Impact investors are divided over what constitutes a responsible exit. Jack Aldane asks what lessons can be learned for those seeking to ensure a positive legacy
Rarely are the risks stacked quite so high as when an impact investor prepares to withdraw its investment. Get it right and not only does the exit secure a profit but it also makes sure that the project retains its developmental impact for the long term.
This is what is referred to in the industry as a ‘responsible exit’ because without a considered withdrawal by the investor in terms of the buyer and continuing development goals, impact investment makes little sense to begin with.
The Global Impact Investing Network (GIIN)’s recent report, Lasting Impact: The Need for Responsible Exits, makes the case for a more in-depth look at what these exits require. It argues that everything from the type of asset sold at exit, to when and why an exit takes place, can affect the long-term impact of a project. Central to the report is what GIIN terms ‘mission drift’, or the risk of a project straying from its original goals.
An exit may be considered complete once shares in a company are sold, or once real assets such as land are sold instead of shares. Hannah Schiff, research manager at GIIN and co-author of the report, says investors often prioritise exits once committed to a project, partly because they want to entrust their impact to a potential buyer, but also because they know exits are challenging and can have a dramatic affect on returns.
“Even though an exit is only a specific phase in the investment lifecycle, preparing for a responsible exit is something that investors start doing right from the very beginning,” she says.
In most cases, impact investors choose projects with partners that already reflect their mission. This “baked-in” approach however can create the dangerous illusion of responsibility on autopilot.
If a telecoms service provider that targets low-income consumers later increases prices in accordance with the market, the business model can grate with other stakeholders. The mission begins to drift and relying solely on the notion of ‘embedded’ impact is not enough.
Exit with purpose
GIIN highlights the example of LeapFrog Investments’ exit from mobile insurer BIMA as an example where an investment partner enabled a business to continue serving the bottom of the pyramid while scaling it up to reach a wider customer base.
Dr Jim Roth, co-founder and partner at LeapFrog (a company that works to scale financial and healthcare services in emerging markets), told Development Finance that this demonstrates perfectly “the value that can be created for consumers, investors, and markets through profit-with-purpose”.
LeapFrog sold its stake in BIMA in December 2017 as part of a US$96.6 million investment by Allianz X. The purpose of BIMA is to provide insurance distribution and underwriting to low-income people via innovative partnerships with major mobile network operators and financial services businesses.
“Over the course of its investment, LeapFrog helped BIMA to expand its reach among emerging consumers by almost 1500 percent,” Roth says.
LeapFrog’s innovation hub LeapFrog Labs worked with BIMA to develop its first health insurance service as well as another pioneering telemedicine consultation product. The firm then leveraged its relationships with mobile network operators to enable BIMA to secure seven additional partners, providing BIMA with access to over 1.4 billion potential customers.
“BIMA now reaches more than 8.8 million people earning between US$2 and US$10 a day in 14 markets across worldwide,” adds Roth.
Helping a business to scale its operations may enable an investee to achieve an initial public offering (IPO). Short of this however, the task of the investor is to find an aligned buyer for a responsible exit.
Schiff says some investors opt for a two-stage screening process to identify the follow-on buyer that is most likely to carry on their mission, as well as those that are most likely to cause reputational harm to a project.
“For the development finance institutions in particular, they are concerned that they do have this reputational risk,” Schiff says.
Selecting a buyer from within a subset of worthy prospects not only preserves the goals of the investor, she explains, but also raises the likelihood of a decent financial return.
David Osborne, head of the generalist team at the UK development finance institution CDC, says responsible exits are “still in the aspirational stage” for the institution, which to date has exited only very few projects. He readily acknowledges however the role exits play in delivering sustainable development. CDC manages more than 40 direct equity investments totalling close to US$1.7 billion that tend to be minority stakes in companies and investments across sub-Saharan Africa and South Asia.
CDC’s biggest challenge, Osborne argues, often comes from having a responsibility towards a wide number of stakeholders.
“We are responsible to the UK taxpayer, so we have to make the best return we can. We’re responsible to the other partners in the business so we have to be aware of their needs. And we need to be responsible towards the people in the business, and finally the wider stakeholder community,” he says.
Aligning these responsibilities is therefore as important as aligning CDC’s mandate with its stakeholders to begin with.
A handful of CDC’s investments have successfully reached IPO stage. In these cases, original investment partners have agreed to sell their shares to CDC, though CDC has yet to sell any of its own shares. Osborne explains that CDC, rather than exit a project, often stays alongside the management team to maintain influence post-exit and monitor the delivery of its social impact.
One of CDC’s recent exits was the Indian microfinance firm Ujjivan, which Osborne says CDC stepped back from along with International Finance Corporation (IFC), CX Partners, the India Financial Inclusion Fund, Sequoia Capital, and NewQuest, in 2016. Timing was crucial in terms of the exit by CDC itself. ￼
“That whole sector was temporarily affected by de-monetisation in that area. Our view was that its effects were going to be different inside different geographies and for different business models. The firm has come back and recovered strongly, but it was only after it did that it probably no longer needed our help,” he says.
Several investors wanted to support Ujjivan, and CDC saw they cut a very different figure from a hedge fund that would most likely sell up at the next lucrative juncture. These investors promised to be long-term holders of the stock, which would free up CDC’s limited managerial resources to move elsewhere. CDC’s exits are, Osborne says, about tactically scoping out the moment to withdraw from a project so as to concentrate its expertise where it is most needed.
Osborne cities another “fast growing technology business”, in which CDC is a minority shareholder. He claims the business will need a lot more capital to deliver its full potential. The shareholders have been approached collectively by another large tech business whose bid to buy it out came earlier than expected.
For all the risk involved, Osborne says, this sale will reap CDC only modest profits because of the timing but that is not CDC’s overriding consideration.
“You like to think that if you back an early-stage tech firm you’ll make a lot of money, because plenty of them don’t. But the reality is we’re selling too early.”
On this occasion, CDC’s decision to aim for the best long-term impact, rather than maximise the straight financial return for the UK taxpayer, has driven its exit. CDC takes the view that the buyer’s commitment to developing the South Asian tech sector, combined with the depth of its pockets, will ensure an order of magnitude of growth for the business far greater than CDC would otherwise achieve.
“While financially it’s not spectacular, developmentally this is probably the perfect buyer. If we don’t sell now, what’s going to happen? Are these guys just going to start up on their own? Are they going to buy somewhere else? Neither would be financially very good for us,” Osborne says.
The unplanned exit
Impact investment is nothing if not a trade-off between two distinct categories of reward, or so it seems. This is why exiting a project gets complicated.
Through the example of CDC’s latest sell-off, Osborne illustrates the kind of decision that in reverse would lead to reputational damage for CDC or any other development finance institution. One investor that has learned from sub-optimal exits is Lok Capital as GIIN references in the report.
In 2009, Lok invested US$1.75 million in an Indian microfinance institution for a 24 percent equity stake. The microloan business grew well within the first three years, after which Lok began looking for a buyer. After five years of growth, the business still had not managed to attract an aligned buyer to acquire its assets. Lok came under timeline pressure to return capital and close the fund and quickly sold its majority stake.
“There was pressure to go with whatever buyer they could find at that point. It was not a financial inclusion play for them, it was a gold loan company that wanted to have a banking component, which acquired it, and that may have led to some unsustainable growth,” Schiff says.
While most of Lok’s exits have successfully ensured mission continuity, Lok provided this example to GIIN where the outcome was less than ideal in order to provide a rich opportunity for learning.
Although Lok achieved its financial and impact objectives to improve the company’s processes and grow its operations, there were post-sale risks in that the investee carried what is known as ‘concentration risk’, which is when a lender focuses an overwhelming share of its services on small set of borrowers. Lok Capital “did what they needed to do” to get out, according to Schiff, but a more flexible timescale may have allowed Lok to find a more aligned buyer.
GIIN has recently surveyed its members on whether they see a perceived trade-off between high financial returns and preservation of impact. Around half the respondents said they perceived no trade-off as if a project had impact embedded throughout the value chain, an aligned buyer would happily pay a higher price.
“Others may simply be willing to take the lower bid because it’s not as important to them,” Schiff said.
Private equity carries the most liquidity and exit risk, according to the 2017 Annual Impact Investor survey by GIIN. Around 9 percent of the investors surveyed describe their concern about this as ‘very severe’, while 43 percent have ‘quite severe’ concerns.
The 2016 GIIN survey figures are even more revealing: around 53 percent of participants said they felt a responsibility to ensure continuity of impact after exit, while 29 percent said that such responsibility applies only to “some types of investments” and 11 percent said they did not believe investors have any responsibility to preserve impact after exit.
These data, Schiff says, are useful, because they lay the foundation to a “sophisticated approach for investors” for the coming decades ahead.
A fund manager is quoted in the 2016 report, asking: “Who wants their good work to go to waste?”
It is a crucial question; one that is discounted by 11 percent of impact investors but which fortunately, a majority still asks itself.
The trade-offs of value experienced by CDC or Lok are examples of what is at stake for any impact investor in such difficult markets. They form the realities that make catalysing private capital so challenging, and that make the need for innovation around risk so vital. They are the realities which have forced governments to seek collaboration with the private sector in an effort to achieve the Sustainable Development Goals.
As Osborne at CDC says: “We’re often battling on many fronts, and we have to have the courage of our own convictions. It’s right that we question ourselves and it’s right that we listen to criticism from whichever quarter it comes, but we’re still convinced we’re doing the right thing. If what we do looks easy, there’s commercial capital for that.”