How Nonprofits Can Tap Into the Impact Investment Market – Stanford Social Innovation Review

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For more than three decades, a small-but-growing sector of mission-driven organizations known as Community Development Financial Institutions (CDFIs) have been at the forefront of creating equity and opportunity in underinvested communities. Unfortunately, as inequality gaps continue to widen across the United States, CDFIs are struggling to scale their work. Limited funding requires that that they, and other nonprofit organizations, make tough choices about where to focus their efforts.

The burgeoning world of impact investing, however, offers new hope for nonprofit organizations seeking access to capital. As my team at Capital Impact Partners found out, harnessing this market came with a steep learning curve. By sharing our lessons, we hope other nonprofits can follow our path in developing an important new revenue stream and, in turn, create more social impact.

What are CDFIs and how are they funded?

CDFIs play a unique role in the nonprofit world by delivering capital in the form of loans and other investments to projects in various sectors that increase access to social services in low-income communities. This includes sectors such as health care, education, healthy food, housing, and transportation, among others.

CDFIs are focused on impact over profit and risk, so they are often first on the scene in places that traditional financial institutions are reluctant to support. In Detroit, for example, CDFIs operated and supported many efforts for several years while the city was in bankruptcy, before more traditional capital started flowing in.

The majority of CDFIs operate as nonprofits. As a result, the sector has long relied on three areas of funding: grants from financial institutions and government agencies (namely the CDFI Fund operated by the US Department of the Treasury), program-related investments (PRIs) from foundations, and debt capital from financial institutions.

In reality, all of these sources of capital can be hard to come by. That, along with various restrictions that investors and funders apply to their capital investments , further limit CDFIs from growing their balance sheet at a rate necessary to provide community-based organizations the financing they need.

Nonprofits and the impact investing landscape

Two years ago, the management team at Capital Impact began exploring new ways to raise capital to support our mission of building communities of opportunity that break barriers to success. That effort led us to the world of impact investing, which we hoped would allow us to raise the type of flexible and less-restrictive capital we needed. At the time, this was uncharted territory for CDFIs and for many nonprofits in general.

We studied a few examples, including debt security offerings from the World Bank and The Nature Conservancy to support their international work, and Calvert Impact Capital (then known as the Calvert Foundation), which focuses on low-income communities in the United States. But even with these examples as models, the process of getting from idea to implementation was far more complicated than we imagined.

Keys to building a successful nonprofit impact investing offering

While existing examples offered a roadmap, we needed to offer a more robust and accessible product if we were to truly gain access to the broader impact investing space. As we explored our options, we identified a few guiding questions:

  • What would it take to make a nonprofit investment product on par with standard corporate offerings issued by Fortune 500 companies and trusted by investors?
  • How could we most effectively market this investment product to a broad base of investors?
  • How could we target investors unfamiliar with social impact investments?

The journey to launching our $100 million investment note took a winding path. Based on our experience, we have seven recommendations for other mission-driven organizations interested in pursuing their own investment instrument:

  1. Achieve a credit rating. Nonprofits should establish the financial soundness of their organization in the same way corporations or government entities do. Third-party validation helps assure investors new to impact investments and/or the CDFI sector that a given organization is a viable investment. Capital Impact underwent a rigorous review process with S&P Global, after which S&P assigned us the status of “AA issuer credit rating with stable outlook.” Further into the process, S&P reviewed and assigned our investment note with an AA rating. We are one of the few CDFIs rated as an issuer that has a rated product.
  2. Work with an investment partner. Successfully navigating the investing world to put a product in front of the right audiences requires expertise that most CDFIs and nonprofits lack. A strong partner with investing experience will bridge that gap. We worked and continue to work with Incapital, an underwriter and distributor of securities. In addition to its experience working with mainstream corporate brands to launch their investment products, it had a vested interest in working with us: By partnering with us, it could also build out its “Legacy” platform, which offers values-based products to investors.
  3. Ensure the product is widely accessible. There are thousands of investment products to choose from, and if an offering is hard to find or difficult to invest in, your organization will have trouble meeting its goals. Another benefit of working with Incapital is its strong network of broker-dealers who manage the portfolios of millions of individual investors. As a result, large financial firms using its in-house trading platforms (as well as individuals using eTrade, TD Ameritrade, Schwab, and others brokerage services) could access our product. Without this access, Capital Impact would simply not have the marketing capability to scale our investment in a cost-effective manner. We further expanded accessibility to smaller retail investors by allowing purchases as low as $1,000. While large brokerage firms made a bulk of the purchases, we were excited to see some retail investors take advantage of this investment.
  4. Comply with state registration requirements. Accessibility includes thinking about where an organization sells the product. A broad range of investors may know about your product, but if they reside in a state where you are not approved to sell, they cannot invest. With the help of our legal counsel, we applied in all 50 states, each of which requires different levels of review. This was among the most time-consuming aspects of developing our investment note, but we were ultimately authorized to sell in 47 states and the District of Columbia.
  5. Provide a continuous offering. The timing of an investment product’s sale is also important. A “continuous offering” means a product is available to customers over an extended period of time rather than on just a single date. This is particularly important as investors come in and out of the market looking for new portfolio opportunities. With this in mind, our investment note is available for one week beginning on the second Monday of each month. This allows us to re-price our offering based on the market, while establishing a consistent schedule for brokers looking to invest until the full amount of the offering is sold.
  6. Pursue a trusted settlement process. While getting to market is critical, it is also important to consider what happens once investors purchase your product. Investors want a trusted and efficient means by which money and securities are exchanged with the seller. All of our investment note sales are processed through US Bank via the Depository Trust Company (DTC), which provides clearing and settlement services to the financial markets. Because investors use the same service for other types of mainstream securities, having our note “DTC-settled” gives investors extra confidence.
  7. Bring in legal counsel. Securities are an extremely regulated industry, and it is important to understand the do’s and don’ts to avoid potential legal risk. We recommend retaining legal counsel familiar with both your sector and the related intricacies in offering such investments. We used both in-house and hired legal counsel with experience in this specific area. With their guidance, we were able to navigate the rules and regulations, put together the necessary prospectus, and manage our marketing materials.

Exactly two years to the day after our initial conversation with Incapital, our Capital Impact Investment Note went to market. While we were cautiously optimistic based on the steps we had taken, we were thrilled when the first week’s sales results totaled more than $35 million—nearly one-third of our total offering. This speaks both to the process we adhered to, as well as the general appetite for investors seeking a financial return while creating social impact in communities.

Other capital raising options

While we understand this lengthy and rigorous process may be out of reach for some organizations, that should not deter nonprofits from seeking out innovative ways to raise capital. Here are some other opportunities worth exploring to secure capital for social impact work.

  • Creating general obligations bonds based on the same model used by states or jurisdictions to fund public works projects, except with the specific focus of using the revenue from the bonds for community development projects. Examples include recent forays into the market by Reinvestment Fund and LISC.
  • Applying for the US Department of the Treasury’s Bond Guarantee Program, administered through the CDFI Fund. Open specifically to CDFIs, this program offers long-term credit at below-market interest rates to incentivize community investments. The program is designed to function at no cost to taxpayers, as the organization that issued the bond must repay it.
  • Applying for membership in the Federal Home Loan Bank System through a regional chapter, which provides access to the competitively priced financing, community development grants, and other banking services.
  • Seeking equity investments from an institutional partner. For example, Annaly Capital Management invested $20 million in a number of our existing loans. For its part, Annaly will earn a return on its investment while allowing us to use that equity to grow our balance sheet and finance new loans.
  • Partnering with an organization that already has an impact investment platform. For example, as part of our exploration, we joined with Calvert, AARP, and the AARP Foundation to launch the Age Strong Investment Fund. Through Calvert’s platform, organizations and individuals can invest in the fund, and the proceeds go toward making loans to projects that help older adults. Those investors are then eligible for a financial return.

CDFIs and nonprofit organizations should not hesitate to get creative with raising capital. The more we establish our credibility in the marketplace, the easier we can engage with investors. If we have learned one thing, it is that the appetite for supporting our mission-driven efforts exists—we just need to find mutually beneficial ways to engage investors and boost that appetite.

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