THE BLOG
11/30/2015 02:57 pm ET Updated Nov 30, 2016

The Impact Investing Illusion

Bloomberg via Getty Images

For many who have been working in the social enterprise space for a long time, nothing has been quite so startling as the recent lightning fast acceleration of the so-called "impact" investing movement. In the U.S., much of the traction for the movement has been supplied by the rise of new "hybrid" legal forms such as the Benefit Corporation and the L3C, and the spread of the B Corp brand.

Some view these developments as the long-awaited key to scaling solutions to the world's most intractable problems. I'm not so sure about that. In fact, heeding Einstein's warning that "no problem can be solved from the same level of consciousness that created it," I'm worried as hell.

Let me tell you why.

The Antidote To Business

Business is arguably the most powerful institution on earth. At the heart of the impact investment movement is the idea of harnessing its power for the greater good. Indeed, ongoing economic growth has broadly raised quality of life across the globe.

But it hasn't done so fairly. Massive inequality in wealth is the fundamental justice issue of our time. Nor has it done so sustainably. By dumping the real costs of resources, labor, and emissions onto people, communities and the planet, business has enriched shareholders with ill-gained profits, and, in fact, created many of the biggest global problems that we now seek to correct.

It's no surprise that business acts this way. American business leaders, for example, have a legal, fiduciary duty to maximize financial returns for shareholders ahead of all other considerations. These leaders aren't bad people. They're simply doing what the system demands.

The nonprofit and charitable sector came into being as a counterbalance to business. Society realized there was work to be done that business (and, for that matter, government) couldn't do, and created a special regulated class of organization -- the 501c3 -- to get it done.

Originally, these charities were supported by the pure generosity of individuals and their philanthropic foundations. This virtuous circle drove much good work, but it couldn't keep up with the problems. Nonprofits asked, "How can we do more?" and the social enterprise movement was born.

Social enterprises are businesses whose primary purpose is the common good. Charities that started them were suddenly able to use the power of markets to drive their missions forward through earned income streams, and even more importantly, through the enterprises themselves. (For example, through enterprises that employed people facing great barriers.)

Philanthropic generosity could now be leveraged by the marketplace for greater impact. Seemingly, all that was (and still is) holding the social enterprise sector back was the capital to scale and grow them more rapidly.

Mass Confusion

Meanwhile, back in the business world, it became more and more apparent that the relentless drive to enrich shareholders by externalizing real costs was creating more and more harm, degradation and inequality. A few socially responsible business entrepreneurs responded with a sincere desire to build a new kind of company and brand, while some enlightened leaders of large corporations saw that their businesses would be healthier in the long run if they acted more responsibly. The dawn of Corporate Social Responsibility (CSR) was at hand.

CSR was, and still is, challenging. Public companies often treat it superficially, as a matter of compliance, not mission. Many socially responsible private companies have failed in the absence of a sustainable business proposition, while many of the more successful brands have been sold to conglomerates that can eventually emasculate their social values. And many very ordinary companies have exaggerated their CSR virtues to gain marketing luster.

Charlatans are hard to differentiate from the real thing. Out of the need for a method to certify and measure social and environmental responsibility arose a nonprofit called B Labs, which created an idea called the "B Corp".

B Corp is a trademark/service mark owned by B Lab and licensed to companies who undertake a rigorous assessment process that measures things like governance, environmental impact, employee practices and more. A company that earns the mark can rightfully claim to be a very good company that is, more or less, doing no harm.

If the company is making, let's say, widgets, it's making them very responsibly. But unless widgets are truly socially virtuous in their own right, the B Corp mark does not prove that the company is making any social impact at all. It simply says that it's making widgets more responsibly than the next widget company.

As the mark grows in prominence, it bestows a well-deserved competitive advantage versus other widget makers in terms of market image, consumer acceptance, employee attraction and more. The mark can only be earned by a for-profit company. Thus, it also bestows a competitive advantage versus a nonprofit social enterprise widget maker.

Now here's the catch: To grow, a company must attract capital, and is required to put capital holders first. But doing the right thing carries a real cost. The practices that make a B Corp a B Corp can actually be construed (shortsightedly) as detrimental to shareholder interests. To escape this dilemma, the B Corp needs corporate laws that do not require it to put capital first.

This brings us to the "benefit corporation" or "for-benefit corporation", a new kind of corporation that now exists in 31 states, due in no small part to highly effective legislative efforts by B Labs. While different in each state, the general idea is that a benefit corporation is allowed to consider the impact of its decisions not only on shareholders, but also on workers, community, and the environment, and in some cases is required to report to the public on how it is doing. (A stronger, but less popular version of the same idea is the L3C, available currently in eight states.)

A benefit corporation sounds a lot like a B Corp. But it's not! It is simply a company that may put social interests ahead of shareholders. It has legal permission to do so, but it's not required to, and generally doesn't have to prove that it is in fact doing so in any significant way.

Would you rather buy your widgets from a company that is permitted to do the right thing (a benefit corporation)? Of course you would. Would you rather buy them from a company that has proven, with some rigor, that it's making them responsibly (a B Corp)? Better yet. Both of them are better than a widget company that will stop at nothing to deliver higher returns for shareholders.

But neither of them is a social enterprise whose primary overriding purpose is the common good. Making widgets responsibly is not a social purpose. It's the way all widgets should be made. Extreme social responsibility is not social enterprise.

Lusty Capital

What does all of this have to do with impact investing?

Capital is driven by a biological imperative to create a return. It's a horny beast that seeks to constantly reproduce itself.

Back in the day, businesses created returns for their capital holders by actually producing value, and capital actually had to take risks to gain that return. That's no longer true, in the aggregate; the biggest gains are nowadays being made through arbitrage rather than by satisfying real needs.

What caused the Great Recession? There were no longer enough real deals producing enough real value to satisfy capital's lust. So it invented new deals via a dazzling array of financial derivatives that had no underlying value. When the whole thing came crashing down, all of that fake value should have been destroyed. Massive losses should have been taken. That didn't happen, because Wall Street gamed the system. Capital was preserved. All the hot air stayed in the system.

So all of this horny capital, still ravenous with reproductive desire, looks around and sees this sexy, new class of deals called impact investing. It sees a huge potential market at the bottom of the pyramid and a huge opportunity for glossing up its image. And now, it has the structures for making the impact deals through the new and highly overrated benefit corporations and B Corps.

It's no wonder that capital is rushing to the so-called impact market. In fact, how can it not?

In fairness, there are many very well-intentioned, relatively modest individual impact investors who truly seek impact and are willing to earn a lower-than-market return to get it. God bless them. What worries me is the massive deployment of institutional capital from the global banks that is dwarfing the individual investors and family offices, and beginning to gobble up the impact investment advisories that serve them.

Do you sincerely believe that at the end of the day, Goldman Sachs cares more about social impact than about financial returns? If not, what happens to impact when push comes to shove, particularly in a flimsy model like a benefit corporation or B Corp that doesn't necessarily drive real impact in the first place?

Why I'm Worried. What We Can Do

Yes, I'm worried. Very worried. I'm worried that the idea of social enterprise is now more associated with benefit corporations and B Corps than with the selfless, unsexy nonprofit social enterprise model in which impact is part of the DNA.

I'm worried that the work of true social enterprises, that put real impact first, will be overshadowed and ignored.

I'm worried that the illusion of impact investing will shift dollars away from philanthropy. A philanthropic dollar in a nonprofit social enterprise produces an internal financial return that can be recycled again and again to multiply impact. An impact investment dollar demands an eventual exit for itself and its aggregated returns, regardless of whether any true impact was created in the first place. A better deal for the investor, perhaps, but not for impact.

Most importantly, I am worried that the powerful influence of institutional capital will drive the entire social enterprise field towards the lowest common denominator, not the highest.

The impact investment movement has taken on a life of its own. It's highly doubtful that we can roll it back, and I don't necessarily propose that we do. There are some steps we can take, however, to ensure it better serves the common good:

  • Allow nonprofits to obtain B Corp certification;
  • Demand rigorously reported social impact metrics as a condition of benefit corporation status;
  • Create an impact "gate" as a condition of B Corp certification regardless of mere social responsibility scores;
  • Build systems for true cost accounting by all public companies and benefit corporations; and
  • Support corporate charter changes to stop treating corporations as persons and end the primacy of shareholder interests.

Finally, the leaders of benefit corporations, B Corps and nonprofit social enterprises alike must rigorously screen their sources of capital. Every impact investment dollar, and every philanthropic dollar, for that matter, is not the same. There is no evidence to suggest that Wall Street is capable of any behavior other than to maximize returns regardless of social, environmental or human costs.

Avoid the rich allure of institutional impact capital; accept it at the risk of your mission itself.