Impact investing in Latin America and addressing the ‘missing middle’

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Justin Schwartz, Managing Director , IMPAQTO Capital & Michelle Arévalo-Carpenter, CEO, IMPAQTO

As 2021 begins, business leaders across Latin America are musing over the challenge that Professor Klaus Schwab laid down as part of the Great Reset, which emphasises that “the pandemic represents a rare but narrow window of opportunity to reflect, reimagine and reset our world”. What future can business leaders expect to have agency over, after a year of so much instability and ambiguity? Impact investing, and in particular investing in small and growing social enterprises, might hold the answer.

Our generation of business leaders is creating a new paradigm of how capital can support a more equitable, sustainable future. Impact investing has existed for more than a decade, but its role in post-pandemic reconstruction gives it a whole new level of relevance. As our colleague Ted Levinson of Beneficial Returns describes it, traditional investing is moving money into the future we predict, while impact investing is moving money into the future we want.

Impact investing in small business

Impact investing has grown more than tenfold over the past decade in Latin America as highlighted in our “Second Wave of Impact Investment” study published in 2018. Reports from GIIN and ANDE show that more than $25 billion in impact-investing assets are focused on Latin America, with 65% of investors having made their first investments in the region after 2010.

Early-stage social enterprises will be crucial to the post-pandemic economic and social reconstruction in Latin America, given that they lie at the intersection of two key themes. First, social entrepreneurs serve a fundamental role in building a better world post-Great Reset as they create profitable companies that contribute positively to their communities and the planet. Second, small businesses are vital to the region’s economy, and thus it is these companies that will determine the economic future of the region.

Small and medium-sized businesses have a fundamental economic role in Latin America, though their funding needs are often overlooked, with the IADB showing that these businesses create 67% of employment in the region but receive only 12% of total credit. This funding gap is a key barrier to accelerating economic growth, which can be driven by social enterprises like Cusi, a nutrition startup that sustainably sources superfoods like quinoa at fair prices from 35 smallholder farmers. The company is growing quickly, but needs financing to multiply its impact to hundreds of indigenous farming families over the next five years.

Despite the demonstrated funding needs of small businesses, the first wave of impact investing in Latin America has focused on more established markets and larger companies, with 2020 data from ANDE showing that the average investment size among deals in the region is $1 million – an amount which leaves out the smaller businesses that struggle most to access capital.

The “Second Wave” study identified this funding gap as a “missing middle” of impact investment, centred on investment sizes of $10,000-$500,000, which is a key funding stage in the development of every company. Funding before and after this range is more available, in the form of microfinance under $10,000 and institutional funding in the range of $1 million-$2 million and up.

IMPAQTO Capital launches

2021 is a crucial year for business leaders to create innovative financing mechanisms for the companies that will rebuild post-COVID-19. In the Andean region, IMPAQTO is pursuing this goal with the launch of IMPAQTO Capital, a new impact-investing fund providing flexible capital to early-stage social enterprises. IMPAQTO Capital seeks to demonstrate that moving capital to social entrepreneurs in the missing middle stage of their development can be both profitable and generate an enormous impact in the communities in which these companies operate as well as in the entrepreneurial ecosystem.

IMPAQTO Capital is following in the footsteps of a few established impact investors in Latin America addressing the same gap, such as NESsT and Pomona Impact. Yet the region needs these financial innovations to become the norm rather than an exception. To be sure, many have avoided funding early-stage companies due to the high costs of running small funds like these and the added technical support that these businesses require. However, Latin American business and financial institution leaders must act to address the missing middle gap of impact finance and recognize the key role that these growing companies play in the economy of the region.

What is the COVID Response Alliance for Social Entrepreneurship?

The COVID Response Alliance for Social Entrepreneurship is a coalition of 85 global leaders, hosted by the World Economic Forum. Its mission: Join hands in support of social entrepreneurs everywhere as vital first responders to the pandemic and as pioneers of a green, inclusive economic reality.

Its COVID Social Enterprise Action Agenda, outlines 25 concrete recommendations for key stakeholder groups, including funders and philanthropists, investors, government institutions, support organizations, and corporations. In January of 2021, its members launched its 2021 Roadmap through which its members will roll out an ambitious set of 21 action projects in 10 areas of work. Including corporate access and policy change in support of a social economy.

For more information see the Alliance website or its “impact story” here.

In 1972, Buckminster Fuller introduced a beautiful metaphor when explaining our ability to affect society as a whole: just as the trim tab is the miniature rutter that makes a whole ship change direction with a slight shift, investing in the next generation of businesses as we rebuild our economy can be the shift that realizes the world we want to create.

As Prof Schwab would add: “so that everyone who is willing to ‘co-shape’ the future can do so”.