Glossary of Impact Terms

Below is a list of defined terms that are commonly used in the impact investing space. I will periodically update them or add new ones, especially when cross-referencing them in my blog posts. These definitions are based on my understanding, but borrow from publicly available information. I have attempted to include hyperlinks to sources where appropriate.

Accredited Investor

An accredited investor is a type of sophisticated investor (see below). In the United States, according to the SEC, an accredited investor is anyone who earned income in excess of $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, or has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence). A company or private fund may not offer or sell securities unless the transaction has been registered with the SEC or an exemption from registration is available. Certain securities offerings that are exempt from registration may only be offered to, or purchased by, persons who are accredited investors. One principal purpose of the accredited investor concept is to identify persons who can bear the economic risk of investing in unregistered securities.

Benefit Corporation

A benefit corporation is a corporate form that enables for-profit, mission-driven companies to pursue (as part of their legally defined goals) positive benefits to society alongside profits, and that the pursuit of such non-financial goals is in the best interest of the corporation. In this way, the decision-making of the directors and officers of the company is not constrained exclusively by the pursuit of shareholder wealth maximization, and can take into consideration the impact on non-financial stakeholders (workers, community, the environment, etc.) without jeopardizing their fiduciary responsibility. By giving directors the legal protections necessary to consider the interest of all stakeholders, rather than just those of the shareholders who elected them, benefit corporations meet the needs of entrepreneurs who want their businesses to solve social and environmental challenges. Benefit corporation status also bestows marketing benefits, allowing companies to differentiate themselves to consumers who demand greater corporate accountability and responsibility. It also protects the mission of the company through capital raises and leadership changes. Transparency is another hallmark of benefit corporations as they are required to report regularly on their social and environmental performance based on third party standards. Enabling legislation for the establishment of benefit corporations has been in existence since 2010, and exists in a majority of states in the United States, including Delaware. Benefit corporation legislation exists outside the United States as well, notably in Italy. Although frequently confused with certified B Corps, benefit corporations do not have to be certified, although companies that wish to pursue B Corp certification are best served by incorporating as benefit corporations. Patagonia is often cited as a noteworthy example of a benefit corporation.

Blended Finance

Blended Finance is where more risk tolerant (“catalytic”) capital from philanthropic or government sources takes a first-loss position to more risk averse (“commercial” or “private sector”) capital, thereby mobilizing the risk-averse capital into impact investments that seek to achieve sustainable development goals. This catalytic capital “de-risks” the investment opportunity, making it economically viable, typically by charging a rate of return that is considered below market, or not fully risk adjusted. This blending of different types of capital together to achieve development impact is usually possible when three conditions are met. First, the risk of the investment opportunity is perceived to be high, usually because the sector or business model is earlier stage and therefore the risks harder to quantify. Second, to make the economics of the investment viable, the catalytic capital has to be willing to provide a degree of subsidy by earning a return that commercial investors perceive to be not fully risk-adjusted. Third, both types of capital have to see the investment opportunity as a “win-win.” This is usually possible if all parties are interested in achieving a development impact even if the secondary motivations for doing so might be different.

Certified B-Corporation

B Corporation certification (“B Corp Certification”) is a private, third-party certification standard for companies that meet certain social and environmental performance standards as well as transparency and accountability principles. It is issued to for-profit companies by B Lab, a global non-profit organization. To obtain the certification, a company must complete an online assessment and earn a minimum score of 80 out of 200 points. It must then undergo an assessment review process and provide supporting documentation to be certified. The assessment covers the entire operation of a company and measures the positive impact of the company in areas of governance, workers, community, the environment, (e.g. energy efficiency, employee benefits, corporate transparency, etc.) as well as the product or service the company provides. Certification also requires companies to integrate their stakeholder commitments into the company governing documents. The main benefit to B Corp certification is branding. In an era of “green-washing” the B Corp certification acts as a label that helps consumers identify companies that are more trustworthy because they have achieved third-party verified standards. Certified B Corps are often confused with benefit corporations, which refers to a legal form for mission-driven companies.

Community Development Finance Institutions (“CDFIs”)

CDFIs are mission-driven, private financial institutions that provide credit and other financial services to underserved markets and populations with a goal to make them more financially self-sustaining. They expand economic opportunity by providing credit for small businesses, micro-enterprises, affordable housing, charter schools and non-profit organizations. Their target markets include minority and women-owned businesses in low-to-moderate income communities that are not traditionally served by mainstream commercial banks. In the United Kingdom they are known as Responsible Finance Providers.

Donor Advised Funds (“DAFs”)

DAFs are charitable giving vehicles that allow donors to make an irrevocable charitable contribution in a specific tax year to realize an immediate tax benefit and then recommend charitable grants from the fund over time.  Donors can contribute to the fund as often as they like, placing funds into a donor-advised fund account where it can be invested and grow tax-free. At any time afterward, the donor can recommend grants to their preferred, qualified charities when convenient. Donors can contribute cash as well as other personal assets, including stock and real estate. This can create an additional tax advantage if the assets have appreciated in value as the donor can avoid paying capital gains taxes. DAFs also offer administrative convenience and cost savings for donors that would otherwise have to set up a foundation or trust. There are many specialized DAFs that offer impact investment options to donors as an alternative to mainstream investments. In this way donors can magnify the social impact of their DAFs by investing them in social impact ventures until they decide how to donate the money to charity. Since DAF assets have already crossed the philanthropic boundary, they will never go back to the donor, which means DAF capital can afford to be more risk-taking, and thus catalyze other more commercial investors into impact ventures.

Development Impact Bonds (“DIB”)

DIBs are a variation on Social Impact Bonds (see definition below) except that instead of a local government paying for realized outcomes, it is typically an aid agency or a philanthropic foundation that repays the investors. Development impact bonds are also specific to projects in low and middle income countries, whereas Social Impact Bonds are used to finance social interventions in developed countries. As an example, impact investors agree to provide up-front funding to an eye hospital in Africa to perform a predetermined number of cataract surgeries on low-income patients within a specific period of time. The philanthropic organization then agrees to repay the investors’ principal and a predetermined rate of interest if, and only if, this number of surgeries is successfully performed by the eye hospital within this specific time period. In this way, the philanthropic organization only pays for the specific development outcomes (the cataract surgeries) that have been realized, and the risk of not achieving this goal is born by the private impact investors who, in turn, receive a financial return over and above the cost of the surgeries (in addition to the “social” return on the financed intervention) in exchange for taking this performance risk.

Environmental, Social and Governance (“ESG”)

ESG criteria are non-financial factors that investors use to analyze and screen companies. Environmental factors examine issues such as how energy efficient a company is or its level of CO2 emissions. Social refers to factors such as a company’s labor practices, customer satisfaction levels or product safety issues. Governance factors examine issues such as accounting transparency, board independence or whether there is a history of corrupt dealings. There is no one set of ESG factors and they vary in importance across sectors. Some investors are motivated to use ESG factors because of their values, while others are looking to analyze non-financial risks.

Financial Inclusion

Financial inclusion refers to the availability of a full range of financial services that meet the needs of individuals and businesses delivered in a responsible and sustainable manner. According to the Center for Financial Inclusion, this means access to a complete set of high quality financial services (credit, savings, insurance, etc.), provided by multiple providers in a competitive market, priced in an affordable manner and delivered in a way that is convenient, safe and responsible.

Green Bonds

Green bonds (also called “Climate Bonds”) are traditional fixed income securities that are issued in order to raise funds for a project that benefits the environment, such as the construction of a solar power plant or wind farm. Issuers are both sovereign and non-sovereign. The popularity of green bonds has grown substantially over the last several years and demand for green financing is expected to increase substantially as a result of the emission reduction targets in the Paris Climate Accord. Critics of green bonds point out that there is no universal set of criteria to certify what a green bond is, which leaves some bonds vulnerable to “green washing” by issuers. In response, the International Capital Markets Association has established a set of green bond principles to maintain the integrity of the market, and the Climate Bonds Initiative (a UK non-profit) offers green bond accreditation and certification. Another important question is, does the issuer need to be green or just the project that is being financed by the bond? If an oil and gas company issues a bond to retrofit its plant and equipment to reduce carbon emissions, is that a green bond?

Green Washing

Green Washing is the practice of over-stating or falsely claiming the environmental benefits or “impact” of an investment product or service. See “Impact Washing” below.

Impact Investing

Impact Investments are investments made in social enterprises or investment funds that target social enterprises with the intention of generating positive social and/or environmental impact alongside a financial return. The term “double bottom line” is also sometimes used to describe the same concept. Some definitions include “measurable impact” to emphasize that social and environmental returns are often measured and reported to investors. Depending on the strategic goals of the investor, such investments can be made in frontier, emerging or developed markets, and can target a range of financial returns from commercial (“market”) returns to concessional (“below-market”) returns.

Impact Reporting and Investing Standards

Also known by its acronym “IRIS”, this is a catalog of generally-accepted metrics developed by the Global Impact Investing Network (“GIIN”) used by impact investors and social enterprises to measure and report on their social, environmental and financial performance. They were developed to enable “apples to apples” comparisons across different ventures. If two companies are reporting “jobs created” or “greenhouse gas emissions avoided” and both are using the same IRIS definitions, then their performance relative to one another can be more objectively tracked.

Impact Washing

Also sometimes referred to as “Green Washing” is the practice of over-stating or falsely claiming the social and/or environmental benefits or “impact” of an investment product or service, typically in order to sell more of it. Investment managers might have the incentive to impact or green wash their funds or services because they can use the impact or green label to justify charging higher management fees. Impact washing is enabled by a lack of consumer awareness or understanding about what sustainable investing is and how it is different from impact investing. Sustainable investing is also based on factors that can be somewhat subjective in nature and therefore open to interpretation or difficult to audit / quantify.

Microfinance

Microfinance is a category of financial services provided to low income entrepreneurs whose needs are typically not well served by traditional commercial banks. These services include microcredit (the provision of small loans, which are given without collateral) as well as savings, insurance, payments transfers and other basic financial services.

An MRI is an investment made from the endowment of a tax-exempt foundation, which is intended to generate financial returns as well as further its charitable mission by achieving a positive social or environmental impact. In the past, the investing side of a foundation (which generally focused on achieving profit-maximizing, risk-adjusted returns) occasionally came into conflict with its charitable giving side (e.g. a foundation promoting public health holding tobacco or coal mining stocks). With MRIs, a foundation can allocate money to impact investments and still be considered by the IRS to be exercising “ordinary business care and prudence” even if the expected rate of return is less than what it might earn on an investment that is not mission-focused. MRIs are related to, but distinct from “Program Related Investments” (see “PRI” below).

A PRI is a (typically) below-market rate investment made by a tax-exempt, charitable foundation as part of its annual giving requirement. Charitable foundations are required to give away at least 5% of their assets annually in order to maintain their tax-exempt status. Typically this is in the form of grants to non-profits, but PRIs allow foundations to make for-profit investments (loans, guaranties and equity investments) provided that the primary purpose of the investment is to further the charitable mission of the foundation, and not achieve financial gain. The IRS allows PRIs to be treated as grants (counted toward annual giving requirement) provided the goal of the investment is not to generate market-rate returns. Per IRS definitions, this means a purely profit-driven investor would be unlikely to invest on the same terms and conditions as the PRI. Foundations such as Rockefeller and Skoll have used PRIs to make impact investments in social enterprises and other high impact ventures. PRIs are related to, but distinct from “Mission Related Investments” (see “MRI” above).

Regulation A+ (“Reg. A+”)

The 2012 JOBS (“Jump-start Our Business Startups”) Act is a U.S. law intended to encourage the funding of small businesses in the United States by easing many securities regulations. Under the 1933 Securities Act, any offer to sell securities to the public must either be registered with the Securities and Exchange Commission (SEC) or meet certain qualifications to exempt them from such registration. Regulation A of the JOBS Act contains rules providing exemptions from the registration requirements intended to enable some companies to use crowdfunding to raise capital. In 2015 the SEC adopted rules under Title IV of the JOBS Act (commonly known as “Regulation A+”) that expands Regulation A exemptions into 2 tiers. Issuers must be qualified by the SEC before offering securities to the public and must provide an offering circular (a scaled down version of a prospectus). The regulation creates two tiers of offerings. Tier 1 consists of securities offerings of up to $20 million in a 12-month period. Tier 1 must register or qualify their offering in any state in which they seek to offer or sell securities. Tier 2 consists of securities offerings of up to $50 million in a 12-month period and are not required to register or qualify their offerings with state securities regulators. This partially exempts tier 2 offerings from state “blue sky” securities rules (but in most cases a notification process is still required). In addition, Tier 2 issuers must provide audited financial statements, file annual, semiannual and current event reports and limit the amount of securities offered to non-accredited investors to no more than 10 percent of the investor’s annual income or net worth.

The Social Bond Principles are voluntary process guidelines that clarify the key components that issuers should following when launching a Social Bond to promote the integrity of the Social Bond market. The Social Bond Principles have four core components: the Use of Proceeds (legal documentation should describe how the proceeds will be used to address or mitigate a specific social issue and/or seek to achieve positive social outcomes especially for a target population), the Evaluation and Selection Process (disclosures on how the social objectives and the criteria for selecting investments that satisfy the use of proceeds), Management of Proceeds (disclosures on how the proceeds will be tracked internally and segregated from other funds under management), and Reporting (making available periodic information on amounts invested and their expected impact). Examples include investments in basic infrastructure (water, sanitation and energy), affordable essential services (healthcare, education), microfinance, affordable housing and food security. The Social Bond principles were published by the International Capital Markets Association in June of 2020.

A social enterprise is a type of business that provides basic goods and services to low-income populations in an affordable, sustainable and scalable manner. They are typically for-profit, which provides a degree of market discipline and makes it easier to raise capital, but can sometimes be incorporated as non-profits. Basic goods and services refer to things that are typically provided by public utilities in the developed world, such as electricity, sanitation or water, as well as other services like education, healthcare, finance and housing. Social enterprises are often driven by a specific mission, and have business models that are designed with the intent of delivering a positive impact on society and/or the environment. Often this intentionality is demonstrated and monitored by way of specific impact metrics. These characteristics distinguish social enterprises from purely profit-driven companies, which exclusively maximize shareholder profit. This has given rise to new models of legal incorporation, such as benefit corporations, where the mission is embedded in the goals of the company to avoid the potential conflict between profit-maximization and achieving impact. In this way, company directors are freer to make decisions without jeopardizing their fiduciary responsibility to shareholders.

Social-impact bonds, (also known as “pay-for-success contracts”) are not really bonds or fixed income securities in the traditional sense, but are instead a new way to finance and implement social services. Private impact investors pay up front for a social intervention that is preventative in nature and delivered by a third party (typically a non-profit) to a vulnerable population. Local or state governments then promise to use savings from avoided costs to repay the private investors, but only if the intervention is successful, i.e. certain predetermined, measurable outcomes have been achieved. Social impact bonds allow governments to pay only for specific results (hence the name “pay for success”) and brings in private investors, who have a financial incentive to monitor progress and are in a better position to hold the service provider accountable for achieving results. As an example, private investors provide up-front funding for a preschool program for children who have tested as being at risk for needing special education services. The local government pays back investors if, and only if, these at risk children benefit sufficiently from the preschool program, and the government achieves savings from the avoided special education program costs. Predetermined rates of return are paid to investors based on how successful the preschool program is at preventing these children from requiring special education assistance. Other SIBs have financed interventions to prevent re-incarceration and homelessness. Similar structures are used in the developing world in which the outcome payor is an aid agency or philanthropic organization (see “Development Impact Bonds” above).

Socially Responsible Investing (“SRI”)

Socially Responsible Investing or “SRI” is an investment style that is often referred to as “do no harm.” It is an investment strategy that uses various screens or filters (such as ESG factors) to eliminate securities from an investment portfolio that are considered to be harmful to the environment (e.g. coal power) or to society (alcohol, tobacco, pornography, gambling). This latter category is also sometimes referred to as “sin stocks” as they deal with sectors that are considered by some to be unethical or immoral. See also “Sustainable Investing.”

Sophisticated Investor

In many countries, the financial market regulator or securities commission distinguishes between retail investors and “sophisticated” investors. The latter tend to be wealthier and/or more experienced investors who have a better understanding of the risks involved in investing in securities that are not listed and therefore have fewer disclosures. Because of their economic status, they are also in a better financial position to absorb potential losses from riskier investments. Retail investors, in contrast, are less sophisticated and are less able to absorb losses and therefore the financial products they are offered are more tightly regulated. In the EU, sophisticated investors are known as “professional clients.” In the United States they are known as “accredited investors” (see above). Typically the financial regulator establishes qualitative and/or quantitative tests for determining who meets the definition of “sophisticated” investor.

Sustainable Development Goals

Adopted by all of the United Nations members states in 2015, the Sustainable Development Goals are a shared blueprint for ending poverty and tackling climate change by 2030 while working to preserve the earth’s natural resources. The 17 Sustainable Development Goals and 169 targets seek to build on the Millennium Development Goals and complete what these did not achieve by stimulating action over the next fifteen years in these 17 areas of critical importance. The goals include ending poverty and hunger, achieving gender equality, and ensuring the availability of quality education, clean water and sanitation for all.

Sustainable Investing

Sustainable Investing is a portfolio construction methodology that analyzes environmental, social and governance (or “ESG”) factors to screen and select publicly-listed securities for an investment fund across a range of asset classes. Sustainable investment can involve a passive strategy, where the investment manager is simply tracking an index, or an active strategy that entails shareholder engagement through proxy voting and filing shareholder resolutions to influence management and encourage responsible business practices.