Impact Investing: Healthcare Startups vs The Stock Market
Guest post by: Apple Crider, Startup Yields
The desire to give back to the causes and organizations you support is nothing new. Individuals in the United States have been making philanthropic contributions since before the country declared independence.
At the same time, investing in companies is also nothing new. The first stock market was created in 1611 and since then, many individuals have actively participated in the capital markets.
However, more recently a practice has emerged which combines elements from both philanthropy and investing in companies. Impact Investing allows individuals to generate a financial return while supporting the causes that matter to them.
While there are a multitude of avenues to choose from when it comes to practicing impact investing, two of the most prominent are investing directly in healthcare startups, and through making investments in the public markets.
What Is Impact Investing?
While the term impact investing was only coined in 2007, the practice has existed since long before the 21st century. In essence, impact investing describes the practice of prioritizing investments that not only produce a high financial ROI, but also generate beneficial environmental or social impact.
Instead of solely comparing investments based on their quantitative risk and return profile, impact investors will also take into account a variety of qualitative factors when evaluating a company. These include the industry they are supporting, any negative business practices the company maintains, and the environmental impact of the company.
While their goal is still to generate a financial return, these investors wish to do so in a way that supports the causes that matter to them.
Elements Of Impact Investing
There is no one-size-fits-all approach to impact investing because different investors will prioritize different factors and causes when investing. However, there are a number of elements that many impact investors will use when evaluating a potential investment. These can largely be boiled down to two key elements: intentionality and measurement.
The intentions of the investor should include both a financial ROI and a social or environmental impact. It is up to the investor which of these will take precedence over the other.
In general, most impact investments exist along a spectrum of intention ranging from exclusively financial (i.e. traditional investing) to exclusively impact (i.e. traditional philanthropy). Most investors will fall somewhere in the middle of this spectrum and will settle on an investment that meets the level of impact they hope to achieve while still providing the returns they require.
For impact investors, it’s important to not only measure the financial return on their investment, but also the social return on their investment. While measuring social impact is almost always more difficult than measuring financial impact, there are a number of ways investors can quantify this metric.
In the case of environmental impact, an investor could use tons of carbon as a method of quantifying impact. For healthcare investing, we could look at the number of lives a company has saved.
While there is no universal means of measuring an investment’s social impact, based on your priorities and the causes you wish to impact, it’s typically possible to come up with a couple of relevant metrics.
Stock Market Impact Investing
When the idea of Impact Investing was reaching retail investors for the first time, the stock market was one of the only places they were able to practice. In the early 2000s, retail investors didn’t have access to the wide array of investment opportunities they do now. Outside of stocks and bonds, these investors were quite limited in what they could invest in.
Impact Investing in the stock market can take the form of investing in individual stocks or in impact focused ETFs.
Investing in individual stocks through an Impact Investor lens typically involves avoiding so-called “sin stocks” and choosing to invest a portion of your portfolio into stocks that align with your values.
Sin stocks are shares in companies that are involved in activities that are considered unethical or environmentally damaging. These include alcohol companies, tobacco companies, or companies that profit through creating significant amounts of pollution.
Impact investors will avoid these stocks and instead look to companies that align with their values. In some cases, these companies may produce lower returns but this is not always the case.
One of the primary drawbacks of impact investing through the stock market is that your investment is unlikely to make a significant difference for the company you are investing in. A retail investor allocating $5,000 to a $100 billion company is hardly making a meaningful difference in the future impact that the company will have.
However, beyond individual stock investing, investors can potentially make a larger impact with their investment dollars.
Instead of investing into a single company, impact investors also have the option of investing in Exchange Traded Funds (ETFs) that hold a variety of companies targeting a specific impact.
For example, the ETFMG Treatments Testing and Advancements ETF (GERM) provides exposure to companies performing research and developing treatments for infectious disease. The ETF holds 77 different companies in the healthcare industry including Moderna, Biontech, and Bio Rad Labs.
One of the advantages of ETF investing is the increased diversification they provide. If your objective was to invest into companies combating infectious disease, investing in a single ETF is a much easier process than researching dozens of individual stocks.
Additionally, investing in ETFs can potentially make a more significant impact than investing in a single stock. This is due to the fact that ETFs typically control tens or hundreds of millions of dollars. So, if an ETF like GERM is doing well and many new investors are allocating funds there, it may prompt more healthcare ETFs to do the same and bring a significant amount of new resources to the industry.
Even so, ETFs rarely are able to produce the same impact that investing into private companies can.
Healthcare Startup Impact Investing
For retail investors, it has only become possible to invest in startups and private companies over the last 1-2 decades. This is largely the result of new legislation like Regulation CF and the proliferation of startup investing platforms. Prior to this, only well-connected investors with a significant net worth had the opportunity to invest in these companies.
In many cases, investing in private companies directly, specifically in the healthcare industry, can be one of the best ways to practice impact investing. This is because your funds are going directly to the company, your capital can make a larger impact, and you are able to hyper-focus your impact.
Unlike the stock market where in most cases you are buying shares from other investors, when investing in startups, you are typically buying shares directly from the company. As a result, the capital that you contribute goes right back into the business rather than to another trader.
Additionally, on a percentage basis, the money you invest makes a much more significant impact for the company. If you invest $5,000 into a publicly-traded company like Moderna with a $180 billion market cap, you’d own 0.000002% of the company. For Moderna, this is a miniscule drop in the bucket.
However, if you invested that same $5,000 into a startup like Enclear Therapies that was listed on Bioverge when it was raising a $2 million round, you would have made up 0.25% of that round. While that still wouldn’t make you a majority owner in the company, your impact is orders of magnitude greater than what it would be in a publicly-traded company.
On top of that, most healthcare startups are extremely focused on one cause. As an investor, this allows you to hyper target your investing to the particular issues that matter to you.
For example, Enclear Therapies is a biotech company that develops devices to halt the progression of neurodegenerative disease. If this is a cause that matters to you, the impact of your investment in Enclear has the potential to be significantly greater than one in a more generic healthcare company.
How Do Impact Investments Perform?
It’s common to assume that by making impact investments you are sacrificing a portion of your return potential for the positive impact your investment is generating. While that may be true in some situations, it’s not always the case.
In a recent study from the Global Impact Investing Network, it was found that 67% of stock market impact investors had the goal of generating risk-adjusted market-rate return. These investors aim to achieve financial returns on par with the overall market while creating social impact with their investments.
The same study found that 88% of stock market impact investors saw financial returns from their investments that were either in line with their expectations or outperforming. This demonstrates that an impact focus does not inherently mean lower investment returns.
Startup investments on the other hand come with significantly more risk than public equity investments. This is largely due to the fact that these companies are smaller and not as well-established as most publicly-traded companies.
At the same time, healthcare startups are subject to additional volatility as a result of regulatory hurdles and policymaking. While these companies do have the potential for significant upside if they go on to become successful, the 90% failure rate for startups should be taken into consideration before investing.
Why Impact Invest?
For many people, it’s important to contribute to causes that matter to them while also generating a financial return. Impact Investing exists at this intersection and allows individuals the ability to create positive change in the world while planning for the future.
Impact Investing challenges the notion that investors should solely prioritize financial returns and that social and environmental issues can only be addressed through traditional philanthropy.
As impact investing continues to reach a wider swath of retail investors, it’s likely that more creative ways to address societal issues will arise as individuals continue to think outside the box.
Investors looking for a broader impact in the healthcare industry may be content with investing in healthcare stocks or healthcare impact ETFs. These investments allow individuals to allocate capital to causes that matter to them in a way that doesn’t require any additional work.
However, for investors that are willing to put in a bit of extra work to generate a significantly more focused impact, investing in healthcare startups may be a better fit. With a more targeted approach and greater magnitude of impact, this avenue may have greater appeal.
Either way, there has never been an easier time to start impact investing and putting your dollars to work on causes that matter to you.
If you enjoyed this article, please check out my beginner’s guide to startup investing over on my blog Startup Yields.