Catalytic First-Loss Capital: Research and Case Studies
In the nascent but growing impact investment market, some opportunities with strong potential for social or environmental impact are perceived as having significant financial risk. Catalytic credit enhancement tools, such as first-loss capital, can encourage the flow of investment dollars to these companies and projects, by improving their risk-return profiles and, thus, incentivizing others to invest. Providers of such credit enhancements have several motivations, including magnifying positive impact and fostering market development. At the same time, there are legitimate concerns related to market distortion and moral hazard. This is where careful expectation setting and deal structuring is paramount, and lessons on both fronts can be learned from real-world experiences.
This issue brief from the Global Impact Investing Network (GIIN) details the motivations, benefits, considerations and suitable scenarios behind the use of catalytic first-loss capital in impact investing transactions. Catalytic first-loss capital refers to socially and environmentally driven credit enhancement provided by an investor or grantmaker who agrees to bear first losses in an investment in order to catalyze the participation of co-investors that would not have otherwise entered the deal. Catalytic first-loss capital has gained recent prominence in impact investing as more investors look to enter the market.