Impact Investing in East Africa: It should not only be about scale

If impact investing is about creating jobs, increasing incomes, transforming lives and building stronger economies, then scalability is important, but it should not be the only thing that counts.

It is my job to speak with social entrepreneurs in East Africa. These days I encounter many who say they are faced with ever increasing talk about scale as the one and only marker of success. Some entrepreneurs feel that they get push back from investors when they pitch what they feel are realistic growth scenarios for their fledgling businesses, especially those in traditional sectors like agriculture or if they are building a business not centered on a shiny tech solution. I find this disturbing. It is as if the void left by our collective failure as an industry to boil down impact into a simple number, is being filled by the demand for scalability. Scalability then, not just as one important success factor or sign of potential and ambition but the singular inclusion criteria. Scalability as the bottom-line.

What might be at play, is that impact investing for the greater good in East Africa has partially been sold on a fallacy that it is easy to earn a buck while changing the world for the better. The truth is quite different as few social enterprises offer that combination of high financial returns and transformational, life-changing impact. Now investors are increasingly emphasizing a business’ ability to scale in an environment where high margin businesses – especially that of the brick-and-mortar type – are few and far between.

This focus on scalability compounds enterprises’ existing and well documented challenge to raise early stage capital from impact investors who shy away from making investments in the range of $50,000 to $250,000 (see for instance here and here). Investors blame their reluctance on the relative high cost of making smaller investments. The GIIN and Open Capital Advisors estimated that there were just 13 non-DFI impact investors making investments smaller than $250,000 in East Africa in 2015 (and just another 12 indicating their investment range to be between $250,000 and $500,000). The combined population of four target markets for investors in East Africa (Kenya, Tanzania, Uganda and Rwanda), is estimated to be 225M by 2030. That’s not a lot of investors for a large and growing market.

Based on what I see and hear, I suspect that the current constellation of active impact investors continues to underserve many early stage social enterprises with a feasible path toward economic viability and meaningful impact. If too few of these promising businesses are sufficiently capitalized, opportunities for massive aggregated impact are missed and we are not building strong sectors and economies supported by more, not fewer companies. Naturally, the pipeline for later stage investors also remains sparsely filled. Investors are not perfect and erring on the side of making fewer early stage investments also means fewer positive mistakes; i.e. funding those companies with seemingly limited ability to scale who end up outperforming expectations.

The focus on scale also risks dumbing down our concept of meaningful impact to being any big number. This ignores the diversity of impact we all see in the market. Some impact is transformational and some is incremental or marginal. Some social enterprises have the potential to double the cash income of smallholder farmers, while another may never do more than improving one aspect of a person’s life, think reducing their fuel cost or enabling them to read at night. Just to be clear, reducing fuel costs and creating access to lighting is nothing to sneeze at, but the point is that this should not be a zero-sum game. Transforming a life should not be valued the same as incrementally improving one. And it might be worse, what if the pursuit of big numbers leads to the prioritization of suboptimal but scalable solutions over better, more appropriate, more dignified solutions?

I do not think that the sector is simply going down the wrong track, but merely going down too few tracks. There is a void that requires filling. Finding, making, managing investments costs money, taking risk costs money, the longer time-lines associated with building businesses in East Africa cost money. An investor seeking to earn back all these costs will be forced to pursue larger, later stage investments and scalable solutions. It is undeniable that in East Africa there is today a trade-off between financial returns on the one hand and social and environmental returns on the other. Acknowledging this and setting investment strategies while incorporating this knowledge is necessary if impact first investing is going to stand a chance.

This is where private-sector oriented philanthropic funders can do more. There surely are multiple pathways for them to help, but one way is deploying philanthropic capital to subsidize the investment management costs and therefore allowing for lower ROI expectations.

There is a need for professional, sophisticated, locally-versed impact-minded fund managers to be given access to investment capital that they can place with highly impactful businesses, large and small, risky and less risky, scalable and less so, but without an expectation to also realize double digit financials returns within 5 to 10 years or even cover all their management costs out of the returns. The opportunity this will create for the sector at large will be significant. Philanthropic funders can catalyse the sector and East African economies by absorbing some of the risks and costs associated with early-stage investing in the region, including the risk that some of the benefits of successful early stage investments will accrue to later-stage investors. Business-minded philanthropists stepping into the void should do so without compromising the expectations they place on the entrepreneurs and the fund-managers, they should still demand a relentless drive, a dogged discipline, and unyielding commitment to the business. More philanthropic capital to subsidize professional management, risk and costs associated with doing business in East Africa should lead to more impactful, viable companies and a better investment pipeline for the sector. Ultimately creating more jobs, more income opportunities and transforming more lives than the sector can do today by focusing on scale and unicorns alone. In the process, through the creation of smaller and larger businesses alike, we create a more robust eco-system of companies and stronger economies.

What do you think?