Legal Challenges in Scaling Impact Investments

13 Nov

Impact investing has opened new doors for businesses and attracted a diverse pool of investors—everyone from fund managers and development finance institutions to pension funds, family offices, and individual investors. With both financial returns and positive social/environmental impacts on the line, the unique legal challenges associated with scaling up through impact investments cannot be overlooked.

Key Legal Challenges for Businesses Seeking Impact Investment 

For businesses looking to secure funding for growth, particularly in impact investing, navigating legal frameworks is essential to avoid potential roadblocks down the line. Here are some of the most critical legal considerations:

Basic Legal Frameworks

Many startups seeking investment lack foundational legal structures, such as tailored articles of incorporation, updated employee contracts, or a well-defined founders’ agreement. Without these, negotiations can become unnecessarily complex and slow down the investment process.

New vs. Existing Investors

New investments raise questions about how they rank alongside initial investors. Early-stage businesses often sign short-term-focused agreements with initial investors, which may not align with long-term growth. Balancing the interests of both old and new investors is crucial to avoid conflicts or restrictive terms that could impede future success.

Impact Measurement Requirements

Aligning on impact metrics is vital, particularly as investors may prioritize social or environmental outcomes differently. While all impact investors seek positive societal change, some might emphasize financial returns more heavily. Companies should establish measurable and transparent impact metrics to align stakeholder expectations early on.

IP Ownership

 Ensuring intellectual property (IP) clarity is a must. Misunderstandings about whether IP belongs to the company or its creators can cause issues, especially when bringing in new investors. Define ownership terms upfront to protect critical assets.

Employment Policies and Contracts

Having updated, compliant employment policies in place protects both the company and investors, ensuring that personnel policies align with current legal standards and operational goals.

Legal Structures & Agreements for Impact Investing 

When structuring impact investments, the same foundational legal frameworks apply as in traditional investments, but with added emphasis on impact metrics and accountability.

Investment Agreement

 A robust investment agreement lays out the terms, expectations, and impact targets, including metrics for tracking and reporting impact. Many investors utilize standards such as Impact Reporting & Investment Standards (IRIS) to maintain consistency in measuring and reporting. This agreement should also cover rights, obligations, exit strategies, and dispute resolution.

Legal Entity Structures

 Most impact investments operate through structures like General Partnerships (GPs), Limited Partnerships (LPs), or private limited companies, often driven by tax considerations. Convertible debt instruments may also be employed to provide early-stage flexibility while maintaining investor security.

Strategic Alignment & Purpose-Driven Investment

Investors in impact-focused businesses seek positive social and environmental outcomes with clear, measurable impacts. According to the Stanford Social Innovation Review, impact can be categorized into three dimensions:

For businesses, aligning on these metrics with investors is essential to showcase both social outcomes and sustainable financial returns.

International Scaling & Cross-Border Considerations

When expanding internationally, companies face additional legal complexities, such as navigating tax regulations, local employment laws, and IP protections in new jurisdictions. Partnering with local legal advisors and aligning on regulatory frameworks from the outset can preempt challenges and foster smoother cross-border scaling.

In conclusion

Impact investing offers businesses unprecedented opportunities to scale responsibly, but only with the right legal foundations in place. From setting up solid corporate structures to crafting clear agreements that reflect both impact and financial goals, ensuring legal clarity at every step helps maximize growth potential while aligning with investor values.

For more information, please contact our head of Corporate and M&A, Richard Hyman on Richard.Hyman@asserson.co.uk