Startup investing: the best way to become an impact investor?
The impact investor seeks two outcomes – a social or environmental benefit and a financial return.
A startup led by ambitious entrepreneurs with good intentions and a solid business model, therefore, seems an ideal impact investment vehicle on the surface.
But is it the best way to make an impact as an investor? After all, it’s not the most common option many would associate with making an impact investments.
Many traditionally think of impact investing as buying shares in big companies in the renewable energy sector, for example.
Now there are certainly advantages of backing an established company that is already making a major positive impact on the world and has finely tuned its business model.
This type of company, performing well in both the impact and profit stakes, will probably have a proven method of maximising the value of your investment. Startups, on the other hand, may still be figuring this out.
Property investment opportunities are also enabling investors to make a positive impact, particularly in tackling the UK’s shortage of affordable housing.
And there is also a growing number of managed impact investment funds which would welcome your investment. They are expertly guided and well-resourced and provide a clear path to impacts and profit.
Established firms, property and managed funds all have their own merits and may suit your aims as an active or prospective impact investor.
But startups are also increasingly attracting attention as an asset class that delivers impact investment results. Your investment could enable an entrepreneur to take on one of the planet’s most pressing issues.
So if you are considering them as a mode of impact investment, what factors may shape your decision?
Startups with a positive impact at their core often take on worldwide issues, or those affecting some of the poorest parts of the globe.
Assuming you want to actively help them to grow, your involvement could broaden your interests and see your business expertise applied to places and challenges you may never have imagined.
For investors who perhaps have just exited their business after many years of building it, these new horizons can be highly alluring. Investing in a startup, rather than a social impact fund as one of many investors, brings you closer to the frontline of this valuable work.
Philanthropy is a vital resource in challenging the world’s problems. Donations and grants save lives, protect the planet and reverse worrying trends affecting communities or entire nations.
Investing in an impact startup, however, arguably does all that and more. An impact business receiving a funding hand out may be under no obligation to use it to grow their influence.
In fact, in many cases it may be simply required to make ends meet as it carries out its much-needed activities.
But the presence of an investor within a startup brings a fresh impetus to grow and become more sustainable. If the business plan is executed well, this in turn gives it a brighter future and enables it to increase its positive impact long into the future.
Exit prospects rising
Various studies suggest consumers are increasingly turning towards ethical companies. Millennials, meanwhile, are said to be driving an increase in ethical investment.
Morgan Stanley reports, from its research, that millennial investors are twice as likely as general investors to back enterprises with social or environmental goals.
If these trends continue, the appeal of companies with good intentions is only going to grow in coming years. Potential buyers or shareholders (in the event of a public listing) may well be queuing up to get involved once the startup is established.
Research into social impact funds provides evidence that impact investments are more stable than the general norm.
Morgan Stanley recently surveyed over 10,000 mutual funds over seven years and found that social impact funds had less volatility than non-impact counterparts. There is no clear evidence that impact startups are less volatile than non-impact ones, but Morgan Stanley’s research suggests that the sector generally is more stable than many others.
Investing in startups of any kind can bring added balance to portfolios otherwise dominated by stocks, bonds or property.
Startups are largely less exposed to the turbulence of the markets and more closely pinned to the ability of the management team to execute its plans. Investors are generally advised to invest in multiple startups for added diversity and balance in their portfolio.
The world needs you
Impact investing has grown rapidly in recent years. From mid-2017 to mid-2018, the value of the impact investing doubled to US$228bn, the Global Impact Investing Network (GIIN) reports.Given that this study only included investment houses willing to put their financials forward – rather than individual startup investors – the real value of impact investment is likely to be much higher.
But is it worth anything close to the demand for impact investors in the world today? For example, GIIN references the US$5 to US$7 trillion the United Nations believes is needed to hit the world’s sustainable development goals by 2030.
We also see countless examples of worsening global problems. Take, for example, recent reports suggesting that the drive to reduce global poverty is slowing down.
From 2002 to 2013, global poverty fell from about 1.6 billion to 800 million despite population growth. In September 2018, however, the World Bank reported that the number of people being taken out of poverty is stalling. Between 2013 and 2015, the latest year with a final estimate, poverty fell by 36 million people per year—half the annual rate of the previous decade.
Such statistics underline the fact that demand for impact investors far outstrips supply. Helping to close this gap by simply investing in an impact fund is, of course, one option. Yet this misses the opportunity to utilise the investor’s expertise, thus making their funds go further.
Sophisticated, business-savvy investors can directly influence the impact startup’s progress. They could be a vital resource in challenging global problems for years to come.
Extra incentives in the form of tax reliefs
Investing in startups potentially carries the added draw of tax relief. In the UK, startup investors may be able to benefit from the Enterprise Investment Scheme (EIS) or the Seed Enterprise Investment Scheme (SEIS).
Amongst other reliefs and incentives, the EIS enables investors to claim back 30 percent of an investment in an EIS-eligible business as income tax relief.
The SEIS was launched by HMRC in 2012 to encourage investment in early stage businesses. It enables investors in SEIS-eligible companies to claim back 50 percent of their investment as income tax relief. It also offers generous tax incentives at the point of exit.
Some impact investors backing startups may benefit from Social Investment Tax Relief. Investors receive a 30 percent tax break when investing in eligible social or charitable enterprises.
Investing in startups to make an impact
There are various ways of becoming an impact investor and you must carefully weigh them up before you part with any funds.
Startups can indeed be a great asset class for impact investors, but whether or not they are the best form of impact investing is a matter of personal opinion.
What is certain, however, is that impact-driven startups, funds and established firms are all playing an important role in fighting back against major social and environmental challenges.
Whichever asset class you choose, your impact investment will make you a part of this vital – and growing – global movement.