by Marta Maretich
Like most social investors, Root Capital assumed the social and environmental due diligence it carried out when assessing potential loan clients was a necessary cost to the organization. When they took a close look at their loan book, the truth took them by surprise.
“We initially set out to build the impact case for social and environmental due diligence,” says Willy Foote, founder and CEO of Root Capital. “Along the way, we started to notice an emerging business case for social and environmental due diligence in the form of reduced risks and new growth opportunities.”
Analyzing its own data from a well-established and diverse portfolio of social lending projects, Root Capital was able to identify five areas where there were compelling synergies between social, environmental and financial interests:
1. Identifying and mitigating credit risk Social and environmental due diligence proved key to mitigating supply risk; related to smallholders selling their harvest to other buyers; and the risk of product rejection due to inadequate quality or certification violations, leading to financial losses.
2. Generating new business Root Capital found it attracts new clients because of their track record of caring about social and environmental factors. Their good reputation in the communities where they operate boosts their business.
3. Identifying businesses with growth potential Businesses at an early stage may not be able to present compelling financial statements. In these cases, due diligence can uncover growth potential; for example, a strong base of producers and the existence of potential higher-value markets.
4. Strengthening businesses Social and environmental due diligence provides an opportunity for clients to identify ways to improve their relationships with suppliers and manage their natural resources more efficiently, improving the viability of their businesses.
5. Deepening relationships with existing clients The social and environmental due diligence process reveals unmet financial needs among existing clients; and gives Root Capital an opportunity to meet them, thus building their loan portfolio with trusted clients.
All this sounds terrific; but what do the numbers tell us about the financial value of social and environmental due diligence?
According to the briefing, early analysis suggests that Root Capital’s social and environmental due diligence program covers its own costs. With five percent of their loan officers; time devoted to it; across a loan book of $120.8 million to 205 enterprises in 2012; initial analysis concludes that social and environmental due diligence helped Root Capital avoid write offs and generated enough incremental revenue to pay for itself.
This is potentially game-changing news for the impact and social investing sector which has long thought this kind of due diligence was a financial cost, not a benefit. It turns out that due diligence can be a means to bring local market knowledge, environmental awareness and community engagement into the financial equation, leading to better decisions for the lender and better impact outcomes.
The impact case for social and environmental due diligence is already strong; Root Capital, with its commitment to measurement and transparency has done much to validate it. With this briefing, and more like it planned for the future, Root Capital is now taking steps toward building the business case. For the impact sector, it is a further sign that the practice of impact and social investing is advancing and at the same time becoming a mainstream way of doing business.
It is also something of a challenge to the rest of us: When will other impact investors choose to reveal and make useful sense of their numbers? When you see how unexpected the results can be, you know that the sooner we all do it, the better.
For more on this and future briefings, go to Root Capital’s website.