Step 1: Developing an Investment Strategy

Before you invest in an entrepreneur, you should consider developing your personal investment strategy. An early-stage investment strategy should be part of an overall asset strategy. Impact investors seek to have their investments generate positive social and/or environmental impact in addition to a financial return. But whether they prioritize financial return or impact, what they define as impact, and how their investments achieve this, varies greatly according to their impact investment strategy.


Your impact investment strategy should take into account three basic items: your investment priorities, your impact goals, and your assets. We have included here the essential items that relate to creating a strategy for the early-stage portion of our portfolio. This process will help you articulate your mission, define achievable goals and objectives based around a particular theory of change, decide in what manner you will approach investments, identify and manage constraints and risks, and track your investments’ progress.

1. Setting investment priorities. It is important to identify your investment priorities in the broad scheme of your overall investment portfolio.

Impact-First-Financial-Firsta. Financial-first or impact-first? In many ways, the dichotomy of impact versus financial-first is overstated, and some experts in the sector prefer to present this duality in terms of sequence rather than opposition. That said, as much as impact investors strive to achieve “blended” returns, we still make altruistic and investment decisions from two different brain centers. Thus, when a decision boils down to prioritizing either financial or social return, you should understand your financial and impact return targets.

Impact investors tend to fall into two general categories. Financial-first investors optimize financial returns with a floor for social/environmental impact. If you’re this kind of investor, you’re going to look for market-rate return potential inside subsectors that will yield some social and/or environmental good.

Impact-first investors value impact over financial returns. They are willing to accept a lower-than-market rate of return (they have a financial floor), in return for optimizing social or environmental impact. It should be noted that just because impact-first investments optimize for social return, it does not mean that their investments cannot beat market returns. “Impact-first“ only designates investors that have a higher threshold for risk due to prioritizing impact. Some Toniic members experienced better than market returns from their impact-first investments in 2008 and 2009. These investors often pave the way by supporting new business models that will later become attractive to financial-first investors – once the company needs growth capital.

Investment priority example:
Toniic member Francois de Borchgrave invests in health, education and the environment in the developed world. His primary motivation is to demonstrate that financial returns can be achieved in addition to social returns in order to motivate other capital holders to invest in businesses creating impact. He differentiates his approach from mainstream investing by what he calls “investing with an acceptable discount.” Depending on the investment, he is willing to accept a discount of up to 1/5 of the return in exchange for more social impact.

b. What portion of your portfolio will be devoted to early-stage impact investment? If you are targeting market-rate returns, you may wish to allocate more of your portfolio to impact investments; conversely, if you are an impact-first investor, you may wish to limit your commitments to a discreet portion of your portfolio in which you are willing to take more risk. Many impact investors have both types of investments in their portfolio. There are no hard and fast rules here, but your commitment to impact can influence and be influenced by the kind of assets you deploy and the types of returns you expect. More considerations about how to deploy your assets can be found in Evaluate Your Assets.

Total Portfolio Approach.
Asset-ClassSome investors have decided to place all of their assets under the screen of impact, aiming to find appropriate impact-oriented investments for every asset class, including early-stage privately-held investments. Meyer Family Enterprises is an example. They have designed a customized impact-oriented portfolio for each asset type they hold and aim to be 100% invested for impact by 2020. The diversification of risk under the total portfolio approach does not change significantly to achieve this. The difference is that within each asset class, the Meyer Family identifies ways to invest for impact as well as return. Their early- stage impact investing is part of the private equity and debt portions of their portfolio.

2. Define your impact and align with your investment themes. Spend time reflecting on your impact goals, which include your mission and values, and your industry and investment themes, your sector depth preference and your geographic targets. The end result should provide clarity about your own theory of change and investment strategy.

a. Articulate your mission and values. This is a reflection exercise that will help as you begin to formalize your impact investing policy. Ask yourself what measurable impact you are seeking to achieve through your investments. Who is the ultimate beneficiary of your work? What are the values and characteristics you seek in the entrepreneurs and enterprises you wish to invest in?

b. Decide on industry, impact goals and investment themes. Once you have articulated your mission and values, you should have a general sense of the industry sectors and investment themes you’re interested in. Examples of industry sectors in impact are health and wellness, water, and education. For a more complete list of areas of impact, consider using the IRIS sectors, which are fast becoming a norm in the impact investing industry. Impact goals are defined by the kind of outcomes you want produced to address a problem, injustice or public or private-sector failure, such as improving the lives of women, reducing global warming, or ending poverty. Now, combine these and translate them into more specific, process-based investment themes—for example, a food and agriculture impact theme might mean supporting initiatives that are regional, promote diversification, and harness or encourage sustainable practices. It’s common for investors to start with some general themes and refine them over time, focusing on more specific tangible outcomes. It is also common for investors to start with a narrow focus and then broaden their interests as they are exposed to deals through investor networks. An excellent example of a sector strategy in Health Care in the US is Grantmakers in Health’s Guide to Impact Investing.

To learn more about the financial performance of this portfolio, see a newly released report, Evolution of an Impact Portfolio. This report demonstrates that impact investments can compete with, and at times outperform, traditional asset allocation strategies.

c. Consider your sector knowledge to determine the investments you want to hold in your portfolio within the investment themes you identified. Some investors like to focus their portfolio on a specific sector so they can get involved in different business models aimed at solving the same problem. This provides a level of perspective and expertise that can be shared across and among entrepreneurs. Taryn Goodman of RSF Social Finance says her focus on agricultural deals has enabled her to “tell pretty quickly if the business is using a poor strategy or seeking the wrong type of financing.” Other investors like to diversify sectors and geographies to distribute their risk so they are not over-exposed in one area. Sector choice is also an opportunity to align your value-add with your investment objectives – if you have deep experience in healthcare, you might want to leverage this by investing in impact investments focusing on healthcare.


d. Your geographical breadth preference. The costs and complexities of covering the globe are immense, and can lead to inefficient investing, as investors are often unaware of culture or regulatory geographic specificities. Similar to your sector focus, determine what region(s) you will target for your investments. Putting a manageable boundary around your geographic preferences will allow you to become more comfortable with the landscape, external risks, and regulatory differences of investing in that jurisdiction and develop helpful networks to support you. More information on regional differences can be found in the Regional Guides.

Regional-FocusYou should also consider the implications of a sector focus alongside a geographic focus, as you can end up in a narrow area with few opportunities. Some Toniic members say it’s important to be flexible about where you draw the line so you are not empty-handed when it comes to developing your deal pipeline.

e. Bring it together to define your theory of change. Now that you have identified impact and investment themes, and you know how broad and deep you wish to go with them, you should think carefully about your theory of change, specifically as it relates to your options as an investor. Challenge yourself to create one or more theories of change that include your sector focus, your target population, and an outcome you care about. This becomes a targeted version of your theory of change, which articulates your own impact as an investor as an if/then statement. For example, if rickshaw pullers had access to social capital to purchase their rickshaws, this asset ownership would then allow them access to the financial system, thereby moving them incrementally out of poverty. A cautionary note: if you are just starting out, be careful not to make the goals so broad or grand that they can prevent you from ever getting started.

3. Evaluate your assets. Every investor has more assets than just cash, and every investor needs to figure out ways to complement those assets to reduce risks and achieve their goals. In evaluating your assets, you will want to consider the size of your portfolio, the type of monetary assets you have, and the best way or ways to deploy them. You’ll also want to evaluate your non-monetary assets in terms of expertise, knowledge gaps, network resources, the pace and style in which you want to learn and co-invest, and the kinds of partners you believe will make you most effective.

a. Consider your portfolio size. In sizing your early-stage impact investment portfolio you should consider diversification of risk, time commitment, desired pace of learning, and follow on reserves.

  • Diversification of risk. Like any investment strategy, diversification of your assets is important to distribute your risk. Given the risk inherent in early-stage investments, investor Josh Mailman recommends doing at least five to ten deals in the $50K range to adequately diversify your portfolio. Another strategy for those with smaller asset bases is to invest smaller amounts in more deals through special purpose vehicles such as those established by The Eleos Foundation. Other investors blend direct investments with fund investments to lower risk. Whatever your strategy, you want to set a guideline that makes sense for your portfolio.
  • Time commitment. Be realistic about the number of deals you can actively manage. If you do not think your schedule allows you to be actively involved in ten deals at a time, you may want to land at the lower end of the range. Stretching yourself too thin can have negative effects on your relationships with both entrepreneurs and fellow investors, as these deals often require time as well as money.
  • Pace of learning. Some investors, like Bob Pattillo, like to do many deals to maintain a quick pace of learning. He develops lessons and expertise from each company in which he invests, so for him, a greater number of deals in his portfolio leads to deeper knowledge.
  • Follow-on reserves for equity investments. Research on angel investments has shown that one of the most significant factors correlating with superior financial returns is the ability of
    the investor to participate in future rounds of investment as the company grows. This means that if you are making equity investments, it is prudent to establish a set-aside for follow-on rounds as part of your pool for early-stage investing. Some Toniic members and other early-stage investors set aside up to 50% of their early-stage pool for follow-on investments.

b. Which investment vehicle is the right one to choose? Now that you have a sense of what you want to invest in and the amount of money you want to devote to early-stage impact investing, it’s time to consider in more detail which vehicles you will use to invest. Both the way the assets are managed and the way you deploy them will have implications on the kind of investing you can do. The more varied your vehicles and tools, the more flexible you can be with entrepreneurs. On the other hand, a dedicated focus to a specific kind of investing can also lead to improved knowledge and experience about that toolset.

Toniic members employ a wide range of asset vehicles for impact investing. The most common choices are private foundations, donor advised funds, public charities, private trusts, private assets and special purpose vehicles.

  • Private family foundations in the US can invest either their endowment assets, called mission-related investments (MRIs), or their program or charitable budgets, called program-related investments (PRIs). A good discussion of MRI and PRI investing can be found on the Mission Investors Exchange website.
  • Public charities have fewer constraints than private foundations; as a result, many nonprofit impact funds are set up as public charities, including New Schools Venture Fund, Root Capital, Calvert Foundation, Beyond Capital Fund and Acumen.
  • Donor Advised Funds (DAFs) through a US public charity allow a donor to set up an account with a US public charity and contribute to that charity account. A donor then “advises” on what is done with the funds contributed to the account. Examples include RSF Social Finance and ImpactAssets.
  • Private Trusts may be set up by families and individuals to support charitable giving and impact investing. There is typically no tax benefit from this type of trust unless tax exemption is pursued.

Blending Capital. During due diligence, Charly and Lisa Kleissner of the KL Felicitas Foundation determined that a program-related investment from their private family foundation was the appropriate investment to make in Grassroots Business Fund. The foundation made an equity investment combined with a grant. The grant to Grassroots Business Partners was for much needed capacity building for the types of investments targeted by the fund.

  • Private Capital is used by many investors because it is the most flexible capital of all.
  • Special Purpose Entity or Vehicle (SPV). Usually a separate legal structure, like an
    LLC or limited partnership, that serves a narrow, specific, and temporary purpose such as serving as the vehicle through which investors aggregate capital to invest in an enterprise or fund.

c. Consider your non-monetary assets. It is important to consider your strengths and weaknesses as an investor, your knowledge of and access to networks, and your personal preferences.

  • Know your resource constraints. Time constraints were discussed above, but it is important to recognize, and resolve, other kinds of resource constraints as well. These could include your mobility, your team, your decision-making constraints (board, spouse, etc.), your expertise, your language abilities, your capital, etc. You can partner with other investors, or with local institutions working on the ground. Sean Moore of Acumen Fund shared how essential these kinds of local partnerships have been for his fund to gain trust and expertise on the ground when investing in Africa. See our Sub-Saharan Africa Regional Guide.
  • Know your investment style. Are you a leader, a joiner or a lone ranger? There are three styles of engagement within the Toniic network. Deal lead is suited for experienced investors who value guiding a deal, seeking the wisdom of other investors and enjoy syndicating to accomplish the capital raise needed. Those who prefer to work with a collaborative team can adopt the second style by joining or coming along side other investors. They can take advantage of multiple members participating in a syndicated round of funding. The third style is a more individual one. Sometimes an investor finds a deal, becomes committed, and invests individually in the deal.

Once you consider your investment priorities, define your goals and evaluate your assets, you have the basics of an investment strategy for early-stage impact investing. You are ready to move on to sourcing an investment pipeline. For some examples of impact investment policies, take a look at Mission Investors Exchange’s website.