What is Giving Compass?
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Giving Compass' Take:
• Geczy et al. investigate the implications of impact investing: revealing the ways in which the practice conforms and diverges from the theory.
• How can impact investors use this information to adjust impact investing strategies? How can best practices be developed and shared between investors?
• Learn more about impact investing at the Giving Compass magazine.
Impact investing private equity and venture capital funds are a rapidly emerging force in capital markets, premised on the service of two goals at once: a financial goal as well as a social-benefit goal. The addition of this second objective complicates the already challenging problem of aligning incentives across layers of agency, and raises the question of how contracting practices should adapt.
We draw on contract theory and a unique set of legal documents from impact funds to answer this both normatively and positively. Contracts struck by impact funds, both forward to portfolio companies and back to investors, use new terms to directly operationalize impact, and also adjust the use of existing terms on governance, investor protection, and other concerns to facilitate it.
Moreover, funds’ direct contracting on impact with investors passes through to their contracting with portfolio companies. For the most part, observed contracting terms align with theory, though they also differ in interesting ways, such as on compensation and covenants. Finally, we find evidence that different forms of contracting serve complementary roles in supporting impact.
Impact investing is a rapidly emerging force in capital markets, at the tip of a broad movement to incorporate social concerns into traditional profit ventures. Its essence is the service of two goals at once: a financial goal as well as a social-benefit goal. The addition of the latter objective complicates an already challenging contracting problem, and raises important questions about how contracting practices can adapt for this emerging space. To answer these questions, we investigate a unique set of 202 legal documents pertaining to impact funds, including both forward to portfolio companies and back to impact investors. Drawing on contract theory, we generate five specific predictions about optimal contracting for this rapidly growing asset class.