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June 12, 2017 at 05:47 AM
There is a meaningful search underway for greater predictability in the impact space, a search that could soon go beyond traditional equity. Another form of investment, impact debt, might be both a good future alternative for existing equity investors, and attractive as a new type of offering for entrepreneurs and mission-driven companies.
Impact debt is a nascent but promising opportunity — a unique option for companies that have resisted equity, or felt that traditional bank debt or the nontraditional venture debt weren’t viable options. It’s a largely unheard-of area of financing (beyond traditional developing world microloans or community development bonds) that’s only now emerging as a possible area of interest. Within the impact investing market, impact debt could encourage the risk-averse capital that’s been sitting on the sidelines to finally get in the game.
A Mission-Driven Focus
At a basic level, impact debt isn’t about socially responsible bonds or financing feel-good projects. And it’s not venture debt, a Silicon Valley creation that has lending institutions financing pre-cash flowing companies in the belief that further equity infusions from large funds will keep them solvent. Nor is it a pure credit line, considering that banks restrict how much they can lend, to whom, and under what conditions.
Debt plus impact is about the convergence of mission-driven companies that are currently throwing off cash and willing to take on small amounts of debt instead of larger growth equity rounds that would dilute their equity or cost them company control. They target the same areas as the overall impact market: health, wellness, environmental solutions, sustainable job creation, medical technologies, water and agricultural resource management. And, as with most other mezzanine debt deals, impact debt allows companies generating cash to still maintain strong management teams, quality balance sheets and scalable business models.
To that extent, impact debt is about a mission-driven focus wrapped within the notions of predictability, financial engineering and basic math. For the right company it’s an easy equation: Avoid the equity dilution and onerous protective provisions, potential loss of voting rights and control, and/or the pressure for accelerated exits that often come with larger growth equity rounds. Though some companies might think twice about taking on impact debt at potential coupon rates of 10 to 14% (plus additional warrants), the calculus still might tilt toward debt as an alternative to late-stage equity where companies are far closer to exit.
More importantly, it may offer the comfort of greater predictability to potential impact investors who’ve been waiting for the impact marketplace to further mature, encouraging them to test the waters at last.
Less Volatile Returns
