How a VC-Style Investment System Can Support a More Just and Humane World

7/20/11

If you were to look under the hood of any big-name IPO these days – such as LinkedIn, Pandora, and someday, Facebook – you’d see a highly sophisticated coordination of capital sources that fueled each to that highly coveted spot: Seed or “Angel” money that got the idea off the ground was followed by early-stage venture capital investors who percolated the company to viability, making it attractive to up-round VC investors and maybe some “mezzanine” financiers. It’s all very integrated, deeply “vertical” and it’s why the $50 billion-a-year U.S. venture market is the envy of the world.

Contrast that with the $10 billion raised for social enterprises that are trying to solve stubborn social problems like food security, safe drinking water, or energy access and maybe one day make a profit as well.

Here, the flow of investment capital is much more disconnected and lacking in the sort of coordinated metrics that are the lifeblood of a great investment ecosystem. Even among investors who have committed themselves to sticking out the often-difficult investment challenges of companies in remote regions and uncertain business environments, there remains only sparse coordination, awareness of one another, and utilization of the growing body of investment best practices.

Take Promethean Power, a solar powered dairy refrigeration start-up based out of Cambridge, MA that participated in the Global Social Benefit Incubator in 2010. Since 2007, they have cobbled together funding from grants, business plan competitions, equity investors and eventually the impact investors like Gray Ghost Ventures and Invested Development, which seek to create impact beyond financial returns, such as social benefits or environmental performance. At each early round, Promethean had to start essentially from scratch – meeting investors, making their pitch and keeping their fingers crossed. While they and other impact investors are to be lauded for valuing social impact, the investment sources were ‘siloed’ – each providing capital for its own mandate. New sources of capital support are now being introduced. If coordinated from the outset, these “handoffs” between funding rounds might have saved time and money for all parties, and accelerated impact.

The Center for Science, Technology, and Society addresses this need for investor cooperation and syndication in a new study that we’re releasing on July 26, Coordinating Impact Capital, A New Approach to Investing in Small and Growing Businesses.

The study, which we undertook with generous support from the Aspen Network of Development Entrepreneurs, we asked 45 impact investors over six months to share with us their investment methods, profit expectations, geographic focus, due-diligence practices, and other factors. Our goal was to unearth some knowledge that could catalyze a more coordinated, venture-capital-style system for social-venture startups.

In addition to finding some interesting trends (more on that later), we identified a series of small, important steps that could be taken now to help create a syndicate structure for socially beneficial businesses.

Among them:

* Articulate new milestone requirements that investors such as grant-making foundations can add to their award documents, which anticipate the next phase of investment. One example: in addition to quantifying job creation and product creation, foundations could also require establishment of a banking relationship, 70 percent or greater expense coverage through revenues, or the adoption of for-profit accounting standards. Those types of requirements lay the groundwork for a handoff to equity or quasi-equity investors.

* Create a “toolkit” for social capital investors that establishes best practices for different phase investors, including grant-makers, soft lenders, quasi-equity investors, equity investors, and commercial lenders.

* Form a “basket” of related social enterprises that can share operational metrics and expansion strategies, reducing transaction costs and diligence costs for investors.

Our study respondents—including impact investment pioneers and powerhouses like Acumen Fund, Good Capital, Root Capital, and Toniic,—almost universally stated that they would like to participate in syndicated investments, either in the context of a specific financing event or horizontally along a phased investment structure – but felt a need to learn more about their potential collaborators.

Fifty-eight percent of the investors we surveyed are “single sourced” from a foundation, a family business, or a high net worth individual. Participation by corporations and financial industry firms is still relatively light, despite the proliferation of social-benefit investment arms at such entities. We believe that we must address the needs of base-of-pyramid markets in sustainable and scalable ways to create emerging markets. There are good economic reasons to do, because essentially all of the population and economic growth will take place in these markets over the next few decades. Corporations would be wise to engage in impact investing, both for the social benefit it creates and as windows into their future markets.

Our data reveal that some funds are creating internal systems for phased investing, which indicates a mounting need for such a “horizontal capital aggregation” system for across the whole impact investing community.

Ad hoc syndicates are beginning to form. We give the example of Gray Ghost Ventures. When making an equity investment in solar flashlight company D.Light Design, Gray Ghost reached out to other impact investors, sharing its due diligence and investor knowledge with them. Investor-led syndication freed up D.Light management to pursue its core business, rather than devote its energy to finding more financing.

Accelerating the impact of more social enterprises will help meet the needs of more of the 4 billion people in base-of-pyramid markets, defined as living on less than $3,000 per year. Sustainable and scalable ventures are clearly required to foster systemic change in these communities. A robust impact investment ecosystem is not just a nice-to-have, but a humanitarian necessity. That happens to align with Santa Clara’s Jesuit values of creating a more just, humane, and sustainable world: it’s our mission.

Thane Kreiner, Ph.D., is Executive Director of the Center for Science, Technology, and Society at Santa Clara University. Follow @

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