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Impact Investing and Donor-Advised Funds

September 11, 2018

Inv.env.650pixAs interest in (and assets dedicated to) impact investing grows, institutional investors, foundations, and philanthropists alike are looking for an entry point into the rapidly growing field. At the same time, growing numbers of social entrepreneurs are looking to savvy investors and high-net-worth individuals as a potential source of funding.

Both groups have identified a compelling intersection of interests in the form of donor-advised funds (DAFs) that specialize in impact investment management and distribution. Charitable assets in donor-advised funds totaled $85 billion in 2017, and awareness of DAFs has grown significantly over the last five or six years. In fact, today there are three times as many donor-advised funds in the U.S. as there are private foundations.

While still just a fraction of the total, a handful of impact-focused donor-advised funds are seeking to bridge what Ayesha Khanna of the Points of Light Foundation calls "the pioneer gap" — by which she means a lack of funding for early-stage impact ventures, supply and distribution constraints, growing demand for expertise and new talent, and the role of partnerships as a lever for scale.

Thanks to the still-nascent but growing philanthropic impact infrastructure built by organizations such as RSF Social Finance, Tides Foundation, ImpactAssets, and others, savvy donors are finding it easier than ever to make impact investments in social enterprises and early-stage social entrepreneurs. Here are six things they are learning along the way:

DAFs can multiply the impact of their philanthropic dollars: Grants are a critical tool for social change, but once grant dollars are deployed, they are gone. Capital that is deployed to an impact investment — either as a loan, equity, or debt — has the potential to be redeployed to meet changing needs.

Donors appreciate that as investment gains are returned to a donor-advised fund, those gains can be recycled into future investments or deployed as grants.

It pays to leverage experience: With more and more impact funds and social enterprises springing up, it can be difficult for individuals to do adequate research and determine whether a given investment meets their financial and impact goals. That’s where an organization like ImpactAssets, which has built a multimillion-dollar portfolio of more than three hundred direct impact investments, comes in.

One helpful tool for donors looking to learn more about impact investing is the ImpactAssets 50, a free, annually updated list of fifty impact investing fund managers that can be filtered by asset class, theme, geography, asset, and third-party validation.

DAFs can eliminate the need for accredited investor/qualified purchaser status: Many private investments are limited to accredited or qualified investors — typically, investors with a net worth of more than $1 million, annual income of $200,000 ($300,000 if declared jointly with a spouse), or a general partner, executive officer, and/or director for an issuer of unregistered securities. However, donor-advised funds with assets exceeding $5 million are qualified and eligible to make impact investments for their donors. By pooling the investments of many donors, such funds can meet the overall investment requirements while lowering the minimum threshold for individual investors.

DAFs maximize efficiency: Donor-advised funds with a donor-directed custom investment program can handle all the significant and frequently cumbersome logistical and custody issues associated with privately held assets.

With private assets, transactions can involve extensive documentation involving term sheets, purchase agreements, and the like. Debt deals and revenue share agreements have to be monitored to determine whether the appropriate payments are being made. And when enterprises fail, workouts need to be arranged and agreed on, sometimes by multiple parties. In many instances, donor-advised funds are able to offer services such as document review, investment execution, conversions, monitoring, and audits.

DAFs also have a number of structural advantages. For example, the donor-advised fund sponsor typically handles all grantmaking and account management and ensures that all grants and investments are conducted in accordance with the law and best practices.

DAFs provide flexibility: Given that no one investment is right for all investors, donors often appreciate the fact that donor-advised funds have the flexibility to invest in a variety of vehicles and structures.

An early-stage enterprise may need a loan for working capital, for example, while another may need equity to get itself off the ground and a third may benefit from a revenue-share agreement. ImpactAssets has recommended an assortment of structures to its clients, including debt, equity, SAFE, convertible debt, revenue share, lines of credit, and social impact bonds.

DAFs can invest globally: Problems such as climate change and poverty cannot be tackled solely at the local or even national level. Many donor-advised funds have the capability to deploy investment and grant capital both domestically and internationally, however. Philanthropists who want to engage across different geographies often use donor-advised funds to deploy capital wherever it is needed to achieve their social and financial goals.

Headshot_sally_boulter_newIf we are to close the "pioneer gap" for social entrepreneurs and solve some of our biggest challenges, we need to use every tool in the financial toolkit. For those who are new to impact investing, a donor-advised fund can be a good place to start.

Sally Boulter is senior engagement officer at ImpactAssets.

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