By Bridgit Evans, Executive Director, SAB Foundation
As social change agents, our goal is to have the maximum positive impact we can on the issues we are tackling. This is what motivates and inspires us. However, amongst the victory we feel when we know that we’ve made a difference in people’s lives, many of us are kept awake at night by the sheer scale of the growing social, environmental and economic inequalities in the world, wondering how we can achieve significantly more scale with finite resources. Part of the answer to this question lies in using some of our available financial resources differently.
The Importance of Diversifying Capital for Systemic Change
Given the scale and urgency of the challenges we face, relying solely on grant funding may not be sufficient to achieve the lasting, transformative change needed. The problems in areas such as poverty, inequality, climate change, health, unemployment and education are vast, requiring multi-sector collaboration and more innovative and diverse financial approaches to complement grant funding. By deepening our understanding and competence in working with a variety of capital sources, philanthropy can play a central role in addressing systemic issues and achieving greater and sustained impact.
Impact investing is a general term used to describe funding for businesses, social enterprises, or non-profits, which generates both measurable social or environmental impact and financial returns. Impact investing can be seen on a continuum from zero financial returns (grants) to financial returns similar to that in the commercial world. The main reason why philanthropy should consider impact investing is because it has the ability to unlock significantly more funding into addressing our major socio-economic and environmental challenges. At a minimum, having the funding returned, instead of granted allows it to be recycled for further impact.
There is also a growing trend amongst philanthropic organisations globally to strategically allocate a portion of their endowment assets toward investments that generate both social impact and financial returns. This approach enables funders s to align their investment portfolios with their mission.
Instead of maintaining a singular focus on grant funding – which still has a critical role to play – there are multiple ways that philanthropy can use money differently to unlock more impact.
Early-stage social innovation funding: driving innovation and scaling solutions
Programme related grant funding still has a critical role to play. However, South Africa has a vibrant culture of social innovation where people are coming up with (often tech enabled) innovative and scalable ways of addressing social and environmental issues in a more sustainable way. Funding high-risk projects that have not yet proven their effectiveness, but which hold the promise for transforming sectors completely and have the potential for high social returns enables experimentation, innovation, and the development of much-needed novel solutions.
Here, philanthropy can play a key role through financial backing and strategic support through mentorship and access to networks. Such partnerships can ensure that promising innovations have the support they need to grow into sustainable, scalable models that can have a lasting impact.
Blended finance: mobilizing private capital for public good
Blended finance involves the use of concessional funds – often from philanthropy or development finance institutions – to de-risk investments and attract private capital to projects that address social, economic and environmental challenges. Leveraging philanthropic resources can incentivize investment in areas that may otherwise be considered too risky for private investors. Understandably, private investors need to ensure protection of their investors’ money. Small, Medium and Micro Enterprises (SMMEs) are considered high-risk and often struggle to attract investment, and if they do, they stagger under high interest rates.
Effective de-risking can be achieved by adept blended funding from philanthropy and private capital, structured in such a way that the interests of all stakeholders are aligned. This enables agreements where philanthropy undertakes to absorb the first losses, should entrepreneurs default. This would encourage more commercial investors to commit funding, and it may also lower the interest rate for the entrepreneur, which makes it less likely that they will default. If more SMME’s could borrow at affordable rates, they are likely to grow and create jobs. These partnerships can unlock significant capital and enable high-impact projects to scale.
Outcomes-based finance: linking funding to results
In outcomes-based finance (results-based financing – RBF), funding is linked directly to the achievement of specific, measurable social outcomes. This approach focuses on rewarding results rather than outputs, ensuring that resources are allocated to initiatives that demonstrate tangible, quantifiable, measurable impacts. This model helps ensure that funds are used efficiently and that outcomes are continuously monitored and measured.
Through outcomes-based finance philanthropy can ensure that their investments are truly making a difference. This requires working closely with partners to set clear, measurable indicators, and ensures that funding is used efficiently for the achievement of predetermined results. Focusing on performance and outcomes, this model holds the potential for catalysing better results over time.
Capital Guarantees: mitigating risk and unlocking capital
Capital guarantees are a financial tool that guarantees partial or full repayment of capital if an investment does not meet its expected outcomes. It unlocks private capital by reducing (perceived) risk for investors and providing security to investors who are risk averse.
By offering capital guarantees, philanthropy can mobilise more funding into projects with significant social impact. By taking on some of the risk, philanthropy can attract private investors who might be reluctant to participate without some level of protection. Capital guarantees can be particularly useful in sectors where projects may involve high upfront costs or risks that are difficult for private investors to bear. By reducing this risk, philanthropy can encourage greater participation from private capital, helping to scale solutions more quickly.
Government partnerships: shaping policy and scaling initiatives
Governments are often the largest funders of development initiatives and have significant resources at their disposal to address social and environmental issues. Through collaboration, philanthropy and government can scale initiatives aligned with public policy priorities, leveraging both public and private capital to maximize impact.
One of the most powerful forms of collaboration between philanthropy and government is co-investment—pooling both public and private funds to support larger-scale collaboratives allowing for more robust, sustainable programmes benefitting from both stakeholders’ strengths. By engaging with governments to influence policy, philanthropy can also help to create an environment that supports and accelerates innovative solutions and allows for more innovative financing.
Building the Muscle: What Funders Must Know to Work with Diverse Capital Resources
As philanthropy looks to deepen its impact, funders must expand their capacity to engage with different types of capital. To do this effectively, they must focus on several key areas:
Risk management and evaluation
Funders must develop the ability to evaluate risk in financial terms and in terms of social outcomes. This involves understanding how different types of capital can complement one another and ensuring that the right mix of funding is used for each initiative. Managing risk while ensuring that social impact is achieved requires robust evaluation methods and flexibility. Philanthropy must educate themselves about this new and evolving field and develop new skills sets to ensure that they can protect their own interests when engaging with commercial investors who speak an entirely different ‘language’. The recently published Impact Investing Guide for Foundations is tailored to build this knowledge and is a valuable resource for those thinking about alternative financing.
Understanding of business
Philanthropy mostly understands impact well but has less understanding of business and entrepreneurship. To understand whether a grant or another financing mechanism would be a better option, funders must be able to determine whether the entity in question has the ability to generate its own revenue, and to what extent. In addition, technical and business support, assistance with access to markets and networks will often be needed to ensure that the investment reaches its potential.
Long-term thinking and flexibility
Systemic change takes time, and philanthropy must be prepared to make multi-year or even multi-decade investments. This requires long-term thinking and the ability to adapt funding strategies as initiatives evolve. Funders flexibility and willingness to adjust their approaches based on the challenges and opportunities that arise over time is key.
Strategic partnerships
Before engaging other investors, whether government or private, a philanthropic organisation needs to develop its own strategy about what it wants to achieve, what sectors it is willing to operate in, and what funding it is willing to commit as well as the nature of that funding. It needs to place itself in a strong negotiating position and be very clear about the social/environmental outcomes it wishes to achieve. It also needs to be aware of the often-extensive reporting requirements when working alongside Government and ensure that it has the ability to meet those requirements.
An extraordinary opportunity
Philanthropy has an extraordinary opportunity to go beyond traditional grant-making and embrace a wider range of financial tools to address our most pressing challenges. Strategically leveraging programme funding and capital can unlock the resources necessary to drive large-scale, systemic change. To do so, funders must be clear on what they want to achieve, and build their expertise in risk management, financial products and negotiation. With these capabilities, philanthropy can play a transformative role in shaping a more equitable, sustainable, and resilient world.