Harvard Law School’s Introduction to Social Entrepreneurship course collaborated with ITP in the creation of this Article. The Impact Terms Guide is divided into substantive areas which explain the theoretical frameworks involved in aspects of impact investing and how they relate to concrete terms found in investment contracts.
This article focuses on how to incorporate the broad principles and practices found in impact investing into impact investing agreements. Investors may also require information on substantive aspects of impact investments, including strategy, origination and structuring, portfolio management, exit, and independent verification. A high-level discussion of such elements may be found in IFC’s Operating Principles for Impact Management. The sample terms in this guide can be viewed as examples of contractual means to apply, address, or implement the elements discussed in IFC’s 9 Operating Principles for Impact Investment.
The Global Impact Investing Network (GIIN) defines impact investing as “investments made with the intention to generate social and environmental impact alongside a financial return.” But three main questions remain: (1) what is “impact”? (2) how should we measure “impact”? and (3) how should we incorporate “quantified impact” into impact investing agreements?
Through the Impact Management Project, more than 2,000 enterprises, investors and practitioners have come together to build global consensus on how we talk about, measure and manage impact. According to the consensus, impact can be deconstructed into five dimensions: What, Who, How Much, Contribution, and Risk.
- The “what” tells us what outcomes the enterprise is contributing to and how important the results are to stakeholders;
- The “who” tells us which stakeholders are experiencing the outcome and how underserved they were prior to the enterprise’s effect;
- The “how much” tells us how many stakeholders experience the outcome, what degree of change they experience, and for how long they experience the outcome;
- The “contribution” tells us whether an enterprise’s and/or investor’s efforts result in outcomes that are likely better than what would have occurred otherwise; and
- The “risk” tells us the likelihood that the impact will be different than expected.
Concerning the first question, the Stanford Social Innovation Review identifies three basic parameters of impact: enterprise impact, investment impact, and non-monetary impact. Enterprise impact relates directly to the social value of the goods or services provided by the investee company. Investment and non-monetary impact, on the other hand, refer to the investor’s input or contribution to the social value created by the enterprise; the only difference is that the former is financial while the latter covers every other form of contribution aside monetary contribution. The other two questions posed earlier in this section seek to ensure the effective interaction of these basic parameters of impact.
Regarding the second question, various measurement standards have been proposed, including but not limited to the Impact Reporting & Investment Standards (IRIS), and the Global Impact Investing Rating System (GIIRS). There are also third parties dedicated to measuring impact, such as Acumen, through its Lean Data Project.
Section 1 of this guide mainly deals with the third question and will inevitably refer to the various measurement standards under the second question. Specifically, we will explain and summarize four feasible approaches typically adopted to incorporate “quantified impact” into impact investing agreements, supported by sample impact terms collected through Toniic’s ITP.
From the legal perspective, the most effective way to ensure a target company takes “impact” seriously is to impose obligations through mutual agreements. In practice, various approaches are taken; this guide covers four common types of contractual obligations used to track “quantified impact.”
Section 1 – Quantified Impact –
How to Incorporate “Quantified Impact” into Impact Investing Agreements
Obligation to Develop a Program to Measure Impact
While an investor may require a target company to informally measure its impact during the operation after its investment, the investor may further require the establishment of a formal program. Such a systematic mechanism can help make the measurement sustainable and transparent.
Sample Term 2-1 – Obligation to Measure Impact
Program to Measure Impact:
The Company must develop a program to measure impact in partnership with [the Investor], utilizing available tools such as IRIS, GIIRS, or other tools mutually agreed upon by both parties.
Sample Term 2-2 – Obligation to Measure Impact
La Compañía deberá de diseñar un programa de medición de impacto social conjuntamente con [ ] conforme a la metodología e indicadores de medición de IRIS (“Impact Reporting & Investment Standards”), incluyendo por lo menos dos visitas de campo al año, al igual que se deberá certificar con GIIRS (Global Impact Investing Rating System) como una GIIRS Rated Company.
The Company must develop a program to measure social impact according to the ‘IRIS’ methodology and indicators, including two visits per year. The Corporation must also get certified by GIIRS as a GIIRS Rated Company.
Sample Term 2-1 is an excerpt from a term sheet dated October 18, 2012, between a Mexican social enterprise and a Mexican impact investor. The term sheet is for discussion purposes only and is not binding on the target company or the impact investor. Nor is the target company or the impact investor obligated to adhere to any of the obligations outlined in this term sheet. Therefore, Sample Term 2-1 does not constitute a legally binding obligation. Similarly, Sample Term 2 is an excerpt from a Spanish term sheet.
If Sample Term 2-1 or Sample Term 2-2 had been incorporated into an executed formal agreement, it should have imposed a legally binding obligation on the target company. There are several points to be noted.
First, be sure to use “must” rather than “may” in this term. While “may” provides a right, option, or discretion, “must” creates an explicit obligation which cannot be waived.
Second, the obligation is to “develop” a program rather than to “ensure effectiveness” of the program. This wording creates some room for the target company to work with. As long as the target company takes reasonable efforts to design such a program, the obligation will be satisfied. An investor may try to push a stricter term in this respect, but its target company will probably resist. Feasibility must be taken into account in applying this term to a specific agreement.
Third, in addition to listing available tools, remember to be explicit that the purpose of the program is for measuring impact.
Fourth, during the development of the program, a partnership with the impact investor can ensure satisfaction of both parties and reduce potential disputes.
Fifth, the term can specify the number of measurements annually. In Sample Term 2, “two visits per year” are required.
Sixth, an investor and the target company need to agree on the impact metrics to be reported. Regarding the tools for measuring impact, both terms explicitly refer to the Impact Reporting & Investment Standards (IRIS) which is managed by the Global Impact Investing Network (GIIN). The GIIN is a nonprofit organization dedicated to increasing the scale and effectiveness of impact investing. The GIIN offers IRIS as a free public good to support transparency, credibility, and accountability in impact measurement practices across the impact investing industry.
Among others, IRIS is the catalog of generally accepted performance metrics that leading impact investors use to measure social, environmental, and financial success. In 2019, the GIIN released the new IRIS 5.0 framework which references the Impact Management Project five dimensions of impact in addition to the United Nations Sustainable Development Goals (SDGs). To choose impact performance metrics, there is no previous experience or specific expertise required. Currently, in the IRIS catalog, one can find metrics for:
- Financial performance, including standard financial reporting metrics such as current assets and financial liabilities;
- Operational performance, including parameters to assess your investees’ governance policies, employment practices, and the social and environmental impact of their day-to-day business activities;
- Product performance, including metrics that describe and quantify the social and environmental benefits of the products, services, and unique processes offered by target companies;
- Sector performance, including metrics that define and quantify impact in particular social and environmental sectors, including agriculture, financial services, and healthcare; and
- Social and environmental objective performance, including metrics that describe and quantify progress towards specific impact objectives such as employment generation or sustainable land use.
In addition to IRIS, GIIRS has also been explicitly referred to, which we will introduce in section “Obligation to Regularly Complete Impact Certifications” below.
Last, Sample Term 2-1 provides “other tools mutually agreed upon by both parties.” These other tools, such as the Social Return on Investment (SROI), can be found in the Appendix of the Getting Started with IRIS Guide. Another tool that can be used to identify the correct metrics is the mapping of the SDGs to the IRIS metrics 4.0 which was released by Toniic in 2017. This tool can help investors and entrepreneurs agree and identify relevant impact metrics based on the SDGs relevant to the company.
Obligation to Regularly Notify/Report to Investor Relevant Impact Metrics
While an investor may require a target company to notify/report its impact metrics during the operation after its investment, the investor may further require the frequency and method. Such a detailed arrangement can help make notifications or reports timely and up-to-date.
Sample Term 2-3 – Reporting Requirements
Obligation to Regularly Notify:
In addition to the information specified in 2(a)(ii) and 4(b), no more than thirty (30) days after the end of each quarterly accounting period, the Company shall notify Purchaser in writing information on the state of the business, including total employment metrics, key performance metrics, and other measures of impact, plus non-quantitative information inclusive of major accomplishments and major lessons learned.
Sample Term 2-4 – Reporting Requirements
1) Monthly conference calls
2) Quarterly reporting on social metrics and performance
3) Quarterly financial statements – balance sheet, income statement, and cash flow statement
Sample Term 2-3 is an excerpt under the section “Information Rights” in a blank template of a Stock Purchase Agreement. By comparison, Sample Term 2-4 is an excerpt from a term sheet titled “Royalty Payment Convertible Note.”
First, it can be seen that, in practice, the most common frequency for such notifications or reports is quarterly; the preferred time is no more than 30 days after the end of each quarterly accounting period.
Second, the notifications or reports shall be conducted “in writing” rather than orally. Otherwise, it will be difficult for the parties to undertake the burden of proof if there is any dispute.
Third, similar to “must,” the word “shall” also impose an obligation that cannot be waived. Avoid using “may” that provides a right, option, or discretion.
Fourth, be explicit that the notifications or reports are expected to be “quantitative” in nature. To clarity, non-quantitative information includes major accomplishments and major lessons learned.
Fifth, Sample Term 2-3 refers to “total employment metrics” and “key performance metrics,” while Sample Term 2-4 generally refers to “social metrics and performance.” For the purposes of notifications or reports, the Global Reporting Initiative (GRI) Standards will be very helpful.
The GRI Standards are the first global standards for sustainability reporting. They feature a modular, interrelated structure, and represent the global best practice for reporting on a range of economic, environmental and social impacts.
For example, regarding the “total employment metrics,” GRI 401: Employment 2016 includes disclosures on the management approach and topic-specific disclosures, including:
- Disclosure 401-1: New employee hires and employee turnover;
- Disclosure 401-2: Benefits provided to full-time employees that are not provided to temporary or part-time employees; and
- Disclosure 401-3: Parental leave
Sample Term 2-5 – Fund reporting requirements
(a) At least once a year, the Fund will submit the following:
- A written social and/or environmental impact report that includes a minimum of 3-5 impact metrics (which must include reporting on the number of underserved entrepreneurs funded (including by race, gender, age)), number of funded companies located in an economically distressed or disadvantaged area, amounts invested originally and as follow-on funding, and number of low-income individuals employed) which will be based whenever possible on existing reporting metrics and practices and which will incorporate IRIS metrics, as feasible and appropriate
- A written narrative impact report that details the social and/or environmental impact of the Fund and its investments, which may include analysis of impact metrics, anecdotes related to the Fund and Portfolio Company(ies) social impact, case studies, changes in social impact thesis or criteria, and other related impact outputs and outcomes.
Sample term 2-5 is used by an investor making an investment in a fund, requesting that the fund manager report to the investor relevant impact metrics based on the impact investment thesis of the investors. Thus the fund manager is reporting both on the fund’s activities and those of the underlying portfolio companies in the aggregate. While used by an investor investing in a fund, the principles of Sample term 2-5 can also be used by an investor to help make assessments across the investor’s portfolio.
Obligation to Regularly Deliver Social and Environmental Impacts Reports
Disclosure of sustainability agenda is a top agenda for businesses these days and even more so for impact investing. Depending on whether an investment is targeted at social impact, environmental impact or both, an investor may require a target company to provide social impact reports, environmental impact reports or a report detailing both social and environmental impact. This is often in addition to standard business reports delivered to investors such as audited or unaudited financial statements.
Social and environmental impact reporting enhances transparency and provides investors with essential information about a range of social and environmental matters of interest to them. More particularly, these reports offer impact investors with the information they need to make informed investment decisions in the future.
Sample Term 2-6 – Information Rights
The Investor will have the right to be periodically informed on the Company’s management and on the projects pursued by the same. The Investor shall be entitled to customary information rights as provided for in the Definitive Agreement, the Company shall deliver to the Investor the following information:
(a) Audited annual financial statements within hundred and twenty (120) days following the close of each financial year;
(b) Unaudited Quarterly and semi-annual financial statements within thirty (30) days of the end of each quarter;
(c) Cash Flow detailing the use of proceeding within fifteen (15) days of the end of each quarter with relevant comments on operations;
(d) Quarterly Commercial report in the specified format detailing the commercial progress made by the Company, with main KPIs;
(e) Quarterly Social and Environmental Impacts Report;
(f) Yearly budget at least thirty (30) days prior to the beginning of the financial year;
(g) Business plan updated each year, at least thirty (30) days prior to the beginning of the financial year.
Sample Term 2-7 – Impact Auditing Rights
[As long as the Investors hold at least X percent of the Shares purchased] OR [During the term of the Loan], each Impact Report described in the preceding paragraph shall be audited by a third-party organization with relevant expertise, [selected by the Investors and reasonably acceptable to the Company] OR [agreed upon by the Investors and the Company]. Costs of the audit shall be borne by the Company. If mutually agreed, the findings of the audit may be publicized by the Investors and the Company.
Optional Audit Language:
[As long as the Investors hold at least X percent of the Shares purchased] OR [During the term of the Loan], the Investors may require that the Impact Report described in the preceding paragraph be audited by a third-party organization with relevant expertise, [selected by the Investors and reasonably acceptable to the Company] OR [agreed upon by the Investors and the Company]. If an audit is requested more frequently than once every [three] years, then the investors shall pay for the audit, unless the audit reveals substantial reporting errors. If mutually agreed, the findings of the audit may be publicized by the Investors and the Company.
Sample Term 2-6 is an excerpt from a term sheet between a Mexican social enterprise and an impact investor. As with other term sheets, the information rights contained in Sample Term 2-6 are non-binding on the parties until included in a definitive agreement signed by the parties. Sample Term 2-7 is a sample term on third-party verification of a company’s impact reporting.
The duration covered by social and environmental reports varies; they could be annually, semi-annually or quarterly. Sample Term 2-6 requires that the reporting be provided to the investor on a quarterly basis. Quarterly reporting has its advantages and disadvantages. On the positive side, it provides investors with information at the earliest opportunity. Depending on other provisions of the agreement contemplated by the parties, the investor may be able to take specific actions or make recommendations where the social or environmental impact is found to be insufficient. On the flip side, however, quarterly reporting might provide less flexibility, overburden the company and take away management time.
The content of social and environmental reports equally varies. However, these generally include information necessary for an understanding of the company’s development, performance, and effect of its activity as it relates to sustainability, corporate responsibility, environmental, social, and governance (ESG), employee matters. The reports should contain detailed explanations of the company’s policies in relation to these matters and in the absence of such systems, a clear and reasonable explanation for not doing so or steps being undertaken to put such policies in place. Also, the reports should contain not just a description of the company’s policies and activities targeted at achieving positive impact, rather, the reports should contain analysis about how much change occurred as a result of those policies and activities.
Furthermore, it is typical to involve third parties to verify a company’s reported performance against its agreed-upon impact metrics. Sample Term 2-7 is an example of this requirement. To be effective, it is essential to state the mode of appointing the independent third party as well as the qualification of the third party. It is also advisable to insert languages clarifying which party bears the cost of the audit. Generally, the cost of such verification is incurred by the company. However, where the audit is required to be done quite frequently, the agreement may provide for the cost of the audit to be born by the investor or jointly by the company and investor. The “Optional Audit Language” is an example of this.
Obligation to Regularly Complete Impact Certifications
With the advent of third-party impact ratings regarded as comparable, transparent, and easy to use, investors can assess the impact of their investments for scalability decisions in the impact investing marketplace. The resultant effect of third-party impact ratings has been the growing demand by investors in the impact investing space for impact certifications. This is especially important to investors as they can compare the impact of their investments across companies, geographies, and industries.
Sample Term 2-8 – Impact Certification Requirement
The Company hereby agrees to complete an impact certification on behalf of the Global Impact Investing Rating System (GIIRS) at least once annually post-Closing
Sample Term 2-9 – Impact Certification Requirements
La Compañía deberá de diseñar un programa de medición de impacto social conjuntamente con [ ] conforme a la metodología e indicadores de medición de IRIS (“Impact Reporting & Investment Standards”), incluyendo por lo menos dos visitas de campo al año, al igual que se deberá certificar con GIIRS (Global Impact Investing Rating System) como una GIIRS Rated Company.
The Company must develop a program to measure social impact according to the “IRIS” methodology and indicators, including two visits per year. The Corporation must also get certified by GIIRS as a GIIRS Rated Company.
Sample Term 2-8 is also an excerpt from a term sheet between a Mexican social enterprise and a Mexican impact investor. The term sheet is for discussion purposes only and is not binding on the target company or the impact investor. Nor is the target company or the impact investor obligated to adhere to any of the obligations outlined in this term sheet. Therefore, Sample Term 2-8 does not constitute a legally binding obligation. Similarly, Sample Term 2-9 is an excerpt from a Spanish term sheet.
Sample Terms 2-8 and 2-9 impose mandatory obligations on the target companies to be certified as a Global Impact Investing Rating System (GIIRS) rated companies. This appears to be a high standard requirement as GIIRS Ratings are much-admired as the gold standard for impact measurement in impact investing.
It is important to point out that exact wording used to impose the company’s obligation to obtain impact certification is crucial to the efficacy of such terms. It is thus preferable that words such as “must,” “shall” or “agree” be used rather than words or phrases such as “may,” “should consider” or other discretionary words.
The GIIRS Rating, powered by the B-Lab under its B Impact Assessment, is a rigorous, comprehensive tool to assess a company or a fund’s overall social and environmental performance. This is done by measuring the impact of a business on all stakeholders on an analytics platform. GIIRS uses IRIS metrics in conjunction with additional criteria to arrive at an overall company or fund-level rating, as well as targeted sub-ratings in the categories of governance, workers, community, environment, and socially and environmentally-focused business models. The GIIRS uses a cross-industry and cross-geographic methodology and utilizes a system that varies based on the sector and market in which the fund or company operates. The GIIRS is also useful in generating data for industry benchmark reports.
The GIIRS fund rating covers three parts (Overall Impact Business Model Rating, Overall Operations Ratings, and Fund Manager Assessment). The rating process is as follows:
- Sign term sheet & join GIIRS fund cohort
- Complete fund manager assessment and validate responses
- Orient portfolio companies to GIIRS rating process and B Impact Assessment
- Use B analytics to interpret and report on impact data
- Share and publicize GIIRS Rating to stakeholders
The GIIRS process for companies is as follows:
- Register for the B Impact Assessment using a custom link
- Complete B Impact Assessment, review and validate responses
- Sign Senior Management Verification Statement & Term Sheet
- Share and publicize GIIRS Rating to stakeholders
- Upon completing the process, the company is at liberty to include the GIIRS Impact Rated logo on its web and marketing materials
Other frameworks for measuring impact that may be considered include IRIS promoted by the Global Impact Investing Network, the Sustainable Accounting Standards Board (SASB) Standards, Global Reporting Initiative Standards, and the International Integrated Reporting Council (IIRC) Framework.
This section posed three crucial questions at the onset — What is “impact”? How is “impact” measured? How can “quantified impact” be incorporated into impact investing agreements? The sample terms and comments above seek to unpack the impact in impact investing to ensure that financial investment opportunities indeed produce social or environmental benefits and possibly the triple bottom lines of economic, social and environmental benefits.
Across all subheadings covered by this section, one major takeaway is the need for carefulness and precision in choice of words and language. Words that allow some degree of discretion should be avoided when the intent of a term is best fulfilled without discretion.
Section 2 – Specific Purpose –
How to Incorporate “Specific Purpose” into Impact Investing Agreements
This section provides an overview of how to incorporate a “specific purpose” into Impact Investing Agreements. While section 1 focuses on impact and how to measure it, section 2’s main goal is to provide impact investors feasible approaches to make sure that the companies where they are investing uphold their commitment towards the social and environmental impact of their choosing.
Section 2 explores four practical feasible approaches that deal with the different stages business organizations can use Corporate law and Contract law to protect their purposes and the social and environmental impact such purposes want to attain. These approaches are company’s (i) specific purpose as a covenant & events of default; (ii) obligation to respect a social business charter; (iii) restriction on usage scope of proceeds; and, (iv) awareness of investment purpose. This section also briefly explores possible incentives and disincentives to promote adherence to a company’s specific purpose.
To explore the above-mentioned approaches, it is important to understand the interpretation of purpose under this context. Since the beginning of the 21st century, corporate purpose is being reinterpreted. Professor Colin Mayer, former Dean of Said Business School at Oxford University, states that the “purpose of business is not to produce profit, the purpose of business is to produce profitable solutions to the people and the planet.” This consideration is shared by many investors who want to make sure they are investing in purposeful organizations.
Incorporating a “specific purpose” into impact investment agreements may be done through a variety of contractual tools, which vary in their enforceability. Impact investors can choose which elements they want to include in their agreements to ensure that the chosen purpose is being upheld. Moreover, impact investors can choose corporate models that have specific corporate purposes built-in, as well as expanded considerations regarding governance. Specific purposes may be based on bespoke shared values or on external tools such as the UN’s Sustainable Development Goals (SDGs). The Global Impact Investing Network (GIIN), for example, has based its approach towards impact investing on the SDGs and has created its impact metric catalog, IRIS, with the SDGs in mind.
The SDGs are part of the United Nations 2030 Agenda for Sustainable Development and provide a shared vision and common framework for action. These goals were agreed by 193 member states as they are universal in nature and they aim to promote an integrated and comprehensive approach that defines responsibilities and fosters accountability among all actors. SDGs are an opportunity for impact investors to match their bylaw or contractual provisions to any of them, ideally drafting measurement requirements.
A corporate form, which is used to align specific purposes and profit motives, is the Benefit Corporation model. Corporate law gives impact investors a variety of legal forms to choose from when incorporating a business organization. Incorporating as a Benefit Corporation is an option in 35 U.S. states and Washington D.C. and allows shareholders to protect the vision they have for their business. These are for-profit enterprises that have social and environmental purposes, allowing long term mission alignment and value creation. Directors must consider the public impact of their decisions, rather than focusing solely on maximizing shareholder value.
Section 2 also explores the topic of how to promote adherence to the chosen purpose through contractual means. Incentives and disincentives are outlined with the objective of showing potential strategies that might be useful to include in contractual provisions to protect a social or environmental purpose.
When incorporating a “specific purpose,” impact investors can choose from a variety of tools. The feasible approaches explained below demonstrate how some of these tools are employed.
From the legal perspective, the most effective way to ensure a target company maintains its dedication to its specified purpose is to impose this obligation through mutual agreements. In practice, there could be four types of obligations to ensure a company behaves according to its specific purpose.
Specific Purpose as a Covenant & Events of Default
Impact investing is, by definition, meant to have a positive impact on our planet and its people as well as financial returns. Many impact investors and enterprises seeking impact capital, however, may have much more specific purposes. If an investment is made with such specific purposes in mind, it may be useful to formalize these purposes in the impact agreement itself. One way of accomplishing this is by including a Social Investment Purpose Covenant.
Such a covenant expresses to all parties involved that such investment is made with specific purposes in mind in addition to monetary gains.
Sample Term 2-10 – Social Purpose Covenant
Social Investment Purpose Covenant:
The social purpose of the purchase of the Note by [FOUNDATION] (the “Investment”) is to improve access to and delivery of quality, affordable healthcare for low-income and other underserved people and communities across the United States, by accelerating the development and implementation of online programs for disease prevention and management for patients primarily serviced by federally qualified health centers (FQHCs) and other safety net organizations that provide medical services to underserved people.
Note that Sample Term 2-10, taken from an anonymized Promissory Note Financing Agreement Term Sheet, takes the form of this formula:
The social purpose of [the impact investment]
is to [accomplish a specific purpose]
for [a target population and geographical area],
by [using a certain method].
This formula may be altered depending on the specifics required by the investors. It is important that the social investment purpose covenant be flexible enough to encompass unforeseen but desirable or necessary program expansions or alterations.
For debt transactions, the social investment purpose covenant may also be helpful in defining the Events of Default.
Sample Term 2-11 – Social Purpose Covenant (debt)
Events of Default:
Events of default under the Note shall be limited to the following: … (viii) a failure to meet the Social Investment Purpose Covenant; …
As Sample Term 2-11 demonstrates, by incorporating the social purpose covenant into the events of default, a failure to meet such social investment purpose will quality as an event of default and will trigger the contractually defined consequences. If Sample Term 2-10 is used in conjunction with Sample Term 1 a failure to work towards a specific purpose for a specific target population and geographical area, by using a specific method will qualify as an event of default and trigger the consequences.
Obligation to Respect a Social Business Charter
Instead of integrating a social investment purpose covenant into the investment agreement, impact investors or entrepreneurs may prefer to require a separate social impact commitment. Such commitments may be in the form of a required by-law or as change to the company charter itself.
Sample Term 2-12 – Social Business Charter
Social Business Charter:
The promoters shall respect a Social Business Charter, which will be attached to the Definitive Agreement.
It will provide:
1) the management will encourage social and environmental impacts
2) the management will identify the indicators of this impact
3) a reporting will be done: the content and the schedule of its presentation in front of the shareholders will be specified.
Such a Social Business Charter provision, as in Sample Term 2-12, taken from a Senior Participating Convertible Loan Term Sheet, may be helpful in assuring appropriate management action and company self-regulation. Just as with a social purpose covenant, the attached social business charter may be as detailed or vague as the parties require, but should be carefully drafted to ensure the appropriate scope of work desired.
Restriction on Usage Scope of Proceeds
Impact investors may not only require a specific purpose but may also require a specific management plan which will lead to the accomplishment of such purpose.
Sample Term 2-13 – Use of Proceeds Restriction
Use of Proceeds:
Operating capital for implementation of the Company’s products with mutually agreed upon partners (including payors, health plans, and providers), including development and testing of a Spanish language version of the product and development of mobile features to make the product more accessible to low-income people
A Use of Proceeds Term, as in Sample Term 2-13, taken from a Promissory Note Financing Agreement Term Sheet, controls the scope of how invested funds will be used. Instead of granting the company full autonomy in determining how to accomplish the defined social purpose, such terms grant investors much more control over the specifics of how the funds will be spent. Specifically, Sample Term 2-13 grants investors the right to determine the “mutually agreed upon partners” with which the company will transact.
This level of control may require investors to become more participatory in the decision-making process before or during the implementation of company programs. By participating in the decision-making process, investors may gain a closer relationship with the company such that they can ensure the social purpose of the investment is carried out.
Awareness of Investment Purpose
Investors may want to ensure that companies understand the larger social purpose of the investment. By incorporating an Ethics Term into investment agreements, investors may require companies to be aware of and endorse the social commitments of the investors, thereby aligning the social purpose of the investor with the social purpose of the company.
Sample Term 2-14 – Ethics Requirement
The Company shall acknowledge having been aware of and agree with the Investor commitments in the area of ethics and sustainable development.
Sample Term 2-14 requires the company to be “aware of and agree with” the commitments of the investor. Such a term may require more research by the company or lead to more open channels of communication between the investor and investee.
Once a specific purpose has been agreed upon and incorporated into investment agreements, it is also possible to promote adherence to said specific purpose through various contractual methods. Incentives and disincentives may be used to ensure the alignment of incentives between the investor and investee.
i. Increase in Founder/Management Equity
If investors are willing to forfeit shares in the company if specific milestones are reached, it is possible to incentivize the founder(s) or management team through an equity reward. By forfeiting shares, the investor is consequently increasing the proportion of management’s equity ownership in the company.
Sample Term 2-15 – Impact Equity Incentives
[For every] OR [Upon completion of [specify impact target], the Company shall have the right to cause the forfeiture of up to [X Preferred Shares] or [X percent of the Preferred Shares], which forfeiture may be structured as a redemption of Preferred Shares at an agreed upon nominal value.
ii. Redemption Price for Equity Transaction
If investors want to achieve a similar result without forfeiting shares, investors may want to alter the redemption price to reflect the company’s social or environmental performance.
Sample Term 2-16
Redemption price reduction based on one metric or milestone: [For every] OR [Upon completion of] [specify impact target], the redemption price per Share shall be reduced by X percent, provided that the price shall not be reduced below [$X per Share] OR [the Purchase Price] OR [a redemption price per Share equivalent to an X percent return per year on the Purchase Price].
iii. Interest Rate Decrease for Debt Transactions
For debt transactions, debt-holders may promote the achievement of their specific purposes through a decrease in interest rate. The rewarded decreased interest rate may apply to the debt as a whole or may be applied to a proportion or predetermined amount of the debt held.
Sample Term 2-17
Impact Performance Adjustment: [For every] OR [Upon completion of] [specify impact target], the rate of the Accruing Interest shall be reduced by X percent. In the aggregate, the interest due on the Maturity Date shall not be reduced by more than the total amount of the Accruing Interest.
As written, Sample Terms 2-15, 2-16, and 2-17 are triggered through the use of a single metric or type of milestone. The term, however, may be made more complex if multiple metrics must be balanced, depending on the complexity of the specific purpose agreed upon.
i. Interest Rate Increase for Debt Transaction
Just as interest rate decreases may be used to incentivize good performance, interest rate increases may be used to disincentivize bad performance. In fact, investors may choose to have a variable interest rate tied to one or multiple performance metrics such that the company is subject to both interest rate increases and decreases as a consequence of their performance in achieving their specific purpose.
Sample Term 2-18
Increase interest rate based on a single factor: If during the term of the Loan the Company fails to cure the violation of [specify the penalty trigger] within X days, the interest rate shall be increased by X percent, provided that the interest rate shall not be increased above the Initial Rate plus X percent.
ii. Forced Repurchase of Investor Shares
Should a company fail to achieve its specific purpose in such a way that leads investors to believe further efforts are futile or inefficient, investors may want to divest from the company. This may be accomplished through a forced repurchase of investor shares. Such repurchase occurs through a forced redemption of shares, which may interact with adjustments to the redemption price as described above.
Sample Term 2-19 – Repurchase of investor share
Forced Repurchase of Investor Shares: As long as any of the Preferred Shares remain outstanding, if [specify the redemption trigger], the Investor may require redemption of [all or any portion of the Preferred Shares held by the Investor] OR [all but not less than all of the Preferred Shares].
Sample Term 2-20 – Restrictions for legal requirements of foundations
Restrictions, Limitations and General Provisions due to legal requirements for charitability that apply to Investor as a private foundation:
- the Fund agrees to use reasonable, good faith efforts to satisfy all investment requirements as provided for in paragraph 1 above within a twenty-four (24) month period following the Investor’s investment, with up to four (4) extensions of three (3) months each available with the written consent of Investor not to be unreasonably withheld based on the Fund’s documentation of a pipeline of reasonably likely investment opportunities that meet the requirements of paragraph 1 above expected to close within the extension period.
- If the Fund does not meet the requirements of paragraph 1 above within the timeframe provided for in paragraph 5(a) or such other time as the Fund and Investor may mutually agree in writing, the Fund shall within one hundred eighty (180) calendar days of the expiration of that deadline return to Investor (a) all invested capital provided by the Investor that does not comply with the requirements of paragraph 1 above and (b) all paid-in capital not irrevocably committed to be invested pursuant to the requirements of paragraph 1 above plus (c) interest on such amounts at the Secured Overnight Financing Rate (SOFR) as averaged daily over the period from the most recent date(s) on which Investor provided the funds to the date that such capital is returned.
- If Fund does not satisfy the requirements as provided for in paragraph 2 (impact reporting) above, then the Fund within thirty (30) calendar days of Investor sending a written request, which request shall describe the failure and means for remedying the failure, the Fund shall either satisfy the requirements, explain in writing why it reasonably and in good faith believes that it has already satisfied the requirements, or present a plan for doing so that Investor deems reasonable in its good faith judgment.
- Because the impact reporting is an integral part of research being conducted through Investor and to ensuring compliance with paragraph 1 above as required by federal law, if the Fund fails to satisfy the requirements of paragraph 2 above after notice and opportunity to explain or cure as provided for in paragraph 5(b), then the Investor shall have the right, at the Fund’s expense, to conduct an audit of the relevant books, records, and accounts of the Fund and access to the relevant managers of the Fund and the portfolio companies to obtain the information necessary for compliance with the requirements of paragraph 2. If the Fund, its relevant managers, and/or the portfolio companies fail to cooperate in providing the information sought pursuant to paragraph 2 above and/or if the Fund does not reimburse Investor within thirty (30) calendar days of submitting an invoice of its related expenses, Investor may demand that the Fund return the greater of the fair market value of Investor’s holdings in the Fund or all invested capital provided by the Investor along with capital paid in by Investor but not yet invested by Fund plus interest on such amounts at the Secured Overnight Financing Rate (SOFR) as averaged daily over the period from the most recent date(s) on which Investor provided the funds to the date that such capital is returned.
- Prior to invoking the provisions of this paragraph 5, Investor shall notify the General Partner in writing of its belief that the Fund is not in compliance with its obligations under paragraph 1, 2 or 3 above. If requested by Investor, the General Partner and Management Company will facilitate a call with the Investor in which the General Partner and Management Company provide an update on the Fund’s compliance with those paragraphs and, at the reasonable request of Investor, document its reasonable, good faith efforts as applicable in this paragraph 5 towards complying with paragraphs 1, 2 or 3 above.
In the event of one of a failure to comply as set forth in (a)(i), (a)(ii), or (b), after notice and opportunity to explain or cure as provided for in paragraphs (b) and/or (c), in addition and without limiting its rights and abilities under the preceding or otherwise, Investor shall have the option to fully opt-out of its remaining commitment(s) and/or otherwise withdraw from the Fund without penalty or consequence, including under any applicable Operating Agreement and notwithstanding provisions to the contrary contained within any such Operating Agreement; after which, Investor shall have no further responsibilities to the Fund.
If the Fund represents and warrants to Investor in writing that cash is not and is not likely to be available to timely satisfy obligations and its subparts and/or that obtaining such funds is likely in its good faith judgment to either jeopardize the ability of the Fund to remain substantially in operation and/or to have a materially adverse effect on one or more companies in the portfolio, then a promissory note that encompasses the payable principal amount plus interest (compounded annually) may be developed and entered on such terms and conditions as are mutually agreeable to the Fund and Investor in good faith. Such note shall be unconditionally guaranteed in writing by the General Partner and provide that any and all costs incurred by or on behalf of Investor to enforce the note, including but not limited to reasonable attorney’s fees, shall be payable to Investor or its proxy in conjunction with its successful enforcement of the note. Notwithstanding the preceding, because of its obligations as a private foundation to comply with federal law, Investor reserves the right to reject such a plan if Investor reasonably and in good faith has determined that the Fund has failed to remedy material failures to comply with paragraphs 1 and/or 2 above and/or document its reasonable, good faith efforts to do so.
Sample term 2-20 is used by a United States foundation to advance the charitable characteristics of its investment activity in the same way as a Program Related Investment would work, as defined by the Internal Revenue Service of the United States government. The foundation’s charitable purposes are to increase the flow of capital to underserved entrepreneurs who are unable to access adequate capital from traditional commercial sources due to their membership in a historically disadvantaged group(s) or the location of their activities in a distressed or otherwise disadvantaged and underserved region. The Sample Term 2-20 enables the foundation to disincentivize the use of proceeds for investments by the funds that do not align with the foundation’s charitable purpose and to have meaningful recourse and accountability thereto.
Impact investors may want to require companies to commit to a specific social, environmental, or economic purpose. Incorporating these requirements into investment contracts is a good starting point in holding companies accountable to act on such specific purposes.
In this section, we have enumerated the tools above independently. However, the various terms, conditions, and incentives are not mutually exclusive. They and may be, and frequently are, used in conjunction with each other in a single investment contract.
Harvard Law School
Temitope Giwa is currently an LL.M. student at Harvard Law School. Upon her admission to the Nigerian Bar in 2016, she worked in Tier 1 Commercial law firm, specifically honing her skills in Corporate Law, Commercial Law and Dispute Resolution. She has significant experience in providing legal solutions to private and public institutions on compliance and corporate governance matters. From the experience garnered and having attended the meetings of several private and public companies, she is well positioned to advise on business values, ethics and good governance. Temitope previously contributed to an information and resource product, CSR FilesTM Corporate Governance Edition. She was also part of the team that hosted the 2015 Africa CEO Roundtable & Conference on Corporate Sustainability & Responsibility where the role of corporate governance on sustainability, the interrelationship between economic-environmental performance, social performance and corporate governance was considered amongst other governance matters. She can be reached via LinkedIn at https://www.linkedin.com/in/temitope-giwa/
João Marinotti is currently a student at Harvard Law School, J.D. class of 2020. He was born in São Paulo, Brazil, and has since lived in the United States, China, and Scotland. João is the founder of Discus Institute, a 501(c)(3) non-profit organization dedicated to fostering innovation through global partnerships to achieve the UN’s Sustainable Development Goals. He currently serves as one of the Co-Vice Presidents of Projects for the Harvard Law & International Development Society for the 2018-2019 school year. João is particularly interested in large-scale sustainable infrastructure projects and co-authored the international project finance legal clinic at the 2018 Workshop on Closing the Investment Gap on Sustainable Infrastructure co-convened by UN DESA, CDP, and the Johns Hopkins School of Advanced International Studies. Prior to law school, he served as rapporteur for the 2017 Symposium on Language, the Sustainable Development Goals, and Vulnerable Populations, held by the Study Group on Language and the United Nations. He can be reached via LinkedIn at https://www.linkedin.com/in/joão-marinotti-66993563
Juan Diego Mujica Filippi is currently an LL.M. student at Harvard Law School. He is a Peruvian lawyer with experience in Corporate and Real Estate Law, as well as in Corporate Social Responsibility. His thesis, Benefit Corporations: a Corporate Approach to Social and Environmental Welfare earned him a Summa Cum Laude law degree and prompted the introduction of a Benefit Corporation draft bill in the Peruvian Congress in early 2018. Ever since, he has dedicated his time to promote for-benefit organizations and to counsel for-profit business organizations on how to craft a social or environmental purpose to become Certified B Corporations or eventually Benefit Corporations. He is currently co-chair of the Latin American Network of B Lawyers. He can be reached via LinkedIn at https://www.linkedin.com/in/juandiegomf
Danni Zheng is a Harvard Law School LL.M. student from China. She earned her Bachelor of Laws and Master of Laws degrees in China, and has work experience at Freshfields Bruckhaus Deringer (Hong Kong) and at the World Bank Group (Washington D.C.). She is the founder of DEEP Career, a social enterprise aiming to “Deliver Equal and Endless Possibilities” for Chinese young talents. She also authored the first comprehensive paper on social enterprise law firms. She is the Alumni Relations & Career Development Co-chair of Harvard Chinese Students and Scholars Association, and the Chair of Shenzhen Discussion/Social Group of Alumnae-i Network for Harvard Women. She is qualified to practice law in China, and leant impact investing, social entrepreneurship, corporate responsibility at Harvard. She can be reached via LinkedIn at https://www.linkedin.com/in/dannylawyer/