The original goal of impact investing was to build out the spectrum between philanthropy and commercial investment. But then the arrival of commercial private equity firms — promising scale and market-rate financial returns, and raising large amounts under the banner of impact investing — pulled all the energy from the sector toward the commercial end of the spectrum, like metal filings to a magnet.
But the emergence of these large investors raised an important question: If these impact investing funds are offering fully commercial rates of return, are they really doing anything the market wouldn’t do without them?
Their growing influence has also highlighted an ongoing challenge for the sector: Rather than having a fully developed and varied spectrum of impact opportunities arrayed between philanthropy and commercial investments, as impact investing had set out to build, we still have a totally bifurcated market. Wealth is given away on one end of the spectrum and invested in profit-maximizing assets on the other.
Yet the sector’s real power lies in its ability to finance solutions to the world’s most challenging problems by combining these types of capital, applying scarce grant money to catalyze larger amounts of commercial capital — an approach now known as blended finance. Philanthropy has the opportunity, the privilege even, of acting as a catalyzer to crowd in larger investors to fund large-scale solutions like off-grid solar, financial inclusion or nature-based strategies for addressing climate change.
In that way, philanthropy and impact investing can complement each other. Both are targeting social enterprises, many of which are young small- and medium-sized enterprises that need various levels of support as they work to grow their businesses in some of the world’s most difficult environments. By working together to create funding solutions for these enterprises, philanthropists and impact investors can support their growth while creating a bridge between charitable giving and commercial investing.
However, there’s an increasingly common notion across the industry that impact investments should be commercially attractive. From our experience as impact investors at SIMA Funds, this belief is holding the sector back. Below, I’ll explore how philanthropic subsidy has played a key role in the development of emerging markets business, clarify some common misconceptions about its role in impact investing, and propose some ways philanthropists and impact investors can work more effectively to put impact-focused industries on the path toward commercial investment.
Two Different Approaches to Subsidizing Industries: Microfinance vs. Off-Grid Solar
The microfinance industry, the first sector to receive a substantial boost from impact investing, grew up on philanthropic subsidy. Financial inclusion has been made feasible globally because of the role philanthropy has played in proving the microfinance business model. Pioneering microfinance firms such as Grameen Bank in Bangladesh received subsidies and initial funding from development finance institutions and foundations, which allowed them to gradually scale their businesses. As of November 2024, Grameen Bank has disbursed over US $39 billion in loans, reaching 94% of villages in Bangladesh and serving 10.66 million borrower members, 97% of whom are female. The bank has achieved a recovery rate of over 96%, which is significantly higher than traditional banking systems.
Other microfinance institutions have gained traction with similar models — including many with a for-profit orientation. For instance, Procredit has built a commercial microfinance business on subsidy that has extensively captured the Eastern European banking market.
Powered by these success stories, within a span of 30 years, microfinance has grown into a US $187.3 billion industry (as of 2022) that is expected to reach a size of $488.9 billion by 2030. In India alone, it is a $46 billion sector, generating multiple IPOs and operating in all 36 of the country’s states and territories. This would not have happened without philanthropic subsidy.
Yet despite this history, there is a persistent belief that impact investing can be commercial and should aim to boost the development of industries without subsidy or philanthropic support. An example is off-grid solar: This sector holds great commercial promise, with some of its largest companies reaching $100 million in revenue. But it has also faced many challenges, partly due to COVID-19, partly due to the business models deployed — and partly due to a lack of subsidized impact investment or philanthropic support to help these businesses overcome structural and market barriers. The importance of this support is widely recognized within the off-grid solar industry, where subsidies and concessional funding can play a critical role in de-risking businesses, enabling them to scale and serve low-income customers who may not yet be able to afford commercial pricing models.
I attended a recent meeting where industry representatives from the various segments of the off-grid solar sector discussed these challenges — and more importantly, explored some solutions. One of their recommendations was that the sector needs more subsidies — especially results-based financing structured to reduce the cost of the product to the consumer and help boost the profitability of the company. This type of subsidy is just one example of how philanthropy can play a role in supporting the growth of emerging business sectors seeking to solve the world’s foremost challenges, in partnership with other constituents like development banks and impact investors. These businesses cannot reach scale if they must depend exclusively on commercial investment: That’s why, even in developed markets like the U.S., the renewable energy market is very subsidized. It is hard to understand why we cannot also subsidize the off-grid sector in emerging markets, where reaching profitability and scale is far more challenging.
The greatest goal of philanthropists is — and should be — to generate social impact, and some may wonder why they should subsidize investments in businesses for whom profit is a core motivation. But the ultimate goal of philanthropic subsidy is to open new pathways for private investments that eventually take the place of subsidized impact investments. This may not be possible in all cases, as challenges like rural electrification in emerging markets are so daunting that they may always require some degree of subsidy. But in other cases, this subsidy can be a temporary measure that enables a sector to grow to the point where it can attract commercial capital. Both philanthropy and private investment have their strengths and limitations, but the world needs them to work smartly together to bring impactful businesses and industries to scale.
How to Create Greater Synergy Between Philanthropy and Impact Investing
However, for collaborations between impact investors and philanthropists to succeed, there are a few important misconceptions that need to be resolved. And both groups will need to adjust their approaches in different ways.
On the philanthropy side, foundations — which tend to define their scope rigidly — will need to embrace more flexibility in selecting opportunities that support their broader missions, even if they may not precisely align with the types of projects the foundation would normally fund. By giving their teams greater latitude to use their judgment to select these funding opportunities, foundations can stay true to their missions while also opening the door to new collaborations with for-profit partners.
Another important area for philanthropic funders to consider is that their traditional aversion to supporting for-profit solutions in low-income settings is increasingly outdated. This aversion was based on the fear that these businesses might exploit vulnerable customers and communities, but investors’ growing focus on the environmental, social and governance (ESG) impacts of their portfolio companies makes this risk less of an obstacle.
Additionally, foundations have been reluctant to make program-related investments or recoverable grants because they do not have the right resources to evaluate them. Like most impact investments, these types of financial instruments are more complex than traditional grants: To pursue them, foundations need to assess factors such as the financial sustainability of the business model, projected cash flows, risk exposure and the likelihood of achieving social impact goals. This requires resources like specialized financial expertise, tools for impact measurement and the capacity to conduct thorough due diligence. Yet many foundations lack in-house financial professionals with experience in these sorts of structured investments, making it difficult for them to accurately evaluate and manage these types of funding.
Furthermore, once they start to make these sorts of investments and have acquired the financial skills to evaluate their likelihood of success, philanthropic funders often become very conservative, like bankers, and are reluctant to take risks — even when the investment promises a high potential impact. Grant makers at these same foundations are often willing to fund risky projects without the expectation of any of the funding coming back, because they view the likely social impact of this funding as worth the risk. Why can’t foundations take the same approach with program-related investments?
On the private sector side, adjustments will also need to be made. For instance, some businesses seeking philanthropic funding are purely focused on profitability without much regard for the double bottom line. These companies may seek philanthropic funding because they underestimate the rigorous due diligence that foundations undertake, or because they believe they can promise enough superficial alignment with a foundation’s impact goals to successfully secure funding. And while such attempts rarely succeed with well-governed foundations, there are instances where vague or poorly defined impact criteria may allow these businesses to slip through the cracks. While this highlights the importance of strict evaluation frameworks that enable foundations to weed out this sort of enterprise, it also shows the need for businesses themselves to ensure that they are genuinely committed to the double bottom line of financial and social impact before soliciting philanthropic support.
Additionally, when seeking partnerships with philanthropic funders, for-profit impact investors need to do a better job of defining the social outcomes they’re trying to generate and announcing these outcomes upfront, then tracking them and tying their financial incentives to their social performance. These incentives might include performance-based payments for achieving impact targets, concessional funding or grants that reduce costs if outcomes are met, or enhanced credibility that attracts future funding. Such incentives ensure accountability and a focus on delivering measurable social impact alongside financial returns.
In a sector where greenwashing is an increasingly common problem, and practically anything can be presented as an impact investment regardless of the business’ actual impact, this transparency is important. To create it, investors must provide clear definitions of what qualifies as “impact investing” — along with easily understood social impact matrices that clarify the impacts they’re targeting, and their plan for pursuing them through their interactions with philanthropic partners. The UN’s Sustainable Development Goals have provided a clear targeting of development priorities that both private and public sector institutions can agree on. Further work needs to be done by impact investors to ensure that their social missions are clearly defined under a common and well-understood matrix, to facilitate transparent collaboration with partners in the philanthropic sector.
Multiple Roles Philanthropy Can Play in Impact Investing
We at SIMA believe that, when these collaborations are conducted effectively, philanthropy can be a catalyst for impact investing, playing multiple roles that can boost impact on both sides. Here are a few important examples of these roles, and some observations on how to make these partnerships more effective:
I. Spurring Innovation
One important role that philanthropy can play is to spur innovation. Foundations could explore how philanthropic funding can be more strategic, by testing new funding models that leverage blended finance or concessional funding to address complex social and environmental challenges while attracting commercial investors. They could also support business innovation, by working with investors who are looking for new ways to tackle social and environmental issues through the companies they support.
For instance, one of my impact investor friends is allocating funding to protect reefs by supporting the business ecosystem for enterprises that rely on ecotourism. This is not a fully commercial activity, and it requires investment capital that does not come with the same expectation for financial returns as traditional commercial investments. This funding is enabling experimentation to determine which business models might successfully leverage ecotourism, conservation fees or other revenue streams to ensure sustainability. However, this experimentation could also reveal that a non-profit approach or a hybrid model may be more suitable in certain contexts — especially if financial returns are insufficient to sustain the initiative. The role of philanthropy here is to provide the flexible, patient funding needed to test and refine these approaches, bridging the gap between non-commercial conservation efforts and commercially viable solutions.
This kind of experimentation and innovation is a very important element in funding impact-focused business activities in challenging markets. But while innovation is essential, we also need to put capital into the growth, profitability and stabilization of companies.
II. Risk Mitigation
Risk mitigation is one of the most important elements that foundations can play in impact investing. Philanthropic funding can shorten the time it takes for a company or a fund to become sufficiently attractive to investors looking for market-rate returns. Through grants and program-related investments, foundations can take on some of the early risks that can slow progress toward profitability, which are typically perceived to be higher than they actually are — especially in the early stages of impact ventures or funds. These perceptions can deter commercial investors who prioritize market-rate returns.
Foundations, through grants and program-related investments, can help mitigate these perceived risks by demonstrating that a business model is viable, its impact is measurable or its operations are scalable. This can shorten the timeline for attracting investors by reducing uncertainty and proving the potential for both financial and social returns. And, in those cases where the risks are indeed real (e.g., operational, regulatory or market-related risks), foundations can also play a critical role in addressing these early-stage challenges.
Philanthropic funding aimed at risk mitigation can attract commercial capital that amounts to multiple times the initial investment. I have seen this leverage reach levels that are 100 times greater than the philanthropic capital invested. Impact investing provides a great platform for foundations to leverage their limited resources in this way. The power of this approach can be seen in the Energy Access Relief Fund, a $90 million fund SIMA established in the post-COVID period, in which the Rockefeller Foundation, Shell Foundation and IKEA Foundation provided the early risk-mitigating investments. Shell Foundation’s $1 million investment in this fund was leveraged 90 times, and through these resources, the fund has deployed about 100 loans across 20 countries in sub-Saharan Africa and Asia. Just think about the impact this sort of leverage can make on a cause that is important to a foundation.
III. Industry Building
In development work, the paths we are trying to walk on sometimes do not exist: In other words, we have to create the systems and framework for effective development of the impact investing industry — while simultaneously participating in that development. An excellent example of this industry-building dynamic is the Global Impact Investing Network (GIIN), the largest platform for impact investors to disseminate knowledge, which has become an essential supporter of the sector’s ongoing development.
Five Principles for Fostering More Effective Partnership
To help build on these three key roles, we would like to propose a set of principles — based on SIMA’s experience as impact investors — that would be of great value in fostering more effective partnership between philanthropy and impact investors:
- Directing scarce resources like grants toward a particular goal should be the priority: Foundations should leverage their limited grant funding strategically, directing it to initiatives with clearly defined and impactful goals, rather than spreading it thinly across multiple areas or projects without focus. And there should be alignment between grant funding and larger, transformative objectives, such as de-risking high-impact projects, catalyzing innovation or enabling initiatives that cannot yet attract commercial capital.
- A greater appetite for risk is essential — among foundations, impact investors and commercial investors — and flexibility should be provided through policy exceptions, i.e., changes in standard funding or investment criteria to support initiatives that may not meet traditional benchmarks, but hold significant potential for social or environmental impact. These exceptions might include: relaxed collateral requirements for impact-driven projects or enterprises that have a viable business model or measurable social benefits; adjusted return expectations, allowing for lower returns in cases where the social or environmental impacts are substantial; extended timelines, providing longer repayment periods or project timelines to accommodate the challenges faced by high-impact ventures, especially in underserved regions; and flexible eligibility criteria, to support startups or small-scale enterprises that may not meet conventional size, experience or track record requirements but have innovative approaches to addressing critical social issues. The goal of these policy exceptions is to encourage both philanthropic and impact investment capital to take calculated risks in order to support transformative projects that might otherwise be overlooked.
- Profit should be viewed in a broader context, as a tool for advancing both business growth and social objectives.
- It is important to encourage a balance between social and financial returns, in order to foster a mindset and practices that consistently prioritize both goals, rather than focusing solely on one or the other. This balance can be achieved through industry norms, shared best practices and frameworks, rather than through direct enforcement by an external authority.
- The sector must move toward the standardization of impact reporting indicators.
The Alignment of Commercial and Philanthropic Interests
I believe that commercial and philanthropic interests can be aligned. SIMA Funds has recently raised one of the largest commercial and industrial solar green bonds in Africa, which is solarizing businesses and other projects in productive use sectors such as manufacturing, agro-processing, healthcare and education, along with other businesses of various types. Alongside this green bond, which focuses on projects that require a mix of philanthropic and commercial funding to be feasible, we are financing the solarization of hospitals that have sufficient revenue streams or cost-saving potential to attract private investors and sustain themselves financially. Through our foundation, we are also looking to solarize government hospitals and rural clinics that are not fully commercially viable — and we will need blended capital to get this initiative off the ground.
Blended finance could be leveraged to similar effect by other impact investors and foundations across sectors and geographies. There is roughly $105 million in annual grant funding provided by major U.S. foundations alone, alongside the 1.5 trillion global impact investing market that could be seeded through philanthropic efforts. This represents a valuable opportunity for foundations to meet their social objectives — and an equally valuable opportunity for impact investors to enter new markets. The growth of both sectors can only be enhanced by increasing partnership and coordination between philanthropy and impact investing, uniting them in a shared mission to maximize their social impact.
Asad Mahmood is CEO of Social Investment Managers & Advisors, LLC (SIMA).
Photo courtesy of Diva Plavalaguna.
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