Impact investing lingo to know
We all know that moment, the dreaded moment you walk into an event and the discussion sounds completely foreign. Much like any other field, as impact investing has grown, so has the language we use to communicate. There’s plenty of jargon for both impact and investing. At Mission Driven Finance, we believe that impact investing should continually strive to be more inclusive, even in language, so we’re creating a series of “Impact investing lingo to know.” Here are some key terms.
Coined by Jed Emerson as a framework for assessing business models and investments beyond financial returns. Impact investors seek a blend of social, environmental, and financial returns from investment capital. Business models that generate blended value integrate revenue outcomes alongside social value in order to maximize total value creation from capital.
Lots of projects have multiple types of funding, and the composition of those sources makes up the capital stack. Understanding this breakdown is helpful for investors to determine the different levels of risk incorporated within the project and expectations for returns based on the level of risk expected by each funding partner.
Environment, social, and governance (ESG):
Environmental, social, and governance (ESG) factors are sets of standards used by social investors as part of their investment analysis to screen and evaluate whether investments promote sustainable, fair and effective practices and mitigate potential risks. Measurement is not standardized, but, generally: environmental criteria might assess a company’s commitment to stewardship; social criteria may examine relationships within and outside the organization; and governance tends to look into internal controls and organizational leadership.
Used to mitigate risk, a guarantee pledges the transfer of responsibility of debt from one party to another if the party liable defaults. Guarantees can be used in impact investment deals as a credit enhancement to assure investors and unlock additional capital. The GIIN has an excellent report on why impact-focused investors would want to provide guarantees: Catalytic First-Loss Capital
Pay for success (PFS):
Although also known as Social Impact Bonds, PFS projects are not actually “bonds” but rather an innovative financing approach with three key players: private funders, governments, and social service providers. Upfront capital from private funders allows social service providers working as contractors for PFS programs or projects to operate. Then, funders receive repayment from government agency if the service achieves predefined goals on measurable outcomes. Ideally, by tying funding to outcomes and privatizing risk, PFS supports both innovation service delivery and rewards high-quality and effective programs. Here’s how social impact bonds work–in GIF form.
Return on investment (ROI):
Return on investment assesses the efficiency and efficacy of an investment. ROI is generally calculated as net gains/profits (gains minus cost) divided by the costs. Because impact investing seeks financial as well as social or environmental benefit, return on investment is twofold and investors calculate both Financial ROI as well as Social ROI, which helps capture the social or environmental value generated from the investment. Together, these create a holistic picture of complete investment impact.
Debt coverage ratio:
Used as a benchmark for financial analysis, the debt coverage ratio calculates cash available for debt servicing to interest, principal and lease payments in order to understand an entity’s current ability to pay its current debt obligations and help investors assess the likelihood of payback on any future debt. Ratio uses the change in unrestricted net assets plus interest, added to non-cash depreciation, all divided by current notes payable.
At the next event, we hope you can start up a meaningful conversation with confidence (and won’t need to continually hide in the bathroom researching words on your phone.)