There is a lot of attention now on #occupywallstreet - and I find it interesting to see a movement grow, and try to frame a meaningful goal from its "lets start something and see where it goes" genesis. To me, they have identified a "what sucks" but haven't articulated "what we are going to do about it." It is one thing to sit in, and another to stand up and take action. It is also interesting that some movements build, and some attack. The nature of movements is it is hard to define who is in and who is out. Yesterday, the infamous hackers at Anonymous targeted Wall Street for cyber attack- have they joined the movement? is their offer of "help" helpful? I offer this post as an alternative. I see entrepreneurs as society's hackers (in a good way, I hope).
This post is about some thoughts and conversations I have been having about the early steps of impact investing's journey. My concern? That the impact investing field is borrowing heavily from traditional start up finance- private equity (PE), venture capital (VC), angels, and yes, even Wall St. Will packing up these established concepts help impact investing speed towards its destination, or will they instead be a heavy load, or a false destination? Will they be useful, useless or harmful?
The basis of my concern is twofold: 1) this financial system got us to where we are, and has created some of the problems that entrepreneurs, activists and communities now must solve; and 2) the assumptions underlying the processes of this financial system may be antithetical to, or at least misaligned with, the goals of impact investing. Let me try to explain.
At the core of this concern is that financial capital relentlessly seeks returns. And we have built (or evolved) a finance system that satisfies financial capital's needs. The way private investors source deals, negotiate terms, conduct due diligence and monitor their investments is all premised on the idea that the entrepreneur will build a venture that creates (and captures) financial value. This is done through reducing risk, scaling the venture, and pursuing profits. Social and environmental impacts are largely external, in either positive or negative ways.*
But impact investing turns that on its head. And, I believe, calls into question the entire system of financing start ups. At each step, impact investors need to ask "why?" If maximizing social and environmental impact (rather than financial return) is what you want your capital to relentlessly pursue, then how does that happen? If instead it is financial return that is "largely external, in either positive or negative ways," then what needs to change?
At this point, I don't have answers, but I want to encourage founders and funders to think about it.
Let me provide two examples to illustrate my quandary:
1) Liquidity & Exit- early stage financing is premised on repayment. A funder provides money to a start up with an expectation of repayment of a greater amount in the future. This return on investment is, in the end, how success is measured. The longer the start up keeps the money, the greater the expected return. Investors have many opportunities, and an entire system has evolved to track and evaluate investment performance. But why does an impact investor seek liquidity? What if you find the perfect enterprise- one that is flawlessly executing a plan of scaling a solution to a global challenge? Then it seems to me that you wouldn't want to exit until the global challenge was solved. It would be inconsistent to take money from this enterprise to reinvest in a less effective (by definition) enterprise. So the reasons an impact investor would seek exit would be for investments in the less effective enterprises, where they felt they could redeploy their funds to achieve higher impact elsewhere. But it seems to me they should let investments in successful enterprises ride indefinitely, as liquidity would be counter productive for both the funder and the enterprise. Wouldn't this drive a different approach to portfolio design, evaluation and management? (Leslie Christensen and RSF have asked another set of provocative questions on portfolios, as well as provided a suggested approach.)
2) Crowdfunding- one challenge for the impact investing space is its emergent nature. As I wrote a few weeks ago, things that are emergent are "small, weak and hard to predict." There is a tension between many early stage enterprises seeking funding, and impact investors who are looking to help scale proven approaches to achieve impact. Our very own "valley of death". And no established bridges over that valley. The way traditional start up funding has dealt with this challenge has been through keeping investments local, working in syndicates to spread risk early, and tying funding to milestones. But the costs of doing financial deals for funders are often too high for small, dispersed, emergent companies, so these deals are left to universities, angel investors and government agencies (for instance, NIH and NSF research funding, or SBIR/STTR programs). This drives a "funnel-triage" approach. Investors screen hundreds of opportunities to fund a deal. Because they are looking for financial returns, they are looking for the best deals and want to concentrate on obtaining a significant percentage of ownership in order to capture these high returns. But I ask the same question as above- why would an impact investor seek a high percentage of ownership to capture high impact? The only answer I have come up with is ego. And that seems like a bad answer. Ego (and greed) are tolerated by the traditional financial system, because they are aligned with the systemic objectives of financial return. But if the goal is maximizing impact, it seems to me that the funders need to figure out how to efficiently source deals and do more smaller deals initially, until we get through the emergent phase and a more robust system evolves. This is where crowdfunding appears to offer some real benefit, and be more aligned with the goals of an impact investing system. Both founders and funders may become more comfortable with broad risk sharing and evaluation offered by crowdfunds, such as Kickstarter, Village Capital, Kiva, Inventure, Solar Mosaic and Hoop Fund.**
Well, I have written enough. But I'd encourage you to think about many of the "givens" of investment: relative founder/funder ownership percentages, board composition, preferences for equity (anti-dilution, liquidation), metrics. I see a lot of opportunity for change and redesign, but few people talking about it, much less doing it. In a recent deal by a leading impact investor, the Series A documents had one small change from a typical Series A deal. One small change.
So, what do you think? A journey of a thousand miles first starts with a single... question- "where are we going?" I think we need to hack the financial system to do impact investing well and build an alternative... an impact system. What do you think? Who are the pioneers, scouts and guides?
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* This is key. I am not saying there aren't enterprises that don't create financial value through creating social and environmental value. I am saying that the primary objective of their investors is financial value, and social and environmental values are secondary. I am also saying that in the financial system, as long as one stays within societal rules/norms, negative impacts are allowed. The second hand smoke of our financial system, so to speak.
** I recommend Alex Goldmark's recent GOOD article on crowdfunding and Bruce Campbell's good post as well.