April 21, 2021

Why Mainstream Private Equity Firms Should Consider Launching an Impact Investing Vehicle

Three reasons why private equity firms should consider launching an impact investing vehicle.

By: Michael Etzel, Ben Morley, Erica Kelly

Over the past five years, environmental, social, and governance (ESG) factors have rapidly become “table stakes“ for private equity firms. Limited partners now effectively require their general partners to consider these factors, either to help manage risks or to identify potential opportunities for value accretion.

Some mainstream private equity firms, however, are going beyond thoughtful ESG integration to create dedicated impact investment vehicles. TPG, Bain Capital, KKR, and Partners Group, for example, have all chosen to launch funds that aim for meaningful, measurable social and environmental impact in ways that span geographies and asset classes. (For a discussion of the distinction between ESG investing and impact investing, see "Why the World Needs Both ESG and Impact Investing."

Unlike ESG integration, impact investing is not yet a de facto requirement for private equity. Talent is unlikely to leave firms that choose not to launch impact funds, at least for now, and there are other strategic opportunities that have appeal for limited partners.

Yet private equity firms might consider launching an impact investing vehicle as a valuable strategic option that can bring significant benefits—besides being the right thing to do.

Impact Investing: The Right Thing to Do

The first reason private equity firms should consider launching impact investing vehicles is that impact investment has a critical role to play in addressing 21st-century challenges, such as persistent poverty, growing inequality, accelerating climate change, the stark human costs of COVID-19, racial injustice, and other crises and inequities that characterize our world. Indeed, the UN estimates that there is an annual financing gap of $2.5–3 trillion in what is needed to achieve the Sustainable Development Goals by 2030. There is simply no way to fill a gap of this magnitude without enlisting private capital and private enterprise.

Private equity can effect change in ways that neither the public sector nor public market investors can. Firms are uniquely positioned to not only direct capital to opportunities that achieve meaningful outcomes for society, but also ask more probing strategic questions about a company’s products and services. They can roll up their sleeves and shape operations around the triple bottom line of people, planet, and profit. That gives them powerful leverage over their portfolio companies’ impact.

Impact Investing: The Potential for Strategic Benefits

Doing the right thing is not the only reason, however, for private equity firms to think seriously about a move into impact investing. Competition is increasingly intense; limited partners now have a wide range of options for where to deploy their capital. General partners are upping their game in how they differentiate themselves and create value. And one increasingly prominent source of differentiation is impact.

Significant shifts in both the makeup and demands of key constituents within limited partner groups are driving this trend. Importantly, pension funds are realizing that responding to even the narrowly defined interests of future pensioners requires taking long-term social and environmental considerations into account. These funds are among the largest sources of capital for private-equity-focused impact investors. In addition, millennials, who see their legacy in terms of social change, are gaining influence in family offices. Meanwhile, high-net-worth individuals and foundations are thinking about maximizing their influence by integrating financial return and impact considerations across their philanthropy and investment portfolios, rather than allocating x for one and y for the other.

These trends point to interesting opportunities for private equity firms, with those able to demonstrate impact along with competitive rates of return likely to be in demand among limited partners.

Giving Your Firm an Impact Edge

We are excited about the potential for innovation here, and we expect to see many more general partners launch impact investing vehicles in the years ahead. While this may no longer be a white space, there are significant opportunities for innovative, impact-focused extensions across geographies, sectors, asset classes, and investment stages.

An effective general partner strategy is clear about a firm’s investing “edge”—its unique, proprietary assets—and how an extension into impact investing would add to that edge. There are a number of ways to make this extension, but it’s important that it grow out of a firm’s overall strategy and investment practice—in other words, that it comes from your existing “right to play.”

For instance, general partners that emphasize their ability to source compelling investments (e.g., through well-developed networks) may find that an impact focus reinforces this strength, making the investor a more attractive partner to potential portfolio companies. For example, TPG’s RISE Fund builds on TPG’s existing strengths in global growth equity investing: this extension is all about backing high-growth businesses. Many companies in the RISE Fund portfolio are attracted to RISE as a result of its mission. As Dreambox CEO Jessie Woolley-Wilson said when RISE invested, her company gained a partner “whose mission of social impact is perfectly aligned with ours.”

On the other hand, GPs that emphasize their strategic and operational value to portfolio companies will find that social impact expertise can create stronger businesses. An understanding of impact megatrends and regulatory changes, for example, can help a company stay ahead of change. The Bain Capital Double Impact (BCDI) fund, is one example. It builds on Bain Capital’s existing strengths in adding value to portfolio companies: this extension is all about working closely with mid-market portfolio companies to enhance their impact. BCDI deploys its “Strong Start Playbook” in each portfolio company to diagnose, prioritize, and address the critical factors driving financial and impact performance, which in turn creates long-term business value.

These examples highlight ways that a focus on impact might amplify a general partner’s existing strategy. Embracing impact may also capture broader advantages. For example, such general partners will be more likely to attract and retain top-tier talent, particularly millennials, who will make up 75 percent of the workforce by 2025 and three-quarters of whom consider a company’s social and environmental commitments when deciding where to work. They may also attract more diverse advisory perspectives, helping to ensure better decision-making and improve their brands and reputations.

Although mainstream private equity is still in the early days of the trend toward impact investing, we are excited by the breadth and depth of the impact these custodians of capital can potentially achieve. There are many distinctive opportunities for general partners to translate their investing edge into impact in ways that will look different from what we have seen in the last few years. For your firm, these might include applying a strong thesis-driven investment approach to identify sub-sectors with high potential for impact—for example, by harnessing technological advances in ways that mitigate climate change or by addressing racial inequities in society. The right approach for a given general partner will draw on and enhance that firm’s unique strengths and capabilities, with opportunities across a broad range of geographies, sectors, asset classes, and investment stages.

As we continue into the third decade of the twenty-first century, it has never been more critical for all actors in society—including institutional investors—to be directing capital toward building a more sustainable and equitable world.

So what is your firm’s investing edge, and how could you extend it for social and environmental impact?

Michael Etzel is a partner and Erica Kelly is a manager, based in Boston and San Francisco, respectively, at The Bridgespan Group. Ben Morley is a director at Bain & Company’s social impact practice.

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