31 Mar 2013

Time is your best friend, when looking for positive impact with your money

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Cascade

Some months ago, I came across a great discussion in an “Impact Investing” group on LinkedIn, about strategies of exit from investments in social or impact businesses. I have selected the most relevant extracts and thoughts (*).

 
 
 
 

INTRODUCTION

The community of investors lacks experience as few among them have been exposed to such investment products. There are still some conflicts between definition and expectation of what social investing consists in.

The initial point of this discussion was to share cases of successful exits made by impact investors. Exit strategies are a common topic in the whole social finance field. It may be the case that impact investors wish to hold their investments for a long time, as they are often a source of patient capital. Sometimes, the social enterprise structure may prevent an “exit”.
 
It may not seem particularly compatible with the values of social investment to be looking for an exit.
But …
if more social investments can’t demonstrate an exist, then we are going to continue to struggle to attract commercial investors – patient or not! Financial self-reliance and scalability must start to take priority if we want to prove anything more than good intentions.

 

No standard social business-cases

If there is no exit expectation, the investor is better off being called a business partner or a grant funder. There is a big need for grant funding (or funding with no exit expectations) in some of the businesses (in some specific stages). However … assuming that such grant funding is done with the expectation that the funds would be used by the company to “experiment” and develop that commercially sustainable business model.
 
Much of what we find is debt, not real investment (i.e. equity), in turn, there could only be a limited number of ‘exits’ in the traditional sense. Lack of and multiple social enterprise legal structures across multiple jurisdictions, largely un or under-developed capital markets in the countries where many of the ‘investments’ are made, mismatches between return expectations and investment horizons, total lack of liquidity in this sort of instrument in nearly all of the relevant markets, lack of consistent valuation approaches, and the narrow nature of the market that would potentially buy the equity (i.e. supposedly another investor with a similar view of the social dimension) … and many other factors substantially diminish the prospects for true exits any time soon.
 
However, as an “investor”, I am ALWAYS concerned about an exit. This does not mean that I want an exit within a specific time frame. But I want to know that the entrepreneur with whom I have entrusted my capital has both the intention and the capability of, someday, returning it to me… hopefully with a profit. That is what “investing” is.
 

A social enterprise does not mean doing no profit

During due-diligence on startups, it happens to hear the entrepreneur basically saying something like : “I’m going to save the world, you should be grateful that I’m willing to take your money and I have no intention of ever returning it, much less working on your behalf to ensure that it is profitable and sustainable.”
 
We can not expect a never ending flow of free money with the excuse that you are doing service to the world! Impact investing is still… investing. Investors should consider returns. Entrepreneurs should consider profits. We are very patient investors, and have capital deployed right now that is unlikely to see liquidity for 10 years… or more. But to imply that we should simply abdicate any expectation for returns is not acceptable to us.
 
Institutional investors, for example, have actuarial returns that they MUST achieve. Period. Failing to do so puts every one of their beneficiaries at risk. If we, as a community, can’t deliver the returns (income or exits) that they need, we won’t even get in the front door. And if we can’t do that, than impact investing is doomed to remain the niche discipline that it is now, funded by well-intentioned, visionary, progressive wealthy families who see a different future for capitalism.
 
I WANT to see systemic change driven by institutional-scale capital, influencing accounting standards, fiduciary expectations, etc. etc. Yet I remain intensely concerned that the disconnect between the entrepreneur community – “I am changing the world, invest in me!” – and the investing community remains entrenched for precisely the reasons that are so well revealed in this provocative thread.
 

Can social enterprises learn from the microfinance sector ?

Microfinance as a business model has provided successful exits in the past. There is a high level of understanding amongst “investors” both in the equity and debt side regarding such business models and hence potential exits.
 
It is questionable whether the perceptions of high margins (which may not be true always) have drawn investors to microfinance ? It may be more the clarity of understanding of the business model.
 
The other type of “social” businesses that have attracted interest of equity investors are technology backed models of financial services delivery (again) and education, commodity warehousing and dairy. While the technology backed models have seen seed stage investments in India for instance, the investments in the dairy sector/commodity warehousing have been in growth phase companies. The dairy sector has provided some successful exits as well.
 
The other current trend is that there is a lot of noise amongst “social investors” about ivy league educated/connected graduates going back to their countries and starting up a social business. This bunch of people are indeed a great bunch. We need more of them and there is absolutely no doubt about it. They do deserve the attention of “social” investors and everybody else.
 
However, a flip side to such attention is that the social investors often miss out on thousands of local businesses in the hinterland run by the not-so-sophisticated “desi” entrepreneurs.
 
Such businesses are “social” in all possible senses but they don’t have the glamour element in them and neither do the entrepreneurs think they are “changing the world” or something. I agree that there is an increasing trend of investors looking at such non-glamourous entrepreneurs but I think we need to do much more of the same because more often than not, such businesses are often backed by generations of tacit knowledge and experience. Off course, it needs a lot of work to identify them.

 

CONCLUSION

It must be outlined that any business not doing harm is not a social enterprise. That would be more in the realm of “Socially Responsible Investing” or SRI, which largely has been confined to the word of equity stakes in large multinationals.
 
Rather social enterprises must deliberately focus on delivering, measuring, reporting on and being held accountable for both social returns or benefits and financial returns and benefits.
 
Social investors should expect earning a reasonable return that is commensurate with the risk taken.
 
There are not many exits. That’s because social investment does not judge exit as a success. Exit is only important to some people, and markets. But we should not need exits to generate more investment. Investment may come as awareness grows of what the sector can offer. Social value is increasingly being recognised as having potentially much more worth than economic value measures.
 

(*) I do not release the identity of their authors, because I do not want to take the risk of getting their thoughts not reflecting their original meaning, as a result of having picked out of the entire debate.
Nevertheless, I acknowledge the very rich contribution of the participants to this discussion.

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