The Diversity of Capital Gaps Around the World
The impact investing market has recently surpassed the trillion-dollar mark, according to the Global Impact Investing Network (GIIN). However, despite its impressive scale, the impact capital is faced with constraints imposed by mainstream finance. This limits its flexibility to address urgent needs. The GIIN itself recognizes that the top challenge facing the impact investing market is the availability of appropriate capital across the risk/return spectrum.
Catalytic capital, which accepts higher risks and concessionary returns, plays a crucial role in impact investing. It provides the flexibility needed to support projects and initiatives where conventional financing falls short. Examples include microfinance and the off-grid solar sector. Catalytic capital acts as an early investor, paving the way for other investors to support riskier opportunities. This type of capital is deployed by various actors, ranging from development finance institutions and government agencies to family offices and foundations.
To better understand the capital gaps and address them effectively, the Catalytic Capital Consortium (C3) has been working on building an evidence base on capital gaps worldwide. This work has dispelled several myths about capital gaps, highlighting the diverse array of gaps and the need to develop sound strategies to address them.
The Misalignment of Capital and Investee Needs
A common misconception about capital gaps is that they occur only in less economically developed parts of the world. While these areas do face significant gaps, capital gaps can also be found in developed economies with well-established financial sectors. For example, capital gaps exist in sectors such as rental housing in Europe and diverse-led businesses in the United States. It is essential to recognize and address capital gaps across the world, regardless of the economic development level.
Another misconception is that capital gaps can be easily identified by the absence of capital available to potential investees. However, in many cases, capital is available but not in the amounts, terms, and conditions appropriate to the investee. African SMEs, for instance, face capital misalignment due to collateral requirements and unaffordable terms. Understanding all the identifying features of capital gaps is crucial to ensure their recognition and find suitable solutions.
Challenging the Myths of Capital Gaps
The myth that capital gaps solely stem from weaknesses on the part of potential investees is inaccurate and unhelpful. Capital gaps result from misalignments between investors’ requirements and investees’ profiles and values. The demand and supply sides both play a role in creating and resolving capital gaps. For example, closing the gap for diverse-led asset managers in the US involves efforts from both demand-side organizations encouraging diversity and supply-side investors recognizing the need for change in their due diligence approaches.
Another myth is that the gap faced by innovative solutions gradually narrows as they scale. While some gaps may narrow over time, real-world scaling journeys often involve expansion into new areas with greater risks and costs. Second funds may require even more catalytic capital to support scalability and expansion. It is vital to recognize the different valleys of death in scaling journeys and understand that scaling can come with its own set of challenges and capital gaps.
The Role of Attitudes and Values in Capital Gaps
Attitudes and values also play a significant role in capital gaps. Different norms, working patterns, and cultural values can create misalignments between supply and demand. For example, mainstream investors’ inability to accept differing norms in working patterns in artisan producer communities in India creates a capital gap in impact enterprises working with those communities. Differing views on impact intentions can also contribute to capital gaps, as seen in the lack of investment in employee ownership conversions that prioritize worker-owners over outside investors.
Addressing capital gaps requires a comprehensive approach that takes into account both objective factors and attitudes/values. The research and analysis conducted by C3’s Evidence Base grantees have shed light on capital gaps and allowed for the development of more effective strategies. Going forward, it is crucial to continue advancing this agenda to fulfill the potential of impact investing in addressing the needs of marginalized and vulnerable communities around the world.
Analyst comment
Positive news: The impact investing market has surpassed the trillion-dollar mark, showing significant growth and potential for addressing urgent needs. The Catalytic Capital Consortium (C3) is working on building an evidence base and dispelling myths about capital gaps worldwide, leading to more effective strategies.
Short analysis: The impact investing market is expected to continue growing as awareness and understanding of capital gaps increase. Companies and organizations will focus on developing strategies to better address these gaps and align investor requirements with investees’ profiles and values. This will result in more targeted investments and improved support for marginalized and vulnerable communities.
