Impact Rate of Return® Overview
Impact Rate of Return is derived from a formula modeled after the calculation for Net Present Value. In the same fashion that NPV calculates the time value of money, iRR calculates the impact value of money. Therefore, the two formulas’ inputs mirror each other to a certain degree.
The iRR® formula divides future (or expected) impact from an investment by the effectiveness and quality of that impact over time, resulting in its potential rate of impact.
Therefore, iRR is calculated as:
Before computing these variables, a number of attributes relevant to the intended impact must be decided upon. First, organizations identify a single, clearly defined and straightforward metric directly tied to their social or environmental impact goals (we call this the Key Impact Indicator). For example, this unit may be the number of square feet developed for a sustainable real estate project, acres of farmland for environmentally friendly food production, or the megawatt hours generated by a solar power energy investment. In short, the greater the number of Key Impact Indicator units, the greater the potential scale of social or environmental impact delivered by the program.
Second, organizations establish an overall impact goal for their work in terms of their Key Impact Indicator. This creates a comparative baseline for any programs evaluated before an investment or allocation is made. As one example, a real estate firm may establish an overall goal of developing 3,000,000 square feet of new buildout, or in the solar example, to generate 150 MW of energy sustainably.
Finally, organizations need to settle on a uniform scale of qualifications or attributes in order to evaluate the quality of impact being delivered. This scale could be an internally developed scorecard or an existing industry standard. In some cases this is fairly straightforward; in the real estate development example I gave, a good proxy for impact quality is LEED Certification. For environmentally friendly food production, as another example, investors or project managers may utilize the Sustainable Agriculture SAN Standard as their rating framework. This aspect of the methodology makes it incredibly flexible because it allows the formula to be customized to an organization’s specific preferences.
With these attributes established, we can calculate the following inputs for the formula:
Further detail on the iRR methodology is available in Chapter 12 of Social Value Investing, including a variety of use cases and example calculations, as well as a discussion about the model’s advantages and disadvantages.
This methodology is applicable to a variety of organizations hoping to combine impact returns with business objectives. Philanthropies can use iRR to measure their portfolio of grants or program-related investments as well, but in cases where profitability is a consideration, the iRR analysis can easily be combined with traditional financial analysis. For example, investors often set an expected internal rate of return at the outset of their investments and track their returns over the years; similarly, they can do the same with their impact goals by using iRR. In this way, the iRR model combines goals for financial return with discrete goals to improve society, which is useful for businesses placing increasing importance on the active pursuit of positive impact for society.
Social Value Investing, Impact Rate of Return, and iRR are federally registered trademarks of Global Impact LLC and all rights are reserved.