Funds linking management compensation to impact performance, finds research

Impact Capital Managers looks at legal innovation in impact investing

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Impact fund managers are increasingly starting to tie management compensation to the achievement of impact goals, according to new research from Impact Capital Managers (ICM), a membership body for Northern American private capital funds managing over $12bn collectively. 

The research, Legal Innovation in Impact Investing, was conducted with law firm Morrison & Foerster, and draws upon anonymous surveys with ICM’s 67 members who include the likes of Bain Capital, Bridges Fund Management, Morgan Stanley, KKR and TPG Rise Fund. 

Carried interest – a key metric in private equity – is effectively a way to financially compensate GPs to meet or exceed financial targets. Fund managers get paid a percentage of the fund’s profits – so it’s a way to ensure GPs and LPs interests are aligned. Linking impact fund managers’ carried interest or other types of management compensation to impact performance as a way to ensure the funds meet their goals has been widely discussed in the impact investing space but rarely implemented.

But Susan Mac Cormac, Corporate partner at Morrison & Foerster, told RI that while fewer than 15% of funds surveyed tie management compensation such as carried interest to impact goals, the survey shows it is becoming more common as it was “very rare” just five years ago.

She said mechanisms in addition carry included linking bonus compensation to impact metrics such as carbon emission reduction value. 

“Performance-linked securities are also more common when these funds invest in impact – particularly with debt but also with equity,” she added. This could include, for example, lower interest rates when climate mitigation or reduced emissions goals have been met. 

More commonly used legal tools (greater than 50% of respondents) include requiring impact reporting from the GPs and portfolio companies, and including impact orientation in the fund purpose section or investment objective. 

Several survey respondents also said financial penalties or fee suspensions could be imposed if the GP does not meet impact reporting requirements.  

Requiring a third party audit of impact reporting or the targeting of companies with a corporate structure designed to protect impact such as B Corp status is somewhat common (between 15% and 50% of respondents).

Frontier legal tools profiled in the report include providing options for extending a fund’s term if needed to meet impact goals and using term sheets to require diversity and inclusion goals from portfolio companies. 

Marieke Spence, ICM Executive Director, said the purpose of the report was to take the temperature of the market and explore emerging trends around legal tools the impact investment industry is using.  

The research also looked at views on the “impact” label and found concerns that the label had become very broad which could be both helpful and diluting to the market.