquee names such as KKR and Carlyle bringing a flood of new money that is appearing to disturb the equilibrium traditional impact investors had arrived at with entrepreneurs in the space. He hasn’t lost out though. He reaped good returns from the first two funds and is now setting up a debt fund.

    Many other, namely Acumen, Unitus, Elevar, Aavishkar Intellecap and Ankur Capital, are also scaling up with new funds and deals, executives at these funds told ET Magazine. Ankur has nearly 20 investments planned. Aavishkar, too, is raising a $75-million fund and Unitus is planning a $45-million fund. Menterra Venture is also preparing to expand.

    But they are also expecting competition since global players have collectively readied a corpus of some $10 billion to invest in social ventures here.

    The biggest bet so far by a foreign PE fund has been the $50-million TPG Impact investment in Dodla Dairy two years ago.

    But Rema Subramanian, co-founder of Ankur Capital, continues to be optimistic. “The gaps are huge across sectors like agriculture, infrastructure such as cold chains and affordable healthcare. There are many opportunities to be explored.”

    Her third fund is expected to make some 20 deals. Ankur’s portfolio currently includes CropIn (agri-tech) and Niramai (breast cancer screening).

    But CropIn also has on its cap table sector-agnostic US PE investor IDG Ventures. Rail Yatri, too, is backed by Blume Ventures, besides Omidyar Network.

    Industry executives say this convergence of investors is a validation of the success of the impact investment segment.

    “Integration (of various types of investors) is the only way to ensure equitability,” says Subramanian.

    “Across agriculture, education and healthcare, mainstream investors are interested in deals.”

    Blume Ventures, too, sees it as a positive trend. “There is a convergence happening between different types of funds,” says Sanjay Nath, cofounder of the early stage VC firm.

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    Meanwhile, given their expertise in the field, PE and VC firms are seeking meetings with impact investors to better understand the market and also to prospect for joint deals.

    Balance sheet So far
    The evolution of impact investing in India dates back to 2000, when Vineet Rai began scouting for deals here with his Aavishkar fund.

    It took a decade or more and the outsize returns from microfinance for this category of capital to grow. What used to be a homegrown, two-fund story until recently, has since expanded, with at least eight or ten funds being established in the past decade. More recently, the arrival of global giants’ impact units have added to the action in the sector. The first wave of such investments helped microfinance startups targeting the unbanked population and a raft of investors made handsome returns.

    Impact investors do not give donations or grants.

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    They expect to turn around an investment and make money off the deals. Traditionally, such investors provide ‘patient capital’ or give investee companies more time to build the business.

    However, as the market gets crowded with specialised funds and marquee names, some of these rules of engagement, entrepreneurs say, are also under threat. They may have more options to raise growth capital but the fundraising terms from traditional impact investors are not as lenient as they would expect.

    So the new challenge, entrepreneurs say, is to finalise an investor who provides both money and expertise to help them grow their ideas from a business plan to a living and breathing enterprise.

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    However, impact investors they have meet seem to want the best of both worlds -- highgrowth in early stages besides the benefit of longterm investment.

    “As a result, they are neither patient capital nor are they classic tech VCs,” says Ramesh C, who is bootstrapping his agri-tech startup in Tamil Nadu and has approached several investors for fundraising.

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    To his surprise, he discovered that it was easier to move forward with tech venture capitalists (he claims to have received several term sheets). But impact investors were more cautious and took longer to take the first step.

    He asked us not to use his full name or the reveal the name of his firm.

    Other entrepreneurs say that there is little premium attached to going with impact investors, like the founder of a Pune-based startup that signed up with a tech-centric VC in Bengaluru.

    “I wanted a larger round of capital and access to a network that this investor could give me. The impact investor promised more hands-on support but didn’t have the financial heft I wanted,” she says, not wanting to be named.

    Luis Miranda, former chief of IDFC Private Equity and currently chairman of Collective Good Foundation, says impact investors have struggled to show returns beyond financial services. “Outside of the outsized success of investments in microfinance, returns earned by impact investors have been more limited.” According to an estimate by consultancy McKinsey, impact investors exited barely a tenth of their investments between 2010 and 2016. While microfinance exits were strong, returns from other segments were tepid.

    The other challenge for impact investors is to placate limited partners used to bigger returns. “Expecting an IRR (internal rate of return) of 14% in segments that are difficult to deal with and require patience is stupidity,” Miranda says.

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    Impact investors appear to agree.

    “If you’re going to Bihar, you’re not going to have the same return (on investment) as a startup in Bangalore,” says Vineet Rai, CEO of Aavishkar Intellecap Group.

    What he alludes to is the challenge of investing early in a business that often starts in the hinterland with no supporting ecosystem and then catalyzing growth.

    Aavishkar once gave seed capital and helped grow SKS Microfinance (now called Bharat Financial Inclusion). The investor has so far raised Rs 2,200 crore for six funds and closed nearly 70 deals.

    Despite these numbers, the company has made limited returns amounting to Rs 300 crore with exits of around Rs 600 crore expected this year, the fund’s executives said.

    And Rai gives an indication of the current mood among his peers. “Impact investment companies must remain attractive to capital and as an investor, you must expect significant returns… If you don’t return money, the movement will die.”

    Mehta of Lok Capital is also practical. “Ninety per cent of the impact money being raised is coming with the premise that returns can’t be diluted”.

    This means investors need to take bets in segments such as finance that are better structured and support better exits rather than segments such as healthcare and sanitation, which may require patient capital.

    “For entrepreneurs, this can dilute their perception of impact investors,” he says.

    As impact investors battle for their turf with the biggies, they are also keeping an eye out for new opportunities to assert themselves, opportunities like the United Nations’ Sustainable Development Goals that require nearly $2 trillion in investments.

    Much of this capital will be focused in the impact investment sweet spot and funds hope to tap into this. “Over 12 to 18 months, there has been pressure from pension funds and other key investors to tap these opportunities,” says Rai. “The potential for impact investment has grown exponentially.”

    As this market evolves, impact investors hope they have the capital and strategy in place to cash in or risk being left behind.
    ( Originally published on Feb 02, 2019 )
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