Navigating the legal landscape of impact investing: A guide for first-time investors

Impact investing, though promising returns, faces legal challenges in impact measurement, disclosure, and governance

While some investors have been making impact investments for decades, we’re seeing more and more emerging initiatives by both the public and private sectors to accelerate the development and adopt policies that support impact investing. However, navigating the regulatory landscape is still a daunting challenge, particularly for newcomers and those with limited resources.

This article looks at the present landscape with regulatory insights for first-time aspiring impact investors seeking to deploy impact capital.

Impact investing 101

There isn’t a universally agreed definition of what is “impact investing”. However, impact investing is usually referred to when both financial return and social or environmental impact are blended together, usually as a form of investment strategy when deploying capital. As an investor, impact investing presents a unique opportunity to generate financial returns, while addressing global challenges.  

A wide range of funding spectrums when deploying impact capital

In the recent post on e27 that I wrote, we discussed the full spectrum of funding options available to founders and investors. Aunnie Patton Power, an academic who is also an author Adventure Finance did a great work in illustrating different financial structures and instruments ranging from equity, debt and grants may be blended to amplify the impact capital.

Source: Aunnie Patton Power, Adventure Finance

For instance, a nonprofit may continue making its traditional grants as independent deployments of impact capital or as part of larger impact investments (perhaps, partnering with a high net worth individual or a VC fund that has the mandate to invest in impact investments). 

Deciding on how to deploy impact capital

Generally, it may be easier for an investor to invest directly in a business that he or she is passionate about such as via a regulated equity crowdfunding campaign or as an angel investor (usually by signing up in an angel investor club) without the usual hassle of dealing with governance issues unlike a corporate. Alternatively, you may also outsource the investment selection to a professional fund manager such as committing to an existing impact fund as an investor.

When it comes to the funding documents, the usual conventional instruments such as ‘SAFE’ (‘Simple Agreement for Future Equity’ note (i.e. a financing instrument that converts into equity under certain circumstances) or subscription agreement in a priced round may be used when investing in portfolio companies. Additionally, the funding documents may also contain extra provisions like mission related covenants and impact reporting requirements (more on this below).

Figuring out tax incentives and tax implications

As the impact capital space is nascent, you may or may not enjoy tax incentives when you decide to make an impact investment in your jurisdiction. As an impact investor, you may likely need to anticipate challenges including defining what constitutes an “impact investment” (such as for tax purposes, and fulfilling the accurate impact measurement for tax deductions, and ensuring that you have the necessary system in place to keep track of the reporting and compliance obligations). 

Depending on the funding amount, getting a tax advisor’s inputs may be worthwhile to assess if there are any tax incentives that you may benefit from before deploying impact capital. Other usual tax implications may include the usual capital gains tax on the disposal of unlisted private equities.

Defining and measuring impact outcomes

The tricky aspect of impact capital is when it comes to agreeing on the measurement standards, as they are constantly evolving.  Due to the lack of standardised impact measurement and reporting frameworks/metrics, it may be difficult for an individual angel to assess the social and environmental performance of your investments without an agreed and clear frameworks/metrics. 

While there’s no universally accepted framework, you may likely be able to agree on the areas of focus including defining impact goals, selecting relevant metrics, establishing baselines, and tracking progress over time. Standards like the Global Impact Investing Rating System (GIIRS) and the Impact Management Project (IMP) by Global Impact Investing Network (‘GIIN’) may serve as useful and  valuable frameworks. 

As a founder, do get legal advice before agreeing and negotiating on the appropriate impact metrics and frameworks prior to receiving funding from an impact investor as they can be resource intensive for young startups. An impact lawyer can play a pivotal role in structuring your impact investment, drafting impact focused investment documents and agreements, and advising on the appropriate regulatory compliance strategies.   

Final thoughts

Despite the hype surrounding impact capital and the significant growth of impact investment in the Southeast Asia region over the last six years, the sector remains an actively developing landscape. 

An impact investor planning to deploy impact capital will benefit from a better understanding of the various legal structure, tax, economic, and governance implications specific to the impact capital industry based on your current jurisdiction.