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After the Great Recession of 2008, there was a lot of retrospection, particularly in the non-profit space where I spent much of my career. The conversation was mainly about the fact that foundations and not-for-profit endowments lost a massive amount of money in the market when they could have granted more to those serving the poor, addressing societal ills or investing in undercapitalized entrepreneurs and underserved communities. As we navigate through the current fluctuating market conditions, do investors really want to repeat those mistakes?
While the market may bounce back here and there, indicators point to significant headwinds in front of us, especially for traditionally underserved business owners and entrepreneurs. According to many experts, the possibility of a recession will persist through much of 2023.
With that in mind, investors should pull from past experiences and realize that betting on people and entrepreneurship can be more of a winning proposition than leaving money in a highly unpredictable market. Especially one being squeezed by inflation, climbing interest rates, global supply chain issues and geopolitical unrest. Instead of continuing to invest solely in a highly volatile market, this is an ideal point in time to invest for double-bottom-line impact.
I wholeheartedly believe that increasing investment in small businesses led by rising entrepreneurs – and knocking down barriers to flexible risk capital – can change lives, uplift underserved communities, and provide investors with stable returns. As the economy teeters on a possible recession and investors endure diminished returns or losses across their portfolios, most firms right now are challenged to find a nexus of opportunity.
Given the high-risk environment, there may not be a more suitable time to pivot investment strategies and redirect private equity toward small businesses across traditionally undercapitalized regions. Deploying capital that supports entrepreneurs who are driving innovation and permanent job creation in distressed communities has proven to be an effective hedge against market volatility in delivering both strong financial gains and meaningful social impact. This is because small business investing is uncorrelated with the broader market returns.
Because small business investors generally use more flexible, non-traditional investment vehicles to bridge market gaps, they may be less susceptible to broader economic swings. Essentially, these types of investments, which often leverage government incentive programs such as New Market Tax Credits or Rural Jobs Acts, are tied directly to the performance of the companies receiving the investment dollars. And, of course, there is little or no tie at all to how public stocks are performing.
However modest, investments in well-run small businesses and promising entrepreneurs look increasingly attractive in today’s market, while previously “safe” investments appear risky. Morgan Stanley has stated that “sustainable investment strategies may potentially offer downside risk protection to their investors in times of high volatility,” and in years of volatile markets (2008, 2009, 2015, 2018), sustainable funds’ downside deviation was significantly smaller than traditional funds.
Despite concerns that a trade-off exists between returns and generating impact, studies have found the opposite true. A Bain Capital study of 450 private equity exits involving impact funds or impact-related causes from 2015-2019 revealed that the median multiple on invested capital for impact deals was 3.4 — compared to 2.5 for all other deals. This is what a double-bottom line ethos promises: that achieving returns lies in step with achieving impact. Companies that value and deliver impact may be higher quality investments from the get-go, making prioritizing impact an essential part of any investment decision.
Additionally, it is important to point out there is a strong opportunity to support Black and Brown-owned businesses that are particularly impacted during times of economic downturn. Firms and institutions have a tremendous opportunity to veer from traditional investment approaches that can incur steep losses in a down market and, instead, use their funds to address the structural disadvantages that have long worked against Black and Brown entrepreneurs in accessing the capital they need to grow their businesses.
Investing in smart, resourceful business owners can have an outsized impact on underserved communities, catalyzing development and increased prosperity. Because small businesses remain off the stock market, their performance may be less correlated to market performance than their larger, publicly traded counterparts.
However, this is a double-edged sword. By virtue of their size, small businesses are more vulnerable to volatile economic conditions. Right now, they face potentially severe losses in access to flexible capital and other challenges resulting from the inflationary environment.
Therefore, we now have both an opportunity and obligation to sustain communities by investing in the small businesses and aspiring entrepreneurs that hold them together. By deploying capital to businesses in capital-starved markets, we can earn stable returns and support owners striving to make it in a competitive business landscape, providing them with the readiness tools to support sustainable growth and create lasting wealth in undercapitalized communities.
The timing couldn’t be better for investors to consider impact investment options that provide undercapitalized entrepreneurs with alternative financing options. It may be their best opportunity during these volatile market conditions.