Research

Vishal Mehta is Co-founder and Partner at India-focused impact investment firm Lok Capital. In this interview, Vishal speaks to EMPEA about how the firm’s social mission can be measured, as well as the commercial and social opportunity set in the underserved segments of India’s private markets.

Lok Capital’s mission combines commercial and social goals. How do these two interests function together at Lok?

It is a fine balance, and there is no single scientific way to achieve this balance. There are several underserved communities and geographies in India that require basic services and basic products that, to date, neither the pure market-driven models nor the public sector-driven models have been able to address. The question for us then became: is this something we can address? We began experimenting with this line of thinking 12-13 years ago, and have since honed in on achieving this balance. Our experience has shown that the impact we can generate is significant and that the returns are also comparable—in some sectors even better than market rate.

Lok Capital’s unique structure helps us to balance commercial and impact interests. Lok Capital is sponsored by the Lok Foundation, our non-profit parent organization, and half of our carry goes straight to our foundation. This helps us to clearly convey our own motivations, combining both commercial and impact rationales. In the beginning, before we had built a track record, it was a very painful structure to sell to investors. LPs were concerned about how the structure would enforce discipline and provide incentives for the team—which are valid points. However, the same LPs no longer discuss the structure as much, even if, given the option, they would prefer the standard private equity fee structure. More broadly within the impact space, we see the structure garnering the interest of more and more LPs, and we hope to see this innovation gain traction and be used by more impact investors going forward. Given the fact that our commercial performance has been good, we are able to attract LPs with both commercial and impact focus.

In terms of our investing and operational value-add, there are also some differences between us and other private equity firms. For example, some of our companies may take longer and require more patience to meet objectives. But, as we target underserved and unsaturated markets, we can target good returns over time. Of course, as in traditional private equity, you must also think about how you set up your fund and how you select your promoters. Ultimately, we seek balance between making money and addressing underserved markets.

How does Lok measure or benchmark its social mission?

On the impact side, we use broad frameworks to benchmark our mission. In every sector in which we are active, we have defined, sector-specific parameters for what constitutes impact. For example, for financial services, we focus on target group-based identification. For health care, we target the underserved in general—those that lack access to health care facilities. Finally, perhaps most useful is to judge and understand the motivations of the promoters with whom we partner. If we are investing in a venture that we feel has impact, do we see the other side being motivated by the same factors? This is a more subjective judgement to make, but as an investor it is one that you must make. So, while we use some quantitative frameworks, much of it is qualitative.

In terms of reporting, we carry out impact assessments and measure our social returns very carefully. Impact investment, which was at a very nascent stage a decade ago, has since seen many frameworks be developed. You can now systematically begin measuring your impact in addition to your profits. We do this on a company- and portfolio-basis. In addition to producing annual impact reports, we conduct social action planning in our portfolio companies. For example, once we become an equity partner with a company that doesn’t have a starting point for impact measurement, we typically engage an external consultant, conduct operational due diligence and then put a system in place so that the company can carry it out on their own. We try to keep these metrics close to operational metrics, and built in so that they are kept core to the operations of the company. Still, can we quantify it such that we can say that Company X’s impact is greater than Company Y’s? No—we target commercial and impact goals, but we do not try to compare impact metrics across our portfolio companies.

Lok Capital’s first fund focused almost exclusively on microfinance and financial inclusion, while its second fund targets a much wider array of sectors. What inspired this shift, and what sectors offer the most opportunity in India from both commercial and social impact perspectives going forward?

We made this shift for a few reasons. First, as our team was initially getting off the ground and getting comfortable with deal flow for our second fund, we decided to look into expanding into new impact areas in India, and we found that basic services such as health care, education and livelihood jobs are very impactful. Second, we found that the operational and business model side of these companies is very similar to those that we have found in microfinance, where we had built expertise in our first fund. Third, we looked at where we could find deal flow. Based on these parameters, we had long discussions with our LPs and diversified. This is the same strategy we are pursuing in Lok III. One change we have made is that, while in Lok II we pursued education, in Lok III we have dropped education but will be investing in agriculture assets.

How do you see the impact investing industry evolving in India over the next decade? What challenges does the industry face?

In Indian microfinance, after almost two decades of innovation and experimentation, things have come together with the launch of small banks and high regulatory support. There is opportunity to put these factors together in other sectors to generate impact and investment opportunities. I am hopeful that we can apply it in health care and agriculture, specifically. Education is a very highly regulated sector in India, so as a private player I am less confident about the space. Energy could have potential, but the degree of government interface and reliance on subsidies in the space complicate investments to the degree that we feel that waiting for these distortions to disappear is the best option.

In addition to more sectors, you will also see more instruments and more structures. The fact of the matter is that we all started putting money in impact using the old, established VC formula. However, I feel like there is growing realization that limited eight- to ten-year limited life funds might not be the best way to achieve impact, so there is a lot of discussion about longer-term capital. We find that this fits in very well because these are very good businesses—they might require extra patience, but in the end you can make the same returns. Right now, those that have the flexibility to pursue this approach are large family foundations that are not raising third-party funds, but I hope to see firms like ours move in this direction.

Over the next ten years I expect to see more tools, more sectors and better structures for us to use. I am also hoping that the definition of impact will become clearer. I, as a GP, am not as worried—I can do impact, assess it, report it and publish it—but when you go to LPs, especially the large asset managers, they are still confused about what impact means, how to look at it and differentiate it from sustainable investing or ESG. It all gets muddled into one broad category. So, there is a debate taking place regarding how to differentiate different forms of impact in a more nuanced way, and we believe that this is a positive development. As asset managers looking to deploy capital, we should define our offering. We hope that this—in addition to delivering liquidity and providing competitive returns—will help to generate and strengthen LP support for fund managers like ourselves in the impact space.