Managing vs. Measuring Impact Investment

Five years ago, when initiatives like IRIS and B Corp where just taking off, “impact measurement” was the buzzword. Investors were asking: How do we make sure to track the impact of our investments? How can we both quantify and validate our impact? 

These days, we are paying more attention to active impact management—yes, our investment had x verifiable impact today, but how do we ensure that impact is x plus 1, if not times 10, tomorrow? How do we evaluate fund managers and entrepreneurs for their impact, and who should help them decide what metrics are most important to the communities they serve? 

This is related to the concept of “additionality” in impact investment that Paul Brest and Kelly Born explored so effectively in their article “When Can Impact Investing Create Real Impact?” In addition to ensuring that impact capital is either going to specific enterprises or occupying a position in the capital stack that adds additionality to the market, how can investors ensure that it’s creating “additional” impact? 

Savvy funds are learning to better implement practices that will lead to impact additionality—and they need our help. I wanted to share the story of how Pi Investments collaborated with Huntington Capital to enhance its impact management through a recent commitment made in conjunction with the successful close of Huntington’s third fund. 

In this case we supported the fund in deepening its commitment to quality jobs in the United States, going beyond traditional job creation to considering factors such as a living wage, benefits, and ownership opportunities within historically disadvantaged communities. However, we hope this story is instructive for any number of sectors and geographies, providing some insight into how Limited Partners can work with General Partners to encourage active impact management, not just measurement, and ensure that top impact funds like Huntington Capital can continue to innovate and set best practices within the field. 

Impact 1.0: Quality Measurement

Huntington Capital was founded in 2000 with a mission to generate top-quartile returns while having a positive impact on underserved businesses and their communities. Its first two portfolios (Funds I and II) showed successful execution toward this thesis, providing healthy returns while generating significant employment for underserved individuals, including women and people of color living in low- to moderate-income zip codes. Huntington has been consistently listed in the Impact Base 50 and has been recognized for its very effective impact measurement processes. Its 2013 impact report shared the following data:

• $87 million invested across Funds I and II
• 75 percent of portfolio meets SBA guidelines for traditionally underserved companies
• 50 percent of portfolio companies located in low- to moderate- income regions
• 2,262 employees supported by these companies—a mix of new jobs and maintained jobs in otherwise-disappearing sectors such as manufacturing
• 63 percent of employees are people of color
• 43 percent of employees are women

Impact 2.0: Quality Management

We at Pi Investments invest in the United States and globally, with a focus on community empowerment and environmental sufficiency. We take a 100-percent approach, meaning that all of our resources across asset classes are slowly but surely moving into impact. We recognized that few funds in the United States focused on economic opportunity for historically disadvantaged communities, and thus were intrigued to learn about Huntington. Beyond the potentially unique mission focus, we didn’t mind its impressive track record. We also appreciated its model of providing mezzanine debt with upside potential, as a more reliable way of entering the underserved market of mid-sized companies. 

At the same time, we were (and remain) hesitant to invest in funds whose sole impact thesis is job creation. Clearly undeserved communities with high unemployment rates need access to jobs. But “job creation” is a slippery concept: Outside of true innovation and demand generation, we can’t do much more than move jobs from one zip code to another. And even when jobs are created in a low-income community, if they are low paying, then by definition they are precisely what keep those communities locked into cycles of poverty. 

How does that work? In general, we don't just have a national unemployment problem; we have an employment problem, where more than two-thirds of children in poverty live in households where one or both parents work. The vast majority of these households are led by people of color, notably African Americans and Latinos who are twice as likely to be working poor.

This is simply because the minimum wage does not provide a living wage for most American families. To earn a living wage, a typical family of four collectively needs to work more than three full-time, minimum-wage jobs (a 68-hour work week per working adult, if there are two adults). Certainly many of us are used to long hours, but I doubt we would be willing or happy to do so—let alone be able to support our families—for $7.25 an hour!

Rather than counting jobs, we were interested in the migration of low-quality jobs to high-quality jobs. From this perspective, we approached Huntington to say that while we were very impressed with its impact measurement in carefully tracking job creation, we wanted to work with them to better address impact outcomes—ensuring that these jobs lead to a better quality of life. This would entail working closely with portfolio companies on not only economic value creation, but also “impact value creation.” 

A focus on impact outcomes was not a challenge unique to Huntington. Fund managers like Huntington work tirelessly to achieve above-market-rate returns for their investors while satisfying a whole host of impact data requirements such as CRA criteria and IRIS indicators. But this approach as it relates to impact measurement is by nature highly focused on outputs rather than outcomes and additionality. This means that while we investors might accurately report quantitative data, we are in danger of losing the focus on impact—in the case of Pi and Huntington, creating high-quality employment and ownership opportunities to reduce poverty in low-to-moderate income communities.

Creating an Impact Management System

Huntington’s founders were aware of the need to drive more intentionality in support of their impact mission—they too believed in the strength of their metrics, but strategically they were interested in continuing to raise the bar. Huntington embraced the idea of an impact management framework, and was open to collaborating with us on designing one. As generalist investors with inch-deep expertise in a variety of sectors, we recognized that we had to educate ourselves on job quality if we were going to help Huntington. Our first task was to make sure we were hearing the voices of low-income workers and prioritizing their needs.

We turned to Transform Finance, a nonprofit I co-founded that builds bridges between finance and social justice; hosts an investor network, which launched at the White House last year with a $556 million member commitment; and supports investors like Pi that are working to amplify their impact. 

Alongside supportive colleagues at the Ford Foundation, Transform Finance helped us interview leading worker’s rights organizations and advocates—including Jobs with Justice, the UC Berkeley Labor Center, and Partnership for Working Families—and identify top priorities for low-wage workers. 

While some priorities—such as health care and a living wage—were predictable, others surprised us. For example, low-wage workers surveyed nationally tended to value paid sick days even more than increases in compensation, in particular the ability to take time to support sick family members. As working professionals it’s hard to fathom the idea that we could not leave to pick up a sick child from school, but for most low-income workers in the United States, that is the reality. We also learned that worker-ownership, typically limited to tech companies, is a hugely motivating force and driver of productivity within companies across sectors. The process was a good reminder that we investors (who are used to being the “experts”) need to reach outside of our usual networks and ensure that the beneficiary perspective leads our priority-setting.

Once we had a starting list of priorities (heath care, paid sick days, a living wage, training and opportunities for advancement, and employee ownership or profit-sharing), we asked Transform Finance to examine the economic impact of implementing such policies at companies. Given Huntington’s commitment to delivering top-quartile performance—and the fact that a poorly performing company can’t create or maintain any jobs, high- or low-quality—we knew this was of the utmost importance.

The good news is that the evidence overwhelmingly shows that treating workers well only enhances company performance (and by extension, fund performance). Here’s some of what we learned (see the complete factsheet here). 

• Paid sick day provision increases morale and productivity. A 2014 study on Connecticut’s paid sick days law—the first state-wide policy in the nation—found that after the law was implemented in 2012, one-third of businesses reported improved worker morale, while 15 percent saw increased productivity and a reduction in the spread of illness. Moreover, only 1 in 10 businesses reported a 3 percent or more increase in payroll cost, which gains in productivity and morale likely offset.
• Paid sick days prevent “presenteeism” (when sick workers report to work, but are unwell and unproductive). The business cost actually exceeds that of absenteeism—$160 billion higher than that of absenteeism, according to one study.
• Paying a living wage reduces turnover, which is widely recognized as costing as much as 1.5 to 2.5 times an employee’s annual salary.
• Paying a living wage reduces employee theft. Employees are less likely to steal and less likely to collude with others to steal if paid higher wages.
• Worker ownership decreases turnover, and increases productivity and overall commitment to the well-being of the enterprise—which anyone who has ever held stock options knows intuitively. According to research from Rutgers University, implementing employee ownership leads to a 4 percent permanent increase in productivity and 2 percent increase in shareholder value.

Convinced that we could offer approaches that would enhance both the fund’s social impact and financial return, Pi Investments, with support from Transform Finance, worked with Huntington to help create a “floor and ladder” approach to impact management. This approach would require that all companies in the fund meet basic, minimum requirements in five areas (living wage, health care, paid leave, opportunities for advance, and employee ownership) or show an action plan for achieving this minimum “floor” within a year of the investment. They would then set annual goals to climb the “ladder,” with support as needed from the Huntington management team and consultants. 

Just as any fund checks in with management at least quarterly to assess financial performance and provide value-add, such a framework makes it clear to the company how it can improve its impact performance and guides the fund in its work with the underlying portfolio. It also assures LPs that, rather than just measuring outputs post-haste, the fund is actually actively creating “impact delta” alongside financial delta. 

Impact Implementation

Huntington felt the framework would enable them to put their values more concretely into action. It understood that having an “alignment advantage” with companies would help attract founders who truly believed in treating their workers fairly, and thus would create higher-quality companies. Impact-oriented LPs had already been supporting their work over time, and this framework would just take things to the next level. 

These were of course “forward-looking” statements, and we still had to make our investment decision. We knew that we would ultimately be a small LP compared to others (pension funds, banks, and leading foundations) in the fund, and that the management team would rightly not commit to implementing changes that didn’t serve Huntington’s mission of providing top-quartile returns alongside strong impact. Our trust in the team’s competency and professionalism was a major factor.

But what ultimately convinced us that Huntington was truly committed to excellence in both financial return and social impact was the very legitimate concerns the management team raised about implementation of the framework, and the innovative ideas they brought forward to try and ensure effective implementation. The team proved equally concerned about execution, and wanted to make a commitment that was real in accordance with their values. 

Their primary concerns and mitigation ideas were:

1. As a primarily mezzanine-debt provider, Huntington, by nature, is a minority investor with limited control and/or influence over its portfolio companies. Huntington didn’t want a company to take its money and accept job-quality provisions it didn’t really plan to implement. While impact measurement is written into loan agreements, unless a fund manager wants to actually trigger a default provision based on inability to produce impact outcomes (an unlikely scenario), such provisions are extremely difficult to enforce. 

Huntington also works with mid-market companies across sectors that are not classically defined “social enterprises,” and hence impact is not necessarily written into their DNA. This means that Huntington’s potential to add impact is an even more exciting and challenging endeavor than other funds may face in the context of impact management.

Huntington’s proposed solution was to align incentives for the management to implement impact practices,focusing on the carrot more than covenant-related requirements. Given that its debt is structured with “a kicker function for upside” (meaning with the opportunity to make more money if the company is successful), one way that Huntington could reasonably incentivize the company to implement changes would be through additional financial incentives. What ultimate structure Huntington’s “carrot” will take is to be determined, but it is this sort of innovative thinking about impact management that will lead the sector to strong outcomes, not just outputs. 

2. Huntington also wanted to ensure that it developed sufficient expertise about implementing job-quality practices so that it could be a credible advisor to its portfolio companies. It committed to and is in the process of hiring an impact associate, who will lead ongoing work on impact management strategy and support portfolio companies on an ongoing basis (feel free to contact me if you can recommend a candidate).

This showed that Huntington was committed to enhancing its impact management practices with or without us—and perhaps even more extensively than we could’ve imagined. We were clearly aligned. 

We are now proud LPs of a fund that we believe has the potential to lead the way in impact management practices, and most importantly, ensure that thousands of working people—notably women and people of color—in the United States can move from a place of poverty to stability. We hope that Huntington’s journey, thoughtfulness about impact, and willingness to lean on its LPs for support will be a model for funds in the sector. 

Lessons for the Field

This last year was an intense learning experience for both us and for Huntington Capital. It has informed our work moving forward in a few ways:

• We are now acutely aware of the difference between outputs and outcomes, and try to assess the impact additionality of our potential investees. We therefore spend much more time on the impact management systems of funds and entrepreneurs, rather than focusing just on measurement systems. So far the response has been quite positive, as everyone is in business because they too want to drive positive change, not just measure impact in the rearview mirror.
•  We recognize that fund managers are tasked with an incredible amount of work for small management fees. If we want to ask managers to innovate on impact, we need to put in time ourselves, or provide them with resources for either other aligned service providers or new in-house support.
• We see that, particularly in the field of job creation, there is a lot of work to do to foster job quality, not just quantity. We are pleased to share that Transform Finance is leading an industry-wide effort to create and implement job quality standards and invite people to reach out to Executive Director Andrea Armeni for more information.
• We also recognize that this approach applies beyond the context of job creation and affects all sectors within impact—how can we invest in real estate without fueling gentrification? How do we support sustainable agriculture without engaging in land grabs? In general, we need to stay more regularly informed of the needs of the people we purport to serve and develop new standards in line with their interests. We try to make sure that our usual diligence circles include people most affected by these issues, and encourage funds and entrepreneurs to keep in touch with advocacy groups and community organizations that might not traditionally partner with the investment field.

Impact investment is still evolving. No one knows how to maximize impact and end poverty, or we would’ve done it already. We need to empower collaborative, innovative fund managers like Huntington to push the horizons of impact, and challenge ourselves to ensure that our capital is contributing both impact and financial additionality.

Read more stories by Morgan Simon.