The Forgotten Human Capital Gap

By Ross Baird, Executive Director, Village Capital, and Simon Desjardins, Director, Access to Energy, Shell Foundation.

According to Noam Wasserman’s The Founder’s Dilemma, 65% of start-up failures are due to “people problems.” While this is a global phenomenon, early stage enterprises serving low income consumers in emerging markets face an especially tough challenge of attracting and retaining top talent.  In the growing world of impact investing that seeks to support such enterprises, most of the focus to-date has been on solving for the financial capital gap that prevents many promising ideas from scaling up. Structured efforts have been made to connect investors to opportunities and provide support to entrepreneurs on how to more effectively pitch their businesses to potential funders. While financial capital is indeed a critical barrier, an increasing body of evidence suggests that it is not the most important one.  In a 2012 survey, Village Capital alumni (all founders of companies with core impact objectives) cited talent acquisition and retention as their #1 barrier to growth (easily beating financing).

This finding was the impetus for Village Capital and Potencia Ventures to research the state of the human capital market in social enterprises operating in emerging markets.  Over the past 6 months, we have surveyed over 200 organizations and conducted in-depth interviews with 35 founders, managers, investors and HR experts at organizations operating in 25 different countries.

We’ve worked to diagnose the specific HR-related problems facing these enterprises and the actual toll they are taking on the sector. Later this spring, we’ll be releasing our full  report, which will point to potential disruptive solutions and further areas for research. We’ve listed two of the more basic conclusions below, which may not be surprising to some readers – certainly not for the small handful of organisations testing new talent acquisition approaches. What is surprising to us is how little is being done overall at a global level to address these challenges given their obvious importance.

1)  Hiring talent is a year-round, under-resourced activity. Over half of the surveyed enterprises are actively hiring year-round. Only 20% of enterprises surveyed had a dedicated staff member for HR and hiring activities. The vast majority of investors, accelerators, and capacity-building programs are providing limited or no HR support.

2)    Enterprises are already paying for outsourced HR Services—and are massively underwhelmed. In-depth interviews with in Kenya and India revealed that a large percentage of start-ups—over 50%– have paid for external HR services to support their recruitment efforts, yet most have been disappointed with the results.

Over the next few weeks, we will be conducting more in-depth interviews to further validate the results of our activities to-date and to stress-test a few potential high level solutions tailored to small businesses.

Interested in sharing your HR experience and expertise? We would love to hear from you! Please get in touch with Lily Bowles (lily@vilcap.com) to schedule an interview and have your input included in our report.

Creating vs. Capturing Value

Creating versus Capturing Value

 

The Commonwealth of Virginia is a wonderful place to live, in large part because people here care about both tradition and innovation – and we harmonize them by creating new value.  Nowhere is this clearer than in Virginia’s recent emergence as a great wine producer. Several hundred years ago, Thomas Jefferson tried to produce wine near his home, Monticello.  It didn’t work. Only in the past decade or so have Virginia’s winemakers started producing truly world-class wines. And just last year, the area around Charlottesville, Virginia, was named an official American Viticultural Area (“AVA”).

 

I was thinking about value creation last week when I was at the Case Foundation, whose founders, Steve and Jean Case, have made a significant commitment to impact investing—an investment strategy which support enterprises proactively seeking social/environmental outcomes in addition to financial returns). Most of our conversation at the Case Foundation centered on how we could make impact investing the norm—rather than a niche exception that only a handful of families, investment firms, and foundations engage in—in the U.S. economy.

 

But the conversation began with a discussion of Early Mountain Vineyard, a winery near my hometown of Charlottesville, which the Cases opened in 2012. I am a regular visitor to wineries around Charlottesville, and when I was asked what I thought of Early Mountain, I responded, “the product is a work in progress, but the user experience is awesome.”

 

Product vs. User Experience: What Impact Investors can Learn from Winemaking

 

It takes time for a new winery to produce great wine, and for a two-year-old winery, Early Mountain is off to a solid start.  But—they’ll say this themselves—they have ambitions for a product that is far greater than where they are today. To reflect these goals, the team at Early Mountain is focused on ensuring that you will have an awesome experience when you visit. Their beautiful tasting room showcases the best wines from across Virginia.

 

In addition to Early Mountain wines, you can buy the Barboursville Nebbiolo (my personal favorite when it comes to Virginia wines), the King Family Meritage, or great local cider from Potter’s Craft. As you tour their facilities, you learn about Virginia’s tradition of winemaking and the growth of the entire industry, while enjoying some great local food and gorgeous mountain views too. Early Mountain’s team cares deeply about their wine, but they are just as dedicated to building the Virginia wine industry as a whole. They make sure that your visit is an all-around terrific experience.

 

Because I enjoy visiting Early Mountain so much, I have a lot of goodwill towards them as they develop great wine. I keep coming back, in the meantime, because even though the wine is early in development, I have an awesome time there. And as I tell all of my friends in DC, Virginia wine country is a fascinating—and inexpensive—weekend visit, and my wife and I even have a guest room in Charlottesville, so they don’t have to make the drive back and can stay with us for Sunday brunch. (This offer invitation may even be too good; I had a friend visit from London just to experience Virginia wine country in November.)

 

Impact Investing: While the Product is Great, The User Experience Needs Work

What can impact investing learn from the wine industry?* Impact investment organizations (whether they are funds, start-ups, or intermediaries) can learn a lot from Early Mountain. New ideas and companies take time to develop, just like start-up vineyards. As they do, we should focus on what’s within our control: Giving customers an awesome user experience.  For impact investing firms like ours, investors are the customers.  At Village Capital, we believe that we owe it to our investors to provide great interactions with our portfolio companies as they grow, make money, and create social impact.

 

If you are an investor looking to invest in for-profit endeavors that achieve social and environmental objectives, the current user experience is usually pretty frustrating. Finding and sourcing opportunities is exhausting; to continue the analogy, going to Early Mountain and tasting the “best of Virginia” is way easier than going to fifty wineries in a day to find what you like. Although going to wineries is fun, everyone has their limit. Similarly, an investor’s most fun opportunities—direct investments with high risk and high upside—are also only a small part of anyone’s portfolio. Investors also complain about the over-glut of options for which there is no quality control, because there are lots of corked bottles out there in the impact investing world.

 

Impact investing faces a massive problem when world-changing entrepreneurs can’t find capital—it is a problem we work on every day—but when working with investors who have intentionally decided to invest with impact, we often do ourselves a disservice when it comes to the user experience.  I sometimes feel like our wineries not even taking the time to organize or even label the wines.

 

Where are We Getting Stuck? Capturing vs. Creating Value

 

So, why are investors having such unsatisfying user experiences? The main issue is that most investor-facing activities today capture value instead of create it. Most investors work through intermediaries (just as most wine drinkers buy their wine from wineries, wine shops, grocery stores, or liquor stores, rather than drink their own homemade wine). All too often, intermediaries or advisors package investment opportunities for an investor without adding any additional value – think of that overwhelming moment in the grocery store when you’re staring at rows and rows of bottles in the wine aisle.

 

Better intermediaries will strive to give advice, like the knowledgeable sommelier or wine shop owner, someone who doesn’t just capture value but who creates it.  They will provide support and assistance that vets or improves the investment opportunity in some way, or critical analysis and understanding that enables the investor to have a better, more seamless user experience engaging with the opportunity.

 

How to Create Value:

 

If you’re working in the world of impact investing—in which the content/opportunities are relatively new—the fundamentals are similar to Early Mountain. It’s going to take time to develop truly excellent wine.  But how do you get good customer reviews in the meantime? It’s a matter of creating versus capturing value.

 

1)   Make the user experience seamless, engaging, and fun. If you’re an investment firm or intermediary, give the customer a lot of touchpoints to have an engaging and fun experience. Early Mountain’s focus on food, ambiance, and views make me excited to be there. Similarly, funds and intermediaries tend to be more successful when they have engaging impact reports, chances for investors to interact with entrepreneurs, and easy ways for investors to learn and engage with the investments they make.

 

2)   Know what you are trying to accomplish, and what problem you are trying to solve. Early Mountain’s mission—building Virginia’s wine industry—is something I resonate with as a proud resident of Virginia. The fact that Early Mountain actually sells their competitors’ wines shows me their values in the larger problem they are trying to solve as an enterprise, which creates an emotional connection. Similarly, in the investment world, funds that are trying to solve the problem of “not enough impact investing” tend to be less successful. Being specific about WHAT you are trying to accomplish (in our case at Village Capital, moving oceans of capital towards high-quality companies intentionally seeking impact) and HOW you are trying to accomplish it (in our case, a disruptive peer-selection model that we think works better than the traditional venture model) engages investors on a deeper level.

 

3)   Create your own content. Early Mountain makes its own wine. That matters. It’s easy to advise someone on what they are doing right and wrong, but credibility comes from results. One of our partners, Chilton Capital, both invests their own dollars and also builds products for their clients. The founder, Chris Knapp, says that “we stand under the bridge we build.” As a result, their investees, and investors, have given them much more credibility as they have gone through the hard work of content creation and aggregation.

4)   “How can I help?” A mentor of mine told me a long time ago to end every meeting with this question. Early Mountain’s showcasing of Virginia wine as an industry—and not only its own wines— gives its visitors an awesome user experience, but also builds goodwill among partners, co-sellers, buyers, and the local community as the enterprise grows. When I am fundraising for Village Capital or one of our portfolio companies, I try and figure out what the potential investor wants—and recommend it (even if it’s not us). That adds value. Early Mountain doesn’t make a great Nebbiolo—yet—but I am thrilled that I can get one there along with great food while enjoying a world-class view.

 

It will take time for the impact investing—and Virginia wine—industry to grow, but our content is terrific. Focusing on creating value in the user experience is the next step.

 

*I will not address here the common joke “If you want to make a small fortune in the wine business, have a large fortune to begin with and acquire a winery.” It is possible to make attractive financial returns the wine business just as it is possible to make attractive financial returns in impact investing. It is also possible to lose a lot of money in both.

 

 

 

“Demand” vs “Need”

You can always count on people not to do what they don’t have to do.” –Merrick Furst

When we talk with entrepreneurs, we often hear, “X person NEEDS Y,” or “X person NEEDS this service.” But need doesn’t build a successful enterprise–demand does. And building a successful business relies on finding authentic demand–as opposed to need–from the people who are paying for the business to run.

DEFINING VALUE PROPOSITION IN TERMS OF “NEED”

What’s amazing about the term “need” is that it is rarely used by the person who is the subject matter of the term. “These folks NEED X,” or “The population NEEDS Y” is much more common than people saying “I NEED X.” ‘Need’ represent a lack of something–and something that people can’t live without. But “Need” is usually diagnosed by a third-party–someone who hasn’t experienced the lifestyle of the person who “needs” the desperate thing.

The average person doesn’t speak of themselves in terms of need because (a) people are often too proud to admit they need something–and live their lives accordingly; and (b) the average person doesn’t NEED very much. The human condition is so resilient that people can tolerate most anything they are faced with–as soon as they’re faced with it. There is very little that people NEED, in the literal sense.

Not understanding this has killed hundreds of well-intentioned businesses trying to make an impact. Businesses have said what people “need”: lighting, cookstoves, buyers for their coffee or other products–without recognizing that, when it comes down to it, making a purchase requires a significant behavior change, and people won’t change their behavior for very much. Pushing a behavior change for “need” rarely, if ever, happens.

DEFINING A VALUE PROPOSITION IN TERMS OF DEMAND

What do people do–if they don’t need stuff? They demand it. Demand is a funny thing. It’s hard to diagnose–or understand. In the words of Merrick Furst–the inspiration behind the quotation at the beginning of this article: think of the last five things you bought. Write them down: we’re waiting. Can’t remember? Most people have no idea why they bought stuff, and when they do–they look at what they bought and say “I didn’t really need this.” Now–think of the last thing you bought that you were excited about–that you were excited about in the way you’d tell a friend. Think of the hop in your step you get when you think about that thing.

THAT is demand–demand that animates and excites. I bet if someone tried to convince you to give up or sell the thing that you are thinking about that you’re excited about–you wouldn’t do it. Entrepreneurs kill themselves every day to convince people to buy their thing, and you’re sitting there thinking about something you love so much you would have to be convinced NOT to buy it. Now THAT is demand.

The problem when you are building businesses that have an impact: the temptation is SO great to focus on need–because the needs are so great–that founders and builders of companies don’t recognize that businesses are built on demand, not need, and it requires consistent demand–demand that lasts for years–to build a truly great enterprise.

So how do you determine demand vs. need? It’s truly hard work–but that’s the work we do at Village Capital.

The following is a post from Ross Baird, Executive Director of Village Capital, and Victoria Fram, Village Capital’s Director of Operations and Investments.

 “If I had an hour to solve the problem, I would spend 55 minutes thinking about the problem and 5 minutes thinking about the solution.” –Albert Einstein

Over the past several years, we at Village Capital have seen a growing focus on how important early-stage innovations are in solving major global problems, and the barriers standing in their way.

  • The Omidyar Network’s “Priming the Pump” highlights the “Innovator’s Deficit” – while capital flows to de-risked firms at the scaling stage and is all too scarce for high-risk startups, ‘today’s untried innovator is tomorrow’s scalable business’, and the sector’s success depends on supporting them.
  • Monitor-Deloitte’s “From Blueprint to Scale” cites the lack of available support for ventures in “the Pioneer Gap”—where enterprises developing new innovations can validate their concepts and begin to scale—as the key breakdown preventing more qualified later stage impact investment opportunities.
  • Our own report co-published with the Aspen Network of Development Entrepreneurs, “Bridging the Pioneer Gap,” studied the range of activities—including “incubators,” “accelerators,” or any other terms you might choose—that organizations launch to support and empower entrepreneurs, and the challenges they face.

Each of these pieces make the case that—to really make a difference—organizations that believe that entrepreneurs can solve major global problems should invest at the earliest stages. But this isn’t happening. Anywhere you look, it’s difficult to find risk capital for innovation. Of over 300 self-described “impact investment” firms, fewer than five invest at the catalytic stage—less than $250,000 per investment. According to the Center for Venture Research’s report “Where Have All the Angel Investors Gone?”, capital committed to US companies from angel investors has fallen 25 per cent since 2007.

Reports such as “Priming the Pump” and “From Blueprint to Scale” do an admirable job of creating awareness of the “Pioneer Gap” and advocating for risk capital—but investors looking to catalyze early-stage capital are still risk-averse. In order to make meaningful progress, we need to diagnose what the actual problem is, and then we can start to think through ways of solving it.

So: what’s holding early-stage investments back? We see three key barriers to early-stage risk capital:

1.     The way that venture investment is structured. The venture capital industry most commonly produces funds that have what is popularly known as a “2/20” structure: funds pay their costs (salary, deal-related costs, professional services) out of a budget derived from 2% management fees, and receive 20% of carried interest (profits) from successful investments. According to the Kauffman Foundation in their report “We Have Met the Enemy, and He Is Us,” this has led to larger fund sizes, due to simple math: 2% of a larger number means higher salaries and more year-on-year cash flow than 2% of a smaller number. (All this despite the same Kauffman Foundation report shows that funds with smaller sizes in the VC world consistently produce higher returns.)

The second structural issue is the ten-year closed-end fund. Typical funds have a ten-year life-cycle, meaning that ventures that receive investment from venture funds are required to repay investors within a ten-year period from the kind of liquidity that results from an acquisition, public offering, or other cash event. (Companies that did not have that kind of liquidity within ten years include Coca-Cola, Hewlett-Packard, and UPS, to name a few).

So—small funds are incredibly rare, because it’s very difficult for them to pay the bills. This leads to less early-stage investment, because:

2.     Transaction costs, per investment, do not reach economies of scale. As any investor will tell you, it costs the same amount of money to do a $50,000 investment as it does a $5 million investment—in transaction costs (diligence, under-writing, legal fees, accounting, compliance). With funds incentivized to be larger (due to problem #1), they have little incentive to make seed investments (which cost them the same amount to close), particularly because they are under a five-year time pressure to put a large amount of money out the door.

As a tangible example: we at Village Capital are trying to work through this problem directly in trying to structure our own investment vehicle. For 90% of the companies we have funded, we are the first capital in—and we have been making investments at an average of $50,000/company. We have a unique peer-to-peer diligence model that cuts the transaction costs of diligence 75%, while yielding comparable results to a traditional investment model to date—but we’re still left with two problems. A) To leverage this diligence process and make a dent in the needs of seed-stage enterprises at scale, we need to do a high volume of transactions, and B) Post-diligence transactions costs don’t reach economies of scale. Even taking sourcing and diligence out of an investment vehicle’s budget, the economics of a small fund are still near impossible to achieve on standard 2% fees.

 

3.     Evidence of return of capital from non-IPO, non-acquired companies due to investors using the wrong structure to deploy capital. I addressed the problem of liquidity earlier this year in a blog post: “Liquidity: The Original Sin.” Traditionally, investors have looked to initial public offerings (IPOs) and major acquisitions of companies as significant events that can compensate them, financially, for the risk taken at the earliest stages. As a result, most investments worldwide use term sheets created for early-stage Silicon Valley consumer technology companies (which are disproportionately likely to go public or be acquired by a larger company). For most companies in our realm, working in industries addressing major global problems (agriculture technology, education, energy), IPOs and acquisitions are rarer, due to the combination of difficulty of IPOs and promoters worried about mission and company culture being diluted as part of a larger company.

This should be absolutely fine—investors should be looking to build great companies, not acquire-able or list-able companies—but the pressure for liquidity (in order to return cash in a traditional venture fund structure to investors) means that this isn’t the case. While investors are focused on discovering innovation in new products and services in underlying companies, there has been remarkably little innovation in investment structures that could potentially alleviate these problems. There are outliers: GroFin in Africa has invested $600M in early-stage businesses using a revenue-share structure, and John Kohler at Santa Clara, among others, has been promoting a “Demand Dividend” structure to provide alternative finance to early-stage ventures, but these are outliers.

Caveat: Not confusing “patient/flexible capital” with “infinite capital.” I will say one thing—investors are fiduciaries, and they have a responsibility to their investors to make a return on capital[1]. Proposed solutions to the problem above should be more elegant than “let’s give grants to early-stage startups” or “investors need to be more patient.” Real innovations in fund structure, enterprise development, and policy/public advocacy are possible that can address each of these four problems.

So where do we go from here? The impact investment industry is building fund structures that a significant amount of data suggest are setting it up for failure. Why? As the Kauffman Foundation report cited earlier suggests, “investors…succumb time and time again to narrative fallacies, a well-studied behavioral finance bias.” People are building these structures because that’s what investors do.

What do we do differently? We’ll keep this brief—in the spirit of the Einstein quotation, the point of this piece is to clarify diagnosis of the problems—but we’re excited to work on the solutions in the coming months. A few initial thoughts:

1)     Fund structure: Both data and experience suggest that the traditional 2/20 venture capital fund structure is not working, and in a 2009 poll, a majority of partners at venture capital firms thought the industry was broken. Yet 2/20, closed-end, traditional fund structures are what most of the industry uses because that’s the default option. Funds that invest in innovative goods and services should not limit an innovation-focus to the substance of their investments—they should extend it to themselves. We plan to explore more evergreen funds and holding company structures that start to get at this problem, and welcome examples.

2)     Transaction costs: While an enterprise that consolidates and reduces transaction costs for early-stage investors is not the most glamorous company in the world, it is solving a real problem that stifles innovation. A range of experimentation—AngelList investor syndicates are one example—are trying to get the cost of deals lower, but this remains an area ripe for disruption.

3)     Policy advocacy: Sarbanes-Oxley and the cost of going public for early-stage enterprises is only one policy route holding back early-stage companies. Regulations are good and necessary, but the high cost of regulation (in the US and abroad) puts a disproportionate burden on early-stage companies (compared to corporates, who are better resourced to comply). Early-stage companies feel the effect from a tax structure that disincentivizes start-up companies from investing in R&D, to regulations that now burden them with compliance when they solicit prospective investors for start up capital.

4)     The right capital for the right use: This is an area where we have seen the most innovation in the last year. From venture debt to revenue-share structures to innovative dividend-based investments, we have seen quite a few people working on this problem—but the vast majority of term sheets remain based on Silicon Valley consumer technology.

True innovation needs to go beyond just investing in innovative products and services. We’d love your thoughts on ways to move beyond problem identification to creative solutions to get the best concepts off the ground to build the world we want.

This piece was originally  the final of a three-part deep dive into “Thoughts from the Trenches” as we kick off this year’s Social Capital Markets Conference. For the series overview, click here.  For the first post, “Talk Isn’t Cheap, It’s Incredibly Expensive” click hereFor the second post, “Marginal Impact Is Better than Doing Nothing,” click here.

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“If I had an hour to solve a problem, I’d spend 55 minutes identifying the problem and 5 minutes on the solution.” –Albert Einstein

Impact investing is, by far, too input-defined.  Often, organizations measure what they’ve done by inputs—consulting hours given (yes, but to what end?) or dollars deployed (great, better than nothing, but to what end), or enterprises served (but how well?).  Metrics are hard—and we are guilty of this, too, sometimes.

Instead of inputs, the true innovators we’ve seen start with a problem-solving prerogative. Instead of “access to education for the poor,” innovators say, “look. There are hundreds of thousands of low-cost private schools serving the poor in emerging markets. Parents—even those living below the poverty line—can afford these schools, so money’s not the problem. The problem is that parents have no idea how these schools are performing, and they’re worried they are sending their kids to bad schools. Families living in poverty are spending as much as 30% of their budget on education. How can we deliver quality information about educational performance to parents—in a way that fits within that 30% budget and solves their problem?”

What we find is that from an impact perspective, many in the social capital markets are not sure what problem they are trying to solve, and confuse high volume of inputs focused on “social entrepreneurship” with real impact on the sector they are addressing. Yet this rarely transfers to the real world.

We’ve found these mistranslations in recruiting for Village Capital cohorts. We look for the best possible ventures to be in our programs—yet we find, often, that when we look for self-described “social entrepreneurs,” we get ventures that are have substandard business quality. We have started recruiting “entrepreneurs addressing X” (and identify the problem for each cohort)—in response, we get a lot of what we call “social entrepreneurs who have never heard of social enterprise.”

The world would do well to understand that the greatest entrepreneurial successes weren’t done under the umbrella of “impact investments” – but probably made a greater impact than any “impact investment” to date. Find a problem, start a business that addresses (does not have to solve) the problem, and make it into a model where someone is willing to pay you for the value that you are creating.

    • Sorenson Communications: Providing communications services in the United States for deaf individuals to communicate with the hearing – huge value and financially successful…therefore valuable
    • Etsy: A B-Corporation that provides market access to small scale artists and individuals producing volumes too small for “major retail” – $40M from venture capitalists; processing $1B in sales; no need to be considered a “social enterprise”
    • Tesla (the electric car company): We don’t need to tell you the problem statement. What we can tell you is that Tesla’s first financing was originally a PRI from the MacArthur Foundation.

How do we get more problem-solvers? Invest in quality infrastructure. Instead of generalist, input-oriented surveys figuring out “why people aren’t doing more impact investing,” figure out specific problem areas within target sectors. We like what ACCION Venture Labs is doing in East Africa or what Pearson Affordable Learning Fund is doing in India, looking at specific leverage points in financial inclusion where entrepreneurs can make a difference.

Instead of input-oriented technical assistance that provides vague “handholding” and “consulting hours” to entrepreneurs, invest in real deliverables: pro forma financials, market tests, customer validation (or business hypothesis nullification), HR services, and more.

Impact investors must be willing to invest in infrastructure, as well as riskier businesses than they might like, if they want quality carriers.

Impact investing has been described as an “emerging asset class.” Yet if we continue to subscribe to the mantra of starting with the problem, we need to identify the clear system-level breakdowns that prevent an “asset class” from being possible, whether it be inefficient markets for start-ups, or the signaling effect of the way we talk about the social capital markets that turns off serious entrepreneurs and investors, or the misallocation of capital to reward risk aversion in a sector that requires risk-tolerant structures to grow big.

So what for SoCap?

    • If you are a service provider and/or entrepreneur, and you meet someone with capital, and you want to work together—figure out what they want to do, and help them solve their problems. If they want to invest in businesses that help address cancer, figure out where they are getting stuck. Is it lack of quality deals? Is it poor problem identification? Is it public policy/regulation around investing in health services? Don’t convince them that they should buy your solution—figure out how you solve their problems.
    • Recognize that other systems we consider “normal” took similar pioneering. People look at the social capital markets and think “this is too hard, there are no exits”.  But people forget – or don’t know – that Silicon Valley, right next door to the SoCap Conference, was built through decades of government and grant funding…and a lot of individuals losing their shirt on deals structured on legal pads. If you are coming to meeting for the sole purpose of making money with no risk, this isn’t the place for you. Stick with S&P500 instead.
    • If you are someone with capital, realize you need to invest in (1) infrastructure, and (2) quality. Don’t assume someone is doing a good job just because they’ve won awards or are getting a lot of press (and hold everyone to the same standard). Figure out what they’ve done, and what they’ve delivered (from a problem-solving standpoint, not just an input standpoint). This is a corollary to the above point—invest in great businesses, and people with thoughtful (and falsifiable, changeable) hypotheses on how to build the businesses. “Patient capital” shouldn’t mean “infinite capital”—we’re investing, not grantmaking. True solutions to major social problems will yield great businesses if done well and with appropriate infrastructure.

So, Finally, What should I Do at SoCap? Figure out what problem you—the attendee—are actually trying to solve, whether it’s at a beneficiary level or ecosystem level—and solve it!

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Ross Baird is the Executive Director of Village Capital. In the past four years, Village Capital programs have graduated 350 entrepreneurs on five continents; $2 million has been invested through Village Capital’s peer selection model. Village Capital alumni have served 4 million customers (2.7 million living in poverty), created 5,000 jobs, and leveraged initial capital 20:1.

Lewis Hower is the Director of the James Lee Sorenson Global Impact Investing Center (SGII Center) at the University of Utah based in Salt Lake City, Utah. The SGII Center is the first transaction oriented student impact investing institute focused on addressing both the current human capital pain points as well as the future growth of the impact investing world. The SGII Center and its previously known entity the University Impact Fund have directly facilitated over $25 million in impact investments focused on the early stage ecosystem over the past three years.

This piece was originally posted as the second of a three-part deep dive into “Thoughts from the Trenches” as we kick off this year’s Social Capital Markets Conference. For the series overview, click here.  For the first post, “Talk Isn’t Cheap, It’s Incredibly Expensive” click here

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“Ours is a critical age; not a creative one.” –Paul Elie

When people stop talking and “decide to do,” they often suffer from analysis paralysis. We’re excited about IRIS, GIIRS, and other common languages/standards as they give people an ability to measure one enterprise against the other. At the same time, many would-be foundations and impact investors are letting the perfect be the enemy of the good.

Progressive impact is better than no impact at all, as long as all parties involved are honest with each other and are always learning—and sharing their findings. If, as we said, a better way forward depends on a lot of at-bats—to extend the analogy—we need a functional system in place for people to swing more times. We need funding mechanisms and support systems to allow a wide variety of learning to take place and be shared.

Current fund structures prevent true iterative learning for both social enterprises as well as impact investors.  Fund managers typically allocate, due to investment fund incentives, a small amount of capital to at most 2-3 impact investment opportunities a year. We don’t blame folks; if you’re doing only 2 deals a year—of course you’re going to be thinking about only those 2 deals a year and getting them exactly right.

Yet we can’t underestimate the opportunity cost of inaction, given the size, speed, and immediacy of the world’s problems. The risk of no action is infinitely bigger than acting on only things that are cookie cutter, which impact investing is becoming defined by.

Impact does not have to be the Holy Grail

Last week, Ross was in Montana. Ross learned that Ted Turner owns 50,000 bison—and set up a chain of bison-focused restaurants, Ted’s Montana Grill—to popularize bison as an alternative to beef in the average American meat-loving diet. Bison, as migratory prairie grazers, have significantly lower carbon emissions than cows, and Ted Turner’s mission—bison-related—is to play a small role in the eating habits of Americans by making bison meat popular.

How do we measure that impact? There is no one venture out there that is going to solve the climate problem in the US. It’ll take thousands of ventures chipping away at different aspects of the problems over time. Instead of bison, impact investors expect unicorns. Yet it’ll actually take bison, more efficient air conditioning units, clean natural gas storage companies, brick tiles that reflect lights, and a thousand more little tweaks like that to make a dent in carbon emissions. We ought to be creating systems that support all of them—at the sector and problem level—rather than looking for the right specific bullet.

By over-emphasizing impact, we create the inappropriate feedback loop cycle. On the investor side, massive organizations spend lots of money and time on the wrong problem – oftentimes just because the “right” problem is too hard to measure and quantify with impact data.

So where are we going wrong?

  • We need to stop over-complicating (and misidentifying) the problems. Impact investing, in theory, is solving social/environmental problems, but very rarely do enterprises identify which problem they are solving. For more thoughts, see this blog post on Village Capital’s problem-based approach—that highlights what we’ve learned (often from Village Capital cohorts gone wrong).
  • We need to recognize that if you solve a problem very well, people will pay you for the privilege. Some people would argue that making money off of solving social problems is wrong. We’ve found that knowing how to make money off of a problem is actually very meaningful—because it makes solving problems a desirable way for people to spend their time and resources…and, in the long run, is the only way they’ll be incentivized to continue doing this hard work.
  • We need to re-evaluate our relationship with risk (and overcome fear of it). People don’t want to take swings at the plate because each swing at the plate costs money. Yet the most effective way to think about realigning how we think about risk is taking it; it is impossible to remove all risk but it is possible to mitigate and share inherent risk. Lewis remembers an investment conversation with Chid Liberty, founder of Liberty and Justice—Africa’s first fair-trade clothing manufacturing company with responsible working conditions, health care, education and ESOP plans for all employees who don’t make clothes seeking a hopeful niche market but rather producing product for some of the worlds largest clothing manufacturers—where Lewis said “Do I know if you can do this or not? Hell, no. Am I willing to put capital behind you to see what you come up with? Absolutely.”
  • Learn by doingOne of Lewis’ mentors has said that the best diligence that he can do is the first $25k investment. Simplifying investment processes, partnering with groups that are already doing it, transparently iterating on lessons learned, and tying rapid subsequent financing to milestones hit are simple places to start. Foundations are pretty big on research and development for the sector—which is terrific. Yet, to date, the lack of empirical data on actual enterprise performance might suggest that research money directed at theory is somewhat misallocated. We don’t need million-dollar studies telling us what to do—we need ten $100,000 studies testing hypotheses in the field, and providing actionable results. We need more risk capital for people showing what works and what doesn’t, not providing ideas on what might and might not work.

So what for SoCap?

    • Figure out what problem—specifically—each individual or organization is trying to solve. Spend lots of time exploring the problem.
    • Figure out the risk tolerance of the individual. If they aren’t somewhat risk tolerant, they are at the wrong conference.
    • Figure out the gameplan for learning-by-doing. How can you test your hypotheses? How would you know if you are right? How would you know if you are wrong? How do you share what you learn?
    • Explore the use of risk capital for funding risk. Program-Related Investments—are by definition risk capital for which only less than 1% of foundation assets are used ( 0.05 of which is put into equity). If you don’t know about program-related investments…you should.

So—we’re willing to take risks. But to what end? How can “impact investing” go mainstream?

For the third (and final) post, click here.

***

We welcome thoughts, comments, additions, and pushback. To keep the conversation going through SoCap, we’ve posted this on the SoCap LinkedIn page - we invite your comments there!

***

Ross Baird is the Executive Director of Village Capital. In the past four years, Village Capital programs have graduated 350 entrepreneurs on five continents; $2 million has been invested through Village Capital’s peer selection model. Village Capital alumni have served 4 million customers (2.7 million living in poverty), created 5,000 jobs, and leveraged initial capital 20:1.

Lewis Hower is the Director of the James Lee Sorenson Global Impact Investing Center (SGII Center) at the University of Utah based in Salt Lake City, Utah. The SGII Center is the first transaction oriented student impact investing institute focused on addressing both the current human capital pain points as well as the future growth of the impact investing world. The SGII Center and its previously known entity the University Impact Fund have directly facilitated over $25 million in impact investments focused on the early stage ecosystem over the past three years. 

 

This piece was originally posted as the first of a three-part deep dive into “Thoughts from the Trenches” as we kick off this year’s Social Capital Markets Conference. For the series overview, click here.  

***

“Talk is cheap,” the old saying goes.

It’s not. It’s incredibly expensive. Talk alone hides the opportunity cost.  A 2012 report from the Kauffman Foundation, “We Have Met the Enemy, and He is Us,” demonstrates that over the last two decades, venture capital firms have under-performed the market as a result of misaligned incentive structures and growing management fees.

A lot of ink has been spilled in impact investing—and a lot of money has been spent—over the past half-decade not directly on innovation or impact enterprises, nor on those directly supporting impact enterprises—but on “advisors” who primarily serve the purpose of telling someone what they should be able to deduce through simple inquiry and observation: that impact investing is risky, there is currently a shortage of investable models and therefore reliable exit opportunities, and that institutions and people need greater comfort and transparency.

Otherwise summarized: this work is really, really hard.

Talk is incredibly expensive. The generalizations above—which have been repeated through advisors and reports until the day is long, have yielded large amounts of money spent not on direct innovation, but on reports regurgitating what we already know. People spend a lot of time thinking about why innovation is risky—but rarely consider the line item budget of de-risking (people’s salaries, time, and, yes direct investment in ventures that fail) to build a larger sector.

Just because impact investing is hard and unproven doesn’t mean innovation isn’t worth an investment. Venture capital was not considered a widespread industry until the Apple IPO; thirty years ago people would not have considered microfinance an investable industry, and ten years ago people would have thought you were crazy if you told them that mobile money would be more widespread in Nairobi than New York. A major philanthropic (yes, money-losing) investment into the Consultative Group to Assist the Poor (CGAP) led to M-Pesa, a highly profitable mobile money platform that over 70% of households in Kenya use for financial services today.

Progress depends on outliers that originate in the fringes. This is commonly described as the “black swan” phenomenon: a person can “prove” that all swans are white—until you see one black swan. But to see a black swan, you need to go looking for a lot of swans. That changes the narrative in a fundamentally important way.

How do we flip expensive talk on its head? When success depends on outliers, we won’t initially know what will work—but we do know that the more we try, the greater the odds of success are. In impact investing, people need to do more, and experimentation becomes the status quo. This can play out in the following:

  • Investment vehicles. Don’t think the GP/LP structure works for impact investing? Launch a new, low-cost vehicle like a holding-company, or make the case that funders need to test it.
  • Exit opportunities. Don’t think that traditional “exits” happen in impact investing? First of all—you’re wrong. Look at the track record of ventures and investors over the past 15 years from SEAF to Aavishkaar to Sorenson Communications to Good Capital, and you’ll find way more than the conventional wisdom. Still unhappy? Work with ventures to secure alternative exit options like New Belgium’s recent employee-owned buyout. Remember, the IPO only became an investable device in 1985.
  • Startup companies. Don’t think there are “enough investable deals?” Keep looking. Don’t rely on conferences and magazines for your “deal flow.” Get on the ground (or be willing to pay for trusted partners that are), in the market you care about, in the place that you care about—and/or invest in/fund people or organizations who already are there and hold them to specific metrics of success and growth.

Look—we’re trying to create an economy where externalities become part of enterprises, people merge the positive—and negative—consequences of their ventures into their upfront operations, and people find meaning in what they do every day. That’s not easy. To create that kind of change, people need to do more, and experimentation needs to become the status quo. Even if the results are not ideal, experimenting gives people material to learn from and is better than doing nothing at all.

So what’s the recommendation for SoCap?

Talk is incredibly expensive. Figure out what the person you’re talking to has done and is going todo—in terms of money, time, effort, energy, impact. You have to accept that if you are going to create progress in the social capital markets, you have to take pioneering risk and support the action—not  reports, conversations, and related jabber that discusses but does not lead to progress.

But this is hard. I have no money for my venture, or I don’t know what to do with my money. I can’t measure my impact.

If this is what you’re thinking, click here for Part 2. 

 

The Problem-Based Approach

This post originally appeared at this link on vilcap.com in July 2013.

“Whenever a theory appears to you as the only possible one, take this as a sign that you have neither understood the theory nor the problem which it was intended to solve.” -Karl Popper

Entrepreneurship is simply problem solving. Despite long odds, entrepreneurs have always had the capacity to surprise the world with problem-solving capabilities. In the late 19th century, the greatest threat facing public health in the U.S. was mounds of dung in the middle of the streets from horse-drawn carriages. No one knew how to solve this problem—until Henry Ford invented the Model T.

Today, we believe entrepreneurs can solve seemingly intractable problems: the lack of access to affordable basic services for billions living in poverty in the U.S. and abroad (health, education, financial services such as credit), or the finite limits of a fossil-fuel based energy system (which, to be fair, is in large part a residual effect of solving the earlier problem of urban sanitation).

Yet very often, entrepreneurs–and those who support them–are either working on the wrong problems, or don’t know which problems to solve.

What problem are you actually trying to solve?

On one end, you have the best talent in the world–and the bulk of risk-tolerant resources–working on what have become known as “First World Problems.” I was speaking earlier this year with a very well-known, incredibly active Silicon Valley angel investor who identified a pain point in his experience of restaurants: “It’s a huge pain when I’m ready to leave dinner and have to wait 20 minutes for the check. If an entrepreneur invented an app that let me get the check immediately, I’d invest.” My response to him: “Really? With everything going on in the world, that’s what your time, attention, energy is going to?” The investor agreed there are other issues out there, but also said that he knew the company was going to do well because it was solving a real problem.

On the other end, you have the rising industry of “impact investing” and “social entrepreneurship”–a world I live in. Impact investing–a rapidly growing investment approach that seeks proactive social/environmental returns beyond financial–and “social entrepreneurship”, a term that describes the application of entrepreneurial solutions to major social problems—are appealing as ideas, yet rarely define what the problems are, and then fit tailored solutions to them. Impact investing, some say, is a “magic bullet” or a “grand compromise”–better for the world than traditional capitalism, but more efficient than traditional philanthropy. Yet when you look at incubators/accelerators, investment funds, and enterprises, interventions seem to be focused on inputs: number of entrepreneurs supported, dollars of capital invested, number of consulting hours dedicated, and number of awards won. What’s missing: a concise identification of the specific problem these enterprises are trying to solve.

The Common Mis-Fire: Entrepreneurship as End, Not Means, for Problem-Solving.

At Village Capital, we’re guilty of this, too. When we launched our first cohort in 2009, we organized 15 for-profit entrepreneurs who were also seeking a positive impact in a specific geographic region (San Francisco, India, New Orleans). As we evolved, we started looking at specific industries: base-of-the-pyramid-facing mobile and energy in Boston; health, education, and financial inclusion in Brazil. Yet we found, even within a single industry, ventures are working in wildly different sectors –with different supply chains, customer bases, policy implications, and end users. (e.g. a pre-K innovation in education has very little to do with a higher-education accessibility initiative).

But the main problem with our approach was this: we were treating entrepreneurship as the end in itself, not as a means to an end. Our core innovation is peer-selected investment. Our hypothesis was this: put a bunch of entrepreneurs together, support them, and fund them through a disruptive peer-selected model, and you’ll make major change in the world. Where we got stuck was focusing on inputs—which don’t guarantee success—rather than the change we were ultimately trying to make. The biggest theme in our companies that haven’t made it (some of which were incredibly well-funded) is that they weren’t fundamentally solving a problem. Sure, they had a solution. They just weren’t solving a real problem that anyone had.

What we found was that the most effective programs included entrepreneurs coalesced around a single problem area—working in different segments of a supply chain or distribution model, they could become one anothers’ customers, establish linkages with corporates who could see a niche-innovation fitting into their larger operational strategy, and attract investors who knew, top-to-bottom, the sector and could see an enterprise from the cohort complementing an existing portfolio company. All of which has led us to re-tool our programs into a “Problem-Based Approach.”

The Problem-Based Approach

The industrial complex–and resulting greenhouse gas emissions–of the agricultural supply chain in the US is a major problem: 30% of the country’s carbon footprint is in agriculture. This is a huge problem–and one that no single entrepreneur can solve. Yet this summer, in Louisville, KY, a group of ventures participating in Village Capital/VentureWell: Louisville are working on entrepreneurial solutions to address pain points on all sides of this problem. SmartFarm is working on mobile-based smart irrigation; Spensa is addressing better monitoring of insect presence, reducing pesticide application; and NOHMS is developing a better lithium battery for vehicles that might transport agricultural inputs and outputs.

In Louisville, we’ve picked a problem that is (a) massive, (b) has subsets that are solvable by entrepreneurs, and (c) is framed in a holistic sector way to enable our teams of entrepreneurs to not only be peers–but customers, advisors, value-add resellers, and bring relationships and intelligence to one another.

“Problem First”

By putting the problem first, we’ve found four things:

1) Customers take priority over investors.
While many accelerators culminate in a “Demo Day,” the highlight of our Village Capital programs now are our “Customer Forums,” where our 15 teams pitch to customers who could buy their product–rather than angel investors whom they’re trying to convince to pay attention–but are just listening to be polite in most cases. (Anyone who is an entrepreneur that has pitched to an investor who showed no interest is nodding, as is anyone who has investment experience who has had to endure a pitch they had no desire to listen to.)

2) The investors who show up are aligned and incentivized–across the sector.
When problems aren’t explicitly identified as a starting point, raising investment becomes an attention-grabbing exercise of people with capital. The problem-based approach brings along investors who are equally motivated to solve the problems the entrepreneurs are working on. As an example, our next program at Village Capital, “Edupreneurs,” is a partnership with Pearson Affordable Learning Fund (PALF) that addresses the problem of quality affordable education for the base-of-the-pyramid in India (unlike in the developed world, education in India is more often than not provided by the private sector, but quality is widely variable). PALF is a strategic initiative of Pearson, the largest education company in the world–not a corporate social responsibility fund. Pearson has incentives to support the fast-growing sector of affordable education for the poor–and could be an investor, customer, value-chain advisor, or all of the above to companies in the cohort.

3) Entrepreneurship engages much more directly with policy.
Entrepreneurship doesn’t happen in a vacuum. People in financial inclusion, for example, rely on policies spanning from banking to mobile carriers to foreign cash controls–and policy sets the rules of the road for what entrepreneurs often can and can’t do. We designed the kick-off of our Louisville program to coincide with the AGREE Conference–a national policy initiative on food and agriculture that brought together everyone from former heads of the USDA to family farmers. We spent an evening and a half-day session with our entrepreneurs engaging with sector experts on a policy level–and, based on feedback, the session created more value for our ventures–and the sector–than the angel investor pitchfest that evening! Policy-makers may not care about entrepreneurship as a means to an end–but they do care (and can dramatically affect, for good or ill) the problems they are solving.

4) Location matters in leveraging problem-based assets.
Louisville is potentially the best place in the country to solve the problem thesis of the agriculture supply chain. Local assets mean customers: from the high volume of family farms per capita in Kentucky and Indiana to the logistics expertise in Louisville due to UPS, Amazon, and Yum Brands, enterprises are able to design their solutions alongside customers–the people who will pay for the problem to be solved. In the words of one entrepreneur, “I’d rather be in Louisville for my business than Silicon Valley.” All of a sudden, the problem-based approach empowers communities worldwide to figure out what problems they are uniquely equipped to solve. Instead of places around the world trying to be “The Next Silicon Valley” (again, input-focused) places can focus on what they do best, giving them a competitive advantage to solve specifically identified problems in the world.

Entrepreneurship is problem-solving, and problems aren’t solved in a vacuum. Some, like the desire to pay as painlessly as possible as a restaurant, strike us in the face because we’re personally inconvenienced. Others, like the need to more sustainably manage our natural resources, or to deliver affordable, outcome-based healthcare for all require longer-term thinking and collaboration with policy makers, corporates, strategic investors, and local assets. But they still first rely on identifying a problem that could be solved through entrepreneurial innovation.

We’re making a bet that by getting ever-more focused on identifying these problems and building the right enabling environment for entrepreneurs, we will drive systemic, sector-level change. And we may not be able to identify the change immediately. As the Omidyar Network writes in their recent report Priming the Pump: “Impact needs to be measured at the sector, not just the firm level.” Just because a specific firm doesn’t succeed doesn’t mean the exercise was a failure. If a firm invents a new distribution model, develops a technology that is licensed or improved on, or raises public awareness of the problem, all solvers benefit.

With the problem first, entrepreneurship is the means; a healthier, more equitable, sustainable, and prosperous world is the end.

 

This post originally appeared in Alliance Magazine on May 16th, 2013.

The inaugural Asian Venture Philanthropy Network (AVPN) summit, more than any other gathering I’ve been to, provided concrete answers to the question: ‘how do business and philanthropy mix?’ Typically, they don’t. Kevin Jones, founder of the Social Capital Markets conference, often describes this as the ‘two pocket phenomenon’: ‘I do good with my philanthropy in one pocket; I make as much money as I can with my commercial pocket, and they don’t mix.’ Yet social entrepreneurship, impact investing and venture philanthropy broadly blur the ‘two pockets’ into one by solving social problems with business models. If business – primarily entrepreneurship – and philanthropy blur into one pocket, the conference addressed the question: what’s the role of each?

The consistent message: in social change, philanthropy provides opportunity; entrepreneurship turns opportunity into reality. I saw three core arguments throughout the conference:

1) Philanthropy and entrepreneurship are means; the problem you’re solving is the end.

Prashant Jhawar, CEO of Usha Martin Group, spoke on the final day about how his family thinks about venture philanthropy and impact investing. His take: don’t just do these things for the sake of doing them, or because you think ‘venture philanthropy’ or ‘impact investing’ is an interesting idea. First, identify the problems you want to solve, then use the appropriate tools to solve them. For Prashant, access to education for low-income families in India is a passion – grants are appropriate in some circumstances; investments in others. But staying grounded in what you are trying to do – and using money and structures as tools, not ends – keeps you from being all talk, no action.

2) Markets can solve the problem you identify, but not all markets are efficient; this is where philanthropy comes in.

Harvey Koh, co-author of the Monitor-Deloitte report From Blueprint to Scale, spoke in the initial plenary of the importance of solving the ‘Pioneer Gap’ – the stage in enterprise development where promising models are tested, receive customer feedback, and go to market. In the ‘two pocket’ world, business provides risk capital to enterprises in the Pioneer Gap. In Silicon Valley consumer technology, where markets are proven, hundreds of prior ventures have hit IPO, and the path to financial success is well trodden. Risk capital in the ‘Pioneer Gap’ typically comes from the ‘commercial pocket’; angel investors in traditional US venture capital provide 50 per cent of all start-up financing in the US.

Yet in the impact investment world, the ‘Pioneer Gap’ is not an efficient funding market: fewer than 5 of over 300 self-identified impact investors invest at less than $250,000 per deal. In a ‘one pocket’ world, philanthropy has a disproportionate role in businesses addressing social change. As an example, Harvey discussed the success of Husk Power, which operates micro-grid power stations in rural Bihar and seeks to bring power to 70 million people who currently live off-grid, and attributed its success to catalytic philanthropy. While Husk Power has received impact investment from Acumen Fund, Bamboo Finance, LGT Venture Philanthropy, and several other conference attendees, it was able to prove and validate its model through $2.3 million in grants from Shell Foundation – necessary to prove micro-grid as a technology and Bihar as a viable market, which traditional investors were unwilling to test. In inefficient markets, philanthropy can de-risk market conditions so that entrepreneurs have the opportunity to thrive.

3) Philanthropy’s primary value is to establish a baseline of opportunity; entrepreneurship provides a chance for growth.

I spoke on a panel where Chester Wooley, CEO of Unitus Impact and a founding board member of SKS Microfinance, and Happy Tan, CEO of Grameen Foundation Asia, reflected on the microfinance crisis in Andhra Pradesh, India, in 2010. The takeaway: one of the biggest risks with microfinance has been mismanaged expectations. Anyone who thinks that microfinance can ‘solve poverty’ is setting up for failure – microfinance can provide a very specific service (financial inclusion) that enables individuals to afford better goods and services at lower prices, but cannot, by itself, provide an income, an education/skills level to achieve that income, and a basic level of health to earn an income.

Financial inclusion, as an example, cannot solve poverty: worldwide, for the very poorest, much of the basics – health, education, social services, housing – are in fact being provided by government, with some input from philanthropy (in some places, very well – in some places, poorly). If those basic conditions are met, financial inclusion innovations have tremendous power to lift individuals out of poverty. Antony Bugg-Levine, CEO of the Nonprofit Finance Fund (who literally wrote the book on impact investing as a former managing director of the Rockefeller Foundation), sums it up this way in his article ‘Complete Capital’: philanthropy provides the safety net, while entrepreneurship and investing provide the chance for growth. In our organization, Village Capital, we see this as well: we operate business acceleration programmes for entrepreneurs – providing a basic level of financial and operational stability for ventures – supported by philanthropy, and we make investments in highest-growth ventures, backed by investors looking for a return on capital.

In three days of intense discussions around how to solve complicated problems, I saw some clarity. And when we’re solving the largest problems of our lifetime – an unprecedented number of wealthy living alongside an unprecedented number of desperately poor, and an increasingly resource-constrained world – with the very powerful tool of business and the critically helpful supplement of philanthropy, we need all the clarity we can get.

 

I originally posted this on vilcap.com (link here) in May. I recently started blogging regularly on this site–and have re-posted some of my posts from earlier this year.

Paul Hudnut (@BOPreneur) and I discussed one more challenge/inkling I’m particularly excited about that’s not directly overlapping with the liquidity challenge, but strongly related: the liquidity/early-stage capital challenge in traditional consumer technology is much less of a problem because entrepreneurs themselves also have much more liquidity from successful exits. Self-made entrepreneurs—the traditional source of most early-stage capital—have much more cash in Silicon Valley than they do in the impact investing space—primarily because liquidity events have occurred neither for investors, nor entrepreneurs. And employee retention, particularly among young social entrepreneurs, is often tough because as employees get older, their cash needs increase, and highly illiquid shares in companies (even if they’re successful) don’t pay the bills.

Yet in Silicon Valley, liquidity is less of a challenge. Early employees of promising, growing companies in Silicon Valley are often investing in other companies, sitting on other boards, bringing the entire ecosystem up with them. A friend of mine was one of the first ten employees at a very famous, now-public Silicon Valley company, and was able to self-finance a fast-growing, well-known, privately-held startup by liquidating some of his shares in the original company. This happens all the time.

So what if we built structures that gave strong social entrepreneurs their own capital to invest, and related it to the liquidity challenge?

The basic concept (which, admittedly, is as ill-formed as Paul’s initial comment on redemption rights in his blog post), is as follows (note: this idea could apply broadly in venture capital):

a)    When raising or structuring impact investment funds, fund managers highlight specific sector/area themes (e.g. education technology; energy in emerging markets; local food).

b)    Fund managers build into the fund a “buyout pool” that would acquire some of the founders’ equity (should the founder want to sell) when the founder reached certain milestones. (Protections would have to be put in place to make sure that if founders were still the CEOs of their own companies, they were properly incentivized to continue to grow the companies).

c)     Founders would commit, in exchange for buyout of their shares, to serve on boards of investments that the fund was making (e.g. if an ed-tech entrepreneur had reached a certain threshold of success, he/she would sit on a board of a new ed-tech company)—providing leadership to new entrepreneurs.

d)    Here’s the bottom line: the now-liquid entrepreneurs could be terrific near-peer mentors to the new investments—and would add value to the portfolio as a whole. Whether the extra cash in the founder’s pocket led to the founding of a new company (which the fund, of course, could have first dibs on investing in) or an angel/seed investment in a new impact enterprise or enough security that the founder wasn’t a flight risk from the original company—the positive benefits are imaginable.

So, Paul, that’s my response—and counter-thoughts. What are you (and anyone reading this) thinking?

 

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