Opportunities for participatory approaches in impact investing cycle

Building on the foundational definitions that underpin participatory processes in impact investing, we identify entry points for participation during the investment process for members of the wider community who will be affected by an investment, intended beneficiaries of an investment, consumers of a product in which an investment was made, and producers of the product. Participatory approaches can bring business benefits, as set out recently by the Asian Development Bank (ADB) and help companies and funds be seen as more compliant to Basel III regulations know-your-customer (KYC) requirements.

Meaningful community participation engages beneficiaries, consumers, and producers in a meaningful way, as a clear decision-making partner. Applying these to each stage of the investment process ensures that the impact that these stakeholder groups want to see in the world is given prominence, and that they have agency to change investment structures for the better.

Stage 1: Sourcing deals and pre-screening of investments

Sourcing is the first stage of the investment process (see Impact Investment Process diagram below) and refers to the efforts undertaken, whether it’s relationship building or desk research, to identify marketable opportunities for an investment. An investment is deemed marketable if it aligns with the overall investment strategy of the fund, institution, or individual investor. Investors have different levels of risk they can take with their money and the pre-screening process helps to decide whether the investment is worth pursuing. Challenge or innovation funds require investees to submit proposals to potential investors, but often it is left to the investors to search for appropriate deals that are both commercially profitable and achieve a level of social impact, which is a considerable undertaking.

Impact Investment Process

For impact investors, pre-screening involves an analysis of whether capital is concessional (accepting less financial return for more impact); an analysis of the risks and benefits involved; geographic; sectoral and impact considerations. Investors typically invest where they have expertise, and often investors can be mandated (by their shareholders) to only invest in certain areas. Environmental, Social, and Governance (ESG) strategies and the business case for the investment are reviewed, which provides more details of the business plan and timeline. The business case describes the overall health of the business and is developed by the investment team over the course of the investment process.

Opportunities for building participation during Sourcing & Pre-Screening:

• Establish community partnerships as a central starting criterion for applicants, by requiring a demonstration of relationships between investees and prospective beneficiaries, with beneficiaries such as community group outlining the likely positive effects and identifying potential threats to their well-being and the investment.
• Prioritise investees that promote participatory processes such as a shared decision-making. This might take place while calculating revenue share to producers, better engaging employees, or identifying the physical location for an investment site. Each business model will present unique opportunities to allow communities to have a say in how their lives will be affected by an investment.
• From the outset, incorporate direct engagement with the people who will be most affected by an investment to learn about current conditions and concerns. For example, phone calls or site visits with a diverse set of community leaders and grassroots organisations already working within the region. The best way to guarantee social impact, is laying a foundation that includes prospective beneficiary insights from the very start.

Stage 2: Due Diligence

Due diligence addresses a wide variety of financial, operational, and legal hurdles when deciding whether an investment is worthwhile. Activities may involve visiting the prospective investee, financial audits of the company, or in-depth risk assessments. This is also a chance for the investor to outline specific changes that they want to see in the company, such as implementing an impact action plan (an outline for investees to comply with specified strategies to achieve social impact), or requesting the company align to a certification standard, such as B-Corp. Due diligence can often be a time-consuming and expensive process, however without it the impact investment assumes a diverse array of risk which includes harms caused to communities.

Consumer surveys are a common mechanism for assessing business quality during due diligence. Some impact investors may even target local communities and get insights on development impacts using questionnaires, for example Acumen’s Lean Data approach. However, in complicated deals where there are genuine risks to be avoided, utilising a deeper understanding of local knowledge provides substantial benefit. Issues such as low literacy, cross-cultural translation, and fear can mean the people you want to hear from most are often the hardest to reach, particularly when using mobile devices. Community participation can reduce the risks and help investors and communities to hold investee businesses to account, be that over their ESG standards, anti-corruption measures, impact and otherwise.

Opportunities for building participation during Due Diligence:

• Face-to-face engagement pays dividends, such as site visits with a prospective and members of wider prospective beneficiary groups. It may be insufficient to just chat to the investee, and its upstream/downstream suppliers.
• Provide opportunities for community members to shape the terms of the investment, such as facilitated workshops or small diverse focus groups.
• Consider validating data accuracy of large consumer surveys by using participatory statistics generated by local people or a participatory rural appraisal pioneered by IDS’ Robert Chambers.

Stage 3: Approval & Contracts

During the approval and contracts process, the mission of the company (or investment fund) is framed and governance arrangements are set. Depending on the type of asset class behind the investment, owning a sufficient part of a company can allow one to have a seat on the company’s board, receive dividends or revenue share, and influence the position of the company for the future through voting rights.

Naturally, financial stakeholders like investors or investee companies have significant power through the resources they provide to a business. Other stakeholders and prospective beneficiaries such as employees or producers should be viewed as core to the approval process, deserving pivotal roles in aligning the terms and conditions behind an investment. We believe including the participation of core stakeholders in the decision-making process should be a principal tenant in social impact investment terms and conditions and governance – guidelines for ethical working conditions or revenue sharing that avoids exploitative interest rates and burdensome repayment plans.

Opportunities for building Participation during Approval & Contracts:

• Roles of prospective beneficiaries and other community stakeholders are enshrined in government structures by including them on the board of directors. For example, the Buen Vivir Fund’s Members Assembly where on the ground expertise and financial contributions are deemed equally valuable contributions to decision-making processes.
• Affording ownership rights to communities, through mechanisms such as the indigenous investment principles, or a golden share arrangement – a nominal share which is able to outvote all other shareholders in certain circumstances.
• Requiring additional financial structures such as the creation of an employee stock ownership plan.
• Consider incorporating Participatory Budgeting (PB) of certain parts of the businesses’ funding. PB is the process whereby budget allocation is made by communities through democratic decision making, and can help improve accountability and transparency, increase fund efficiency of where it chooses to allocate its funding and reduce corruption.

Stage 4: Monitoring

Monitoring investments keeps track of both the financial and impact criteria, identifies further risks, and provides a broad measure of impact created. Investments can be monitored through a governing committee, impact measurement and active engagement on the ground.

Once an investment is agreed and signed, there are typically two types of investors: active and passive (based on level of engagement with the investee). Impact investors are typically more active, and can ensure that communities are engaged in the monitoring process. Impact and financial performance do not always follow the same trajectory, with one function typically taking precedence over the other during the investment period, therefore investors need to also be aware of that balance with their engagement with the firm.

Opportunities for building participation during monitoring:

• Space for ongoing dialogue with communities, more participatory monitoring & evaluation approaches based on human-centered design should be made and that contribute to monitoring data. Traditional financial reporting updates dominate most investor monitoring tools while current social impact reporting trends focus on that which can be most easily counted. Monitoring data should be shared back with communities to confirm the validity of the information.
• Provision of an assessment on firm performance by a representative from one of the consumer or local community groups. This community-driven assessment should be shared directly with the investors without the investee firm serving as a go-between.

Stage 5: Investment Exits

Investors exit for multiple reasons including:

1. To realise returns and profits.
2. To spend resource on new investments
3. They may not have the expertise to take a company to the next stage of its development, and fresh blood is required to help the company grow.

The time investors hold on to their investee companies can vary in impact investing, in fact some of the early stage impact investors are only exiting some of their first investments now. The challenge with exits is that there may not be an alignment with the social aims of the exiting investor, and the ideas of a new investor. Therefore, clean exits are harder for impact investors. Investors have ‘cut and run’ leaving communities worse off than prior to the investment as highlighted in the case of a bioengineering investment made in Liberia. Ensuring continuity, and engaging with the community for a safe and smooth transition should be a priority.

Opportunities for building participation during Exit:

• Involving communities in decision-making process around potential new investors and transition. A stronger process would allow communities to have some level of veto rights on who to sell the company to, potentially enshrined through ownership or governance rights. All of these entry points require a protective procedural structure for communities, an investor who is a proactive champion for increased participation and the rights of the community to be enshrined.