Some of the most impactful investments face the steepest funding challenges, at least in the early stages. While a favorable blend of risk, projected impact, and expected returns can quickly stimulate demand for select impact investments, others struggle to get off the ground. Weighed down by obstacles such as outsize upfront needs, logistical hurdles, and uncertain return potential, such initiatives can falter at the starting gate.
That is where catalytic capital providers thrive. Driven by a “strong impact-first orientation” and the desire to “tackle a tough financing gap,” according to Debra Schwartz of the MacArthur Foundation, these investors can leap in to put a project in motion.
What Is Catalytic Capital?
Catalytic capital is not a fit for all investors. According to a 2019 report from impact investing consulting firm Tideline, the approach relies upon investors who are willing to accept disproportionate risk and/or concessionary returns, yet it can enable “third-party investment that otherwise would not be possible.”
Spanning the gap between grants and conventional impact investments, catalytic capital investors make concessions in any combination of five areas, according to Tideline’s Catalytic Capital: Unlocking more investment and impact:
- Price: Expecting a below-market return, relative to ancitipated risk.
- Pledge: Providing guarantees for credit enhancement.
- Position: Accepting a subordinated debt or equity poisition for the sake of enhancing credit.
- Patience: Sustaining investment over a longer than usual or even an uncertain time horizon.
- Purpose: Being open to unconventional terms in order to meet investees’ needs, for example accepting no collateral or smaller investment sizes.
While allowances like these have existed in a piecemeal way for decades, the Global Impact Investing Network (GIIN) formalized a more holistic approach in its 2013 report Catalytic First-Loss Capital. According to that report, a catalytic capital investor helps improve the creditworthiness of a company by agreeing to be at risk for loss and improving that company’s financial profile. This helps make impact goals more achievable by incentivizing other investors with more conventional risk-return needs to participate.
More broadly, catalytic capital is a key element of blended finance, which taps a variety of sources to support a project until more traditional investors step in.
Catalytic Capital in Action
Respondents to the GIIN’s Annual Impact Investor Survey 2018 highlighted government actions like credit guarantees and first-loss provisions as crucial for impact investment funding. Led by well-established foundations, catalytic investors have increasingly assumed that mantle as well—an important development considering the looming overhang of the COVID-19 pandemic for governments in the coming years.
At the impact level, catalytic capital can be significant. For example, six catalytic foundation investments in the NYC Housing Acquisition Fund paved the way for senior loans from over a dozen more institutions. As of last year, the fund has been able to leverage $415 million to help finance over 10,000 affordable apartments.
In another example, the Cavendish Impact Foundation supplied early-stage capital to a biotechnology firm addressing the historically underfunded brain-health space. The capital helped the company to survive the “valley of death” between startup research and development efforts and the potential commercial viability of its schizophrenia treatment that is ready for the third phase of clinical testing.
The fate of either effort without such timely funding cannot be known. However, the existence of catalytic capital ensured that both entities could ease the financing burden long enough to sharpen their missions and improve their appeal to additional investors.