Investing in assets with the aim of generating a financial return while effecting a positive social or environmental change – impact investment – has enjoyed a growing footprint in recent years. The strength of the strategy is something LeapFrog Investments is banking on.
The firm, initially focused on financial services companies in Africa and Asia, launched in 2007 and raised $135 million for its first fund, the 2009-vintage LeapFrog Financial Inclusion Fund. LeapFrog is now eyeing six times that amount for its latest fund, LeapFrog Investments Fund III, which is targeting $800 million, as previously reported by Private Equity International.
LeapFrog is not the only impact-focused private equity firm to have grown. Seattle-based Elevar Equity more than tripled its fund size from a $23.6 million debut to the most recent, Elevar Equity III, which raised $74 million in 2013, according to PEI data.
Fund managers raised almost $7 billion for the strategy in 2015, according to the latest survey from the Global Impact Investing Network, while managers expected to raise more than $12 billion last year.
“The space is definitely expanding, as we are talking to people all over the world, including Spain and Switzerland, who are rolling out their new impact initiatives,” says Michael Whelchel, co-founder and partner at impact-focused placement agent Big Path Capital. “The interesting piece about [impact investing] is if you have a stated purpose of, 'we're about helping great companies', as a fund manager, it becomes a differentiator.”
Since Fund I, not only has LeapFrog's investor base expanded, but the firm is also receiving larger cheques. In 2015, the firm secured a $200 million commitment from the US government's development finance institution, the Overseas Private Investment Corporation. This was the largest commitment in history to an impact fund and pushed LeapFrog's committed capital beyond $1 billion. It was also OPIC's single biggest commitment to a private equity fund thus far. As a result, LeapFrog became the first billion-dollar private equity firm aimed at equity impact investing.
Jim Roth, co-founder and partner at LeapFrog, declined to comment on fundraising, but did elaborate on the strategy.
As a GP focused on the insurance industry in emerging and frontier markets, he says LeapFrog has three broad buckets of investors. The first is traditional investors, such as pension funds, looking solely for returns on invested capital. The second is impact-focused limited partners, such as OPIC, who are interested in impact and financial returns. The third is strategic investors, which, for LeapFrog, often means financial institutions such as insurers. Strategic investors back a fund such as LeapFrog's to gain exposure to a new market they might consider entering themselves later on, or to secure a front-row seat on fund exits as potential acquisition targets.
“We have fiduciary obligations to get the best price or make sure to do the deal that has the most certainty, but if you're an investor looking to buy an asset that we're selling and you haven't been an investor in the fund, you won't see how the business evolved over time,” he says.
LeapFrog established the LeapFrog Insurance Innovation Circle, which meets quarterly in a workshop format, educating its LPs on themes in the sectors or regions of the portfolio.
Strategic investors can also benefit by doing business directly with a portfolio company. For example, LeapFrog invested in India-based IFMR Capital, which securitises debt of microfinance institutions. In order to manage risks, such as a flood wiping out huge numbers of IFMR borrowers, LeapFrog introduced its re-insurer LPs to IFMR to sell their products.
But because fund participation by this type of LP directly depends on whether LeapFrog's strategy fits into theirs, turnover can occur in the investor base.
“With straight financial investors you will typically get an investor that'll come in fund after fund, but a strategic investor may say, 'I'm no longer interested in Africa and Asia,' or, 'We've gone out of emerging markets completely to just focus on the US,'” Roth explains. “So you can't be assured of the same continuity as you can with a financial investor.”
That said, Roth believes strategic LPs, which make up roughly 70 percent of LeapFrog's investor base, will continue to find emerging markets attractive.
“In the first fund, we had a lot of emerging markets development institutions [in the LP base],” Roth says. “I think as we got our portfolio of innovative businesses targeting emerging consumers, we had higher strategic interest in the next fund.”
An impact private equity investor isn't just after returns, but also works to generate social or environmental benefit via its investments. That means any potential investment must be matched against two sets of criteria: traditional metrics such as the internal rate of return, and impact, which presents another specific challenge.
“We've come across many businesses that make lots of money but have a negative, limited or no social impact, and we've had businesses that do the opposite,” Roth says. “When we look at any deal, we make sure it goes through both the profit lens and the purpose lens. It has to succeed at both going in.”
LeapFrog encountered a business that sold insurance using mobile phones but didn't tell customers the extent of its coverage. Few people made claims as a result, and the company had strong revenue without giving people good value, according to Roth. So, LeapFrog rejected that deal, although the business was very profitable.
While impact investing may require extra work on due diligence, there is no dearth of potential deals.
“I think in the universal data set, yes, there may be a decreased pool of assets [to potentially acquire] but we've never heard someone say, 'I can't find enough good deals,'” Big Path co-founder and partner Shawn Lesser tells PEI. “For example, agriculture and renewables are big growth areas. Holistically, there's going to be [fewer] impact deals, but there are also probably fewer impact fund managers.”
Whelchel notes that another challenge in impact investing is debunking the myth that it isn't profitable, or that returns do not stack up against those of traditional private equity. It comes down to education of the industry on how the strategy works, and Whelchel and Lesser point to the fact that almost a third of the funds they work with have adopted the Global Impact Investing Rating System – one of three systems which measure impact – to provide tangible outcomes.
Roth says LeapFrog has a 10-year track record to show its business model, but it's still a work in progress. “It's easier to persuade people, but you mention 'purpose' and some people still think, 'How much money are you going to lose?'” he laughs. “I think that's something that's still evolving.”