However, if your focus is emerging markets enterprises that can have an impact on people living in poverty, a recent blog by Ceniarth Capital said it best: “Those of us actively allocating capital to fragile enterprises in developing markets recognize that those people who promise comfortable market rate returns while solving global poverty are the equivalent of diet gurus promising that one can lose weight while eating limitless amounts of chocolate cake.”

In a report launched by Oxfam and Sumerian Partners today, we argue that it’s time to look at impact investing differently; to start with a focus on the needs of the businesses working to make a meaningful impact on poverty reduction, rather than on the investors who stand to benefit from their work. Enterprises working in this space are in new territory – continually adapting their business models, earning low and slow returns and operating in markets that are subject to considerable exogenous shocks (e.g., economic instability, weak infrastructure, extreme weather events and poorly developed value chains). These firms will make decisions that can seem irrational if your focus is market return. They may seek out “at risk” populations, such as single moms balancing the demands of work and family, as employees. They may share ownership and decision-making with their workers. They may pay their suppliers not the price that is commonly expected in the market, but a higher price the firm sees as “fair.” The businesses themselves, and the funds that put their money into these firms, organize around the intention to generate a measurable, beneficial social or environmental impact alongside a financial return – and that prioritization is reflected in their structures, processes and activities.

However, to meet the return expectations that have been established by the sector’s push toward the larger mainstream market, we increasingly see conventional emerging markets investments being reclassified as “impact investing.” Arguably, it’s this trend that has transformed TPG’s investment in Apollo Tower, a cellphone tower company in Myanmar, from a standard emerging market foreign direct investment into an impact investment. The impact statement claimed by supporters is that cellphone access has “helped to increase transparency in a country known for tight control of its information, helping the nation take steps toward democracy.” Hmmm. Really? A cell phone company is actually a democracy and governance project in disguise? Seems a bit of a stretch.

As we write in our report, it should not be assumed that an investment in a cell tower, or a wind farm, or any other enterprise in the global south, is inherently socially positive. Rather, it should be incumbent upon the fund to demonstrate how these enterprises are intentionally structured to optimize impact and benefit poor and marginalized groups – rather than only providing implied, incidental or indirect benefits. They should be able to show what difference the fund’s provision of capital and support and engagement has made. Any self-identifying impact investor should be able to demonstrate a clear intentionality to achieve impact.

Furthermore, the research that has set the prevailing “have your cake and eat it too”-sized return expectations has its limitations. Take, for example, the very same GIIN/Cambridge associates “benchmark” report, which included no commentary on the associated impacts achieved and instead used a self-reported intention to generate social impact as the only impact-related criteria for inclusion in the benchmark. The data included a high proportion of funds focused on the theme of financial inclusion, an industry that has depended on decades of subsidies. Finally, the “benchmark” setting was drawn from a small pool of funds, all of which were targeting market rate returns.

Why does any of this matter anyway? Big tent, right? It matters because the rush to the mainstream can pull impact investing away from its original intent and undermine the meaningful role it can and should play in poverty reduction. It matters because high-profile investments such as Apollo Towers shift the goal posts for everyone. It makes philanthropists doing the critical work of providing smart subsidy to funds and enterprises operating in the toughest places ask, as they have of Root Capital, “Am I the dumbest money in the room?” – If everyone else is making tons of money, am I a sucker if I’m giving it away? And it can divert social entrepreneurs from their mission when they are challenged with the trade-off between purpose and profit. As one social entrepreneur told me recently, “Do we really need this money? Is it going to disorganize us from our original idea? The motivating factor will be to meet the profit targets, not looking at the social part. … Maybe the pressure we will feel from the investors will move us to abandon our women’s empowerment mission. We don’t want that to happen.”

We propose six recommendations that we think can provide a more balanced understanding of what is possible in impact investing, letting the sector begin to use money more creatively:

1. We call for a shift of approach in the market; from one in which we tailor funds around the needs of investors to one focused on developing products that serve the needs of enterprises seeking to combat poverty. Specifically, we need wider adoption of alternative fund structures – such as permanent capital vehicles and evergreen funds – and new financial tools that reflect the predominantly “low and slow returns” of most enterprises prioritizing social impact.
2. The sector needs greater transparency around reporting both the impact and financial returns(gross and net) achieved by impact investors.
3. Donors and philanthropists need to deploy smart subsidy and patient capital (return of capital, rather than return on capital) to support enterprises capable of making a meaningful contribution to poverty reduction, and to support hybrid financing models alongside impact investors seeking a net return on capital. Grants, philanthropy and smart subsidy should be seen as part of the impact investing continuum, not its enemy.
4. The industry needs more independent research to understand the enterprise-level experience, and to analyze which structures, approaches and incentives best help businesses to maintain an intentionality to optimize impact.
5. We call on impact investors to agree to a voluntary code of practice that enshrines the intentionality to behave and take decisions in ways that have a primary focus on achieving impact.
6. Impact investors should adopt incentives for optimizing, measuring and reporting impact as well as achieving financial return targets.

We have no problem with financial returns, but let’s not pretend that investors seeking a pure market return can tackle the most complex global challenges in high-risk markets. They cannot. Not in education. Not in health. Not in reducing child labor and forced marriage. Not in water and sanitation. Not even in banking for small enterprises, which continue to be significantly underserved today by markets everywhere, despite SMEs being the biggest generators of jobs and incomes globally. One just needs to look at the history of Silicon Valley or the microfinance industry ­– both completely commercial today – to justify smart subsidy and venture philanthropy. Our memories are simply too short. It’s not about distorting the market – often, there is not much there to distort – it is about catalyzing it.

By Mara Bolis, Oxfam

More than 35 CEOs and civil society leaders of the Business & Sustainable Development Commission (the Commission) today reveal that sustainable business models could open economic opportunities worth at least US$12 trillion and up to 380 million jobs a year by 2030. Putting the Sustainable Development Goals, or Global Goals, at the heart of the world’s economic strategy could unleash a step-change in growth and productivity, with an investment boom in sustainable infrastructure as a critical driver. However, this will not happen without radical change in the business and investment community. Real leadership is needed for the private sector to become a trusted partner in working with government and civil society to fix the economy.

In its flagship report Better Business, Better World, the Commission recognises that while the last few decades have lifted hundreds of millions out of poverty, they have also led to unequal growth, increasing job insecurity, ever more debt and ever greater environmental risks. This mix has fueled an anti-globalisation reaction in many countries, with business and financial interests seen as central to the problem, and is undermining the long-term economic growth that the world needs. The Commission has spent the last year exploring a central question, “What will it take for business to be central to building a sustainable market economy—one that can help to deliver the Global Goals?” Better Business, Better World—the release of which is timed with the World Economist Forum in Davos and the U.S. presidential inauguration—shows how.

“This report is a call to action to business leaders. We are on the edge and business as usual will drive more political opposition and land us with an economy that simply doesn’t work for enough people. We have to switch tracks to a business model that works for a new kind of inclusive growth,” said Mark Malloch-Brown, chair of the Business & Sustainable Development Commission. “Better Business, Better World shows there is a compelling incentive for why the latter isn’t just good for the environment and society; it makes good business sense.”

At the heart of the Commission’s argument are the Sustainable Development Goals (or Global Goals)—17 objectives to eliminate poverty, improve education and health outcomes, create better jobs and tackle our key environmental challenges by 2030. The Commission believes the Global Goals provide the private sector with a new growth strategy that opens valuable market opportunities while creating a world that is both sustainable and inclusive. And the potential rewards for doing so are significant.

The report reveals 60 sustainable and inclusive market “hotspots” in just four key economic areas could create at least US$12 trillion, worth over 10% of today’s GDP. The breakdown of the four areas and their potential values are: Energy US$4.3 trillion; Cities: US$3.7 trillion; Food & Agriculture US$2.3 trillion; Health & Well-being US$1.8 trillion.

“Global Goals hot spots” identified in the report have the potential to grow 2-3 times faster than average GDP over the next 10-15 years. Beyond the US$12 trillion directly estimated, conservative analysis shows potential for an additional US$8 trillion of value creation across the wider economy if companies embed the Global Goals in their strategies. The report also shows that factoring in the cost of externalities (negative impacts from business activities such as carbon emissions or pollution) increases the overall value of opportunities by almost 40%.

“At a time when our economic model is pushing the limits of our planetary boundaries and condemning many to a future without hope, the Sustainable Development Goals offer us a way out,” said Paul Polman, CEO of Unilever, and a commissioner. “Many are now realizing the enormous opportunities that exist for enlightened businesses willing to stand up and address these urgent challenges. But every day that passes is another lost opportunity for action. We must react quickly, decisively and collectively to ensure a fairer and more prosperous world for all.”

While the opportunities are compelling, the Business Commission makes it clear that two critical conditions must be met to build these new markets. First, innovative financing from both private and public sources will be needed to unlock the US$2.4 trillion required annually to achieve the Global Goals.

“As stewards of long-term capital, the investment industry and its clients can support the achievement of the SDGs by creating simple, standardized sustainability metrics integral to the investment process,” said Hendrik du Toit, CEO, Investec Asset Management, and member of the Commission. “We also need new streamlined partnerships with governments and communities that can reduce risks for everyone and bring more private investment at lower cost into sustainable infrastructure development.” 

At the same time, the Commission believes a “new social contract” between business, government and society is essential to defining the role of business in a new, fairer economy. The recently released 2017 Edelman Trust Barometer reinforces this idea. It shows that while CEO credibility is sharply down, 75% of general population respondents agree that “a company can take specific actions that both increase profits and improve the economic and social conditions in the community where it operates.” And they can do so in ways that align with recommendations and actions outlined in Better Business, Better World: rebuilding trust by creating decent jobs, rewarding workers fairly, investing in the local community and paying a fair share of taxes.

“The promise of the Sustainable Development Goals and the Paris Climate Agreement is a zero-carbon, zero-poverty world,” said Sharan Burrow, General Secretary, International Trade Union Confederation, and commissioner. “To achieve these Global Goals, we need to rebuild trust. A new social contract for business where people, their environment and economic development are rebalanced can ensure that everybody’s sons and daughters are respected with freedom of association, minimum living wages, collective bargaining and safe work assured. Only a new business model based on old principles of human rights and social justice will support a sustainable future.”

Throughout 2017, the Commission will focus on working with companies to strengthen corporate alignment with the Global Goals, including: mentoring the next generation of sustainable development leaders; creating sectorial roadmaps and league tables that rank corporate performance against the Global Goals; and supporting measures to unlock blended finance for sustainable infrastructure investment. “We need to show these ideas work not just in a report but on the business frontline,” said Dr. Amy Jadesimi, CEO of LADOL, a Nigerian logistics and infrastructure development company, and a member of the Commission.

“The Global Goals provide a sustainable, profitable growth model for business, and have the potential to trigger a new competitive ‘race to the top,’” said Jeremy Oppenheim, Programme Director of the Commission. “The faster CEOs and boards make the Global Goals their business goals, the better off the world and their companies will be.”

— ENDS —

The Business and Sustainable Development Commission was launched at the World Economic Forum in Davos in January 2016. It brings together leaders from business, finance, civil society, labour, and international organisations, with the twin aims of mapping the economic prize that could be available to companies if the Global Goals are achieved, and describing how they can contribute to achieving them. To access the report, visit report.businesscommission.org (live on 16 January 2017). Better Business, Better World launch events will be held throughout the week of 16 January, first at the Philanthropreneurship Forum in Vienna, then at the World Economic Forum in Davos. Regional events are also scheduled.

To learn more visit www.businesscommission.org.

To read the full report visit report.businesscommission.org.

Follow us at twitter.com/BizCommission

Media Contact:

Iain Patton, Global & Regional Media

i.patton@businesscommission.org  & +44 (0)7956 430543

OUR COMMISSIONERS

The Business and Sustainable Development Commission was launched in Davos in January 2016. It brings together 36 leaders from business, finance, civil society, labour, and international organisations, with the twin aims of mapping the economic prize that could be available to business if the UN Sustainable Development Goals are achieved, and describing how business can contribute to delivering these goals. The full list of our commissioners includes:

• Amr Al-Dabbagh, Chairman & CEO, The Al-Dabbagh Group

• Laura Alfaro, Professor, Harvard Business School

• Peter Bakker, President, The World Business Council on Sustainable Development (WBCSD)

• Sharan Burrow, General Secretary, International Trade Union Confederation (ITUC)

• Ho Ching, CEO, Temasek Holdings Private Ltd.

• Bob Collymore, CEO, Safaricom Ltd.

• John Danilovich, Secretary General, The International Chamber of Commerce (ICC)

• Begümhan Do?an Faralyal?, Chairwoman, Do?an Holdings

• Hendrik du Toit, CEO, Investec Asset Management

• Richard Edelman, President & CEO, Edelman

• Hans Vestberg/Elaine Weidman Grunewald (acting), Ericsson

• John Fallon, CEO, Pearson plc

• Ken Frazier, Chairman & CEO, Merck & Co Inc. (2016)

• Mats Granryd, Director General, The GSM Association (GSMA)

• Helen Hai, CEO, The Made in Africa Initiative

• Svein-Tore Holsether, President & CEO, Yara International ASA

• Mo Ibrahim, Founder, Celtel & The Mo Ibrahim Foundation

• Mary Ellen Iskenderian, CEO, Women’s World Banking

• Dr. Amy Jadesimi, Managing Director & CEO, Lagos Deep Offshore Logistics Base (LADOL)

• Donald Kaberuka, former President, African Development Bank Group

• Lise Kingo, Executive Director of the United Nations Global Compact

• Jack Ma, Founder and Executive Chairman, The Alibaba Group

• Lord Mark Malloch Brown, former Deputy Secretary-General, United Nations (Chair)

• Andrew Michelmore, CEO, MMG Ltd.

• Sam Mostyn, President, Australian Council for International Development (ACFID)

• Arif Naqvi, Founder & Group CEO, The Abraaj Group

• Mads Nipper, Group President & CEO, The Grundfos Group

• Cherie Nursalim, Vice Chairman, GITI Group

• Ricken Patel, President & Executive Director, Avaaz

• Paul Polman, CEO, Unilever

• Vineet Rai, Co-Founder & Chairman, Aavishkaar Intellecap Group

• Grant Reid, CEO, Mars, Inc.

• Dinara Seijaparova, CFO, ‘Baiterek’

• Sunny Verghese, CEO, Olam International

• Gavin Wilson, CEO, IFC Asset Management Company LLC

• Mark Wilson, CEO, Aviva plc

Trickle-down has no effect

There was a time when ‘trickle down’ was the favourite word in the lexicon of economists worldwide. According to this theory, as long as an economy is growing, the benefits will eventually make their way through the system.

For the proponents of trickle-down economics, the belief was that rising incomes at the top end of the spectrum would lead to more jobs, less poverty and higher incomes at the lower end – much like a rising tide lifts all boats. However, over time, it has proven to be a fallacy, just like any other belief in equitable wealth distribution as a natural course of events.

The Global Experience: The Rich get Richer

Indeed, a research study published by the IMF in June 2015 has decisively debunked the theory at a global level. The report titled ‘Causes and Consequences of Income Inequality’ in fact goes on to prove that a rise in incomes at the top can actually adversely impact overall growth, poverty and employment.

Looking at data from 159 countries from 1980 to 2012, researchers found that when the wealthiest 20% see their share of income rise by one per cent, the economy grows 0.1 percentage points slower over the next five years. Conversely, raising the income of the poorest 20% by a single percentage point raises annual growth by 0.4% over the same period.

While it lasted, the misplaced faith in the trickle-down theory appears to have exacerbated inequalities globally. A 2016 report by Oxfam has revealed that the richest 1% have now accumulated more wealth than the rest of the world put together. Meanwhile, the World Economic Forum notes in a 2016 article that the wealth owned by the bottom half of humanity has fallen by a trillion dollars in the past five years.

The African Experience: The Poor stay Poor

In Africa, this woeful absence of a trickle-down effect is borne out by the successive experiences of individual economies that have experienced stellar economic growth, such as Nigeria and Kenya.

Even as Nigeria recently became Africa’s largest economy with growth averaging over 6% each year from 2005 to 2014, the reality remains that most Nigerians still live on less than US$ 2 a day, while the country lags behind in key development indicators such as health.

On the eve of the country rebasing its GDP to factor in the contribution of new sectors to the economy, the then Finance Minister Ngozi Okonjo-Iweala, a former World Bank managing director, confirmed to the country’s business leaders that:

“It is clear that the top five to 10% is capturing most of whatever growth there is and people at the bottom are being left behind.”

Similarly, Kenya woke up to economic disparities with the government publishing a ‘Socio-Economic Atlas of Kenya’ at the close of 2014. The report exposed significant disparities in poverty levels across the country. Just before the government survey of income inequalities was released in November 2014, in autumn came news from theWorld Bank that Kenya had seen its economy grow 25% after statistical revision and is now officially a “middle-income country”.

As Nigeria and Kenya, the pin-up economies for Western and Eastern Africa respectively, wake up to trickle down woes, it is clear that the experiences of other African economies that are emulating their wealthier neighbours is likely to be no different.

Development Infrastructure to bridge the divide

Lately, a survey by Afrobarometer of 35 African countries released in January 2016, struggled to find any correlation between the reduction in poverty seen in 22 countries in the survey and the recent rates of economic growth.

Instead, it found that there was a high correlation between creation of development infrastructure and improvement in the lives of the people at large.

“ While growing economies are undoubtedly important, what appears to be more important in improving the lives of ordinary people is the extent to which national governments and their donor partners put in place the type of development infrastructure that enables people to build better lives,” the report noted.

Then, rather than pushing ahead with a blinkered focus on high GDP growth that is clearly not translating into employment security, poverty reduction or inclusive growth, the solution lies in concertedly creating a conducive environment for businesses that create jobs and empower persons at the base-of-the-pyramid.

Impact Investing to build the infrastructure

It is here that impact investing, with a focussed agenda to grow businesses that have significant socio-economic impact, can make a real difference to the lives of those at the base-of-the-pyramid, instead of trusting to trickle-down economics that has so far only seen the top 5-10% push their economic agendas through at the expense of the majority.

Impact investors seek to start at the roots and build a strong foundation for those pioneering entrepreneurs that are seeking to provide basic amenities such as shelter, food, water and education in a sustainable and viable manner, rather than simply choosing an investment that boosts their financial returns and is regarded as a conventionally ‘bankable’ business.

As a specialist SME financier in Sub-Saharan Africa and MENA, GroFin is one such impact investor that is making a difference to the lives of entire communities in its locations of operation. With a concerted focus on investing in small and growing businesses in priority sectors such as Education, Health, Food Security, Energy, Manufacturing and Water/ Sanitation, GroFin is helping local entrepreneurs tackle key community issues such as health, nutrition, education, electricity, water and sanitation.

So far, over 16 years of applying its SME finance and business support solution, GroFin has made a difference to 7,000 entrepreneurs, sustained over 62,450 jobs and changed the lives of more than 312,270 family beneficiaries through its investments.

Support impact investors such as GroFin and others in Africa with your efforts as an entrepreneur or funding partner. Remember, the fate of an entire continent could rest in your hands.

 This article was originally published by GroFin. 

1. Trust: Rentier economics in our countries is well-documented and as such, investors are likely to touch down in Accra and drive to the project site accompanied by concerns about self-interested officialdom. However, local stakeholders will often have a similarly low opinion of the ‘outsiders’ – informed by their experience of programmes or investments quoted in the millions, high living standards of expatriate staff and the slow pace of progress. ‘Out of the total committed, more is going to personnel pretending to work than anything else’ is a typical refrain. The result is a ‘them and us’ culture which, if not addressed properly, can harm the quality of communication, warp relations and working practices.
2. Expectations: And yet, and yet. Prevailing incentives in major impact-oriented sectors such as agriculture, healthcare and social housing can be an impediment to productivity. For example, as stated by a policy adviser at a recent Savannah Development Authority (SADA) dialogue, business pipelines are distorted by government waivers. There can also be an expectation of ‘handouts’, which, if denied, might create a constituency that will work to frustrate the proposed intervention or at the very least, not assist.
3. Disjointed Strategies: There is no shortage of individuals launching businesses in Ghana with an implicit and real commitment to creating social goods such as healthcare or jobs for communities that need them. They are motivated by profit certainly but alongside that are goals for society at large. However, at times, fear of alienating categories of investor or customer will create distortions or contradictions in business plans or marketing strategies.
4. How to Say No: Generally-speaking, there is an aversion in our community to delivering the word, ‘no’. Points one, two and three above notwithstanding, local partners are often reluctant to display their disagreement directly. With everyone bending over backward to be polite, clients may miss opportunities to get on the same page as their stakeholders. Instead, things just will not happen as expected or seemingly agreed.

In this context, it is important that clients prioritise culture and that they adopt a listening posture concerning internal and external stakeholders. Learning how others have made it work, or failed, taking time to build trust and understand the terrain – in other words ‘local intelligence’ – are equally key. Finally, in deciding how to engage, bear a Songhai maxim in mind, ‘you will spend money or you will spend time’. In setting strategy, it is safer to keep that expectation in mind than to seek short-cuts to making a profit and doing good.

By Songhai Managing Partner Nana Adu Ampofo (London) and Lord-Gustav Togobo Director of Healthcare and Social Impact (Accra)

“A lawyer sponsored us,” Yohannes says, through a refugee resettlement program of the Third Presbyterian Church in Rochester. Yohannes’ father, whose vision is mostly impaired due to stepping on a land mine in 1978, is now a board member of the church. “Being able to come to America and start over on humble beginnings even after stepping on a land mine is one of the reasons why our founders fought bloody battles,” Johannes adds.

His father now works in a probation office, managing cases involving domestic violence. His mother recently retired from a career in nursing. Yohannes went to law school in Buffalo, and clerked for a judge in Western New York. But thanks to another fortunate connection to a mentor in Washington, D.C., he got into the world of finance. “Finance was never in my language. My DNA is fighting for those who are in need and I got that from my father,” Yohannes says. Now, he can’t imagine himself in another industry.

President Barack Obama announced a new federal $1 billion fund for impact investing in 2011, and he eventually called upon Yohannes to finalize its design and make the program permanent. “This program makes sense to me because it fits my theme in life — make a dollar as well as create positive results for our country,” says Yohannes, whom the president officially appointed to serve as senior adviser to the chief investment and innovation officer at the Small Business Administration (SBA).

The specific goal of the $1 billion is to support small business investment strategies that maximize financial return while also yielding measurable social, environmental or economic impact. The program is housed under the SBA’s Small Business Investment Company (SBIC) licensing program. Under the impact investment program, SBIC-licensed funds promise to invest in small businesses in federal priority sectors and underserved communities, while at the same time contributing to the growth and development of the impact investment industry.

One possible example: using some of that $1 billion to invest in a small real estate developer that is also utilizing new markets tax credit financing for a project to create jobs in a low-income neighborhood.

The standard SBIC license has been a sweet deal for many venture capital or private equity funds. Under the program, for every dollar in capital they raise, the SBA matches up to 2-1, up to a maximum of $150 million. Fund management firms then go out with that federally supersized pool of capital and make investments in small businesses. The fund management firm eventually pays back the SBA, with interest. SBA operations require zero taxpayer dollars, instead funding operations through interest earned on its various investments such as SBIC-licensed funds.

The SBIC licensing program was born when President Dwight Eisenhower signed the Small Business Investment Act, on August 21, 1958 — a date that many would argue is also the birth date of the modern venture capital industry. The program provided the first legal framework as well as financial incentives for people to pool money from strangers for the sole purpose of investing in other strangers — specifically, small business owners. As two legal scholars wrote, in 1959, “Congress has for some time been acutely aware of the difficulties facing small business concerns seeking adequate long term financing for modernization, growth and development. It realized that commercial banks are not able to furnish such long term financing, that public [i.e. stock market] sale of small issues of securities involved prohibitive costs, and that private placements had afforded no general solution to the problem.”

The first SBIC-licensed fund managers were essentially the first modern venture capital firms. “The iconic venture capital firms and private equity funds, generally speaking, have received SBIC dollars or have had a SBIC license,” Yohannes says. “Arguably the most iconic brands have received investments through the SBIC license.” Apple, Intel, FedEx, Costco, Staples, even Build-a-Bear are just a few of the companies over the years that got early stage investment from an SBIC license holder.

While there have been more than 300 SBIC-licensed funds at this point, today they are only a small fraction of the venture capital industry, which has grown to have several well-known shortcomings. Eighty-seven percent of venture-backed startup founders are white; 92 percent are men. More than three-quarters of venture capital ends up in just three states: California, New York and Massachusetts.

In some ways, the SBIC program has already been addressing some of that. From 2011 to 2015, SBIC-licensed funds invested $21 billion in more than 6,400 companies, 20 percent of them located in low- to moderate-income areas. A majority of SBIC-licensed capital went into states other than California, New York or Massachusetts. Part of the impetus for the $1 billion SBIC Impact Investment program is to be more intentional about driving capital to communities that have long been neglected by venture capital and other investment sources.

“Early on it appears that our funds invest more in women and minority-led companies than your standard private equity fund,” says Yohannes. “We’re gonna continue to do that, we’re gonna continue to invest money in the Mississippi Delta, we’re gonna continue to invest money in Detroit, we’re gonna continue to invest money in American small businesses where gaps are the widest.”

So far there are seven impact SBICs. One of them, Bridges Ventures, comes from the U.K. Founded in 2002, Bridges Ventures was created solely for impact investing.

“We have a pretty high bar for impact at Bridges, which is one of the reasons why we felt comfortable committing ourselves to the SBA’s impact bar,” says Brian Trelstad, global partner at Bridges Ventures.

In the U.K., the firm has been active in the pay for performance (or social impact bond) space, for example. They regularly speak about or find other ways to share their evolving approach to impact investing, how to measure it and what are some case studies.

In the U.S., Trelstad says, they are looking at businesses that are located in or serve underserved communities, in the areas of health and wellness, education and skills, or environmentally friendly living.

The SBIC license was an invaluable tool to help them raise capital for the fund. Even conventional SBIC-licensed funds automatically qualify for Community Reinvestment Act credit, providing a strong incentive for banks. “It allowed us to get about $18 million of bank capital,” says Trelstad.

The SBIC impact investment licensing process for Bridges took about a year, but didn’t slow them down from their usual process. “While we were fundraising [from investors] we were also going through the licensing process at the same time,” Trelstad says, adding that one of the advantages of the impact investing program is that they could cut the line in front of others seeking conventional SBIC licenses. The SBA evaluates all SBIC licenses on a rolling basis.

Bridges Ventures has made one investment so far out of its SBIC-licensed fund, in an education company. In addition to businesses creating social impact, they’re looking for a few years of positive cash flow, ideally with $5 million to $10 million in revenue. “We have some flexibility to go earlier, but we’re not going to do a complete startup,” says Trelstad.

While the SBIC Impact Investing program was created as a temporary policy under Obama, Johannes and his team are still working to move it into permanent status. “Our goal is before the end of this year. I can’t say exactly when,” says Yohannes.

By Oscar Perry Abello

This section profiles several sources of potential impact investments suitable for institutional investors. Similar to conventional investment management, these sources include companies (private and public), indices, ETFs, and bonds (or other fixed income instruments). For investors who seek to define what makes an “impact investment,” refer to the Appendix for an explanation of IRIS, a series of metrics that encapsulates many environmental and social themes. It should be noted that the number of new impact investment vehicles continues to grow, and this is by no means an exhaustive catalogue. Whatever the objectives or preferences are, this guide can serve as an introduction to institutional investors who are interested in a broad overview of existing impact investment tools and vehicles.

Companies

Many funds choose to invest in companies individually based on their operations or mission. Some specialized venture capital firms, for example, choose to support only clean technologies. Although this is certainly possible for an institutional investor, investments in larger publicly traded companies may be preferred. Institutional investors can choose companies that value certain ethical guidelines in their business operations or products. To determine whether a company qualifies as an “impact investment,” several frameworks can be used. One popular concept that many companies adopt is “corporate social responsibility,” which is loosely defined as compliance with ethical standards in a business model. CSR frameworks can be used to identify companies or organizations that are ethical or impactful in their business operations. Another more active approach for companies is to make social or environmental impact the core of their mission. It is up to the institutional investor to select companies that best fit their appetite for impact (i.e. in operations or in mission) and preferences (e.g. investment horizon, company performance, and company size).

By Rachel F. Wang, Fellow, Bretton Wood’s Initiative.

Download her report at: https://na-production.s3.amazonaws.com/documents/Impact-Investing-for-Institutional-Investors.pdf

“Add Impact” is the new rallying cry of the Global Impact Investing community, which concluded a two-day plenary meeting of its Steering Group in Lisbon, Portugal on July 8. Championed by Sir Ronald Cohen, founder of Big Society Capital (BSC), which is hailed as the world’s first social investment bank, the Global Impact Investing Steering Group is the heart and mind of a growing social investment movement bent on making impact investing mainstream.

By Elizabeth Boggs Davidsen

Entrepreneurs: Submit your projects for funding. Click on image below.

A major reason for this expected growth is the impending transfer of wealth from parents to their children. Millennials and Generation Xers stand to inherit between $30 and $40 trillion dollars from the baby boomer generation. The magnitude of this wealth transfer is unmatched by previous generations. Beyond simply the size of the inheritance, Millennials have different priorities than the generations before them. Younger investors seek investments that yield a social return, as well as a financial one.

When asked about the primary purpose of business, 36% of Millennials selected “Improve Society” as their answer. Other answers included “Enable Progress,” which was chosen by 25% of participants, and “Create Wealth,” which was picked only 15% of the time (Deloitte Survey, 2014).

In the past, investments in emerging or non-traditional markets were viewed as exceedingly risky. A lack of transparency and available information discouraged investors from exploring opportunities abroad. The digital age has changed that. Enhanced connectivity now makes it possible for investors to act wisely when investing in emerging markets. Moreover, the credit ratings in many developing nations—such as Mexico and Brazil—have improved as governments exercise greater fiscal responsibility. This development creates more opportunity for impact investing.

Investing for gender equality is rapidly becoming one of the most popular forms of impact investing. The goal is to promote gender parity and personal empowerment through debt and equity investments. There are three basic types of gender equality investments: supporting female-owned enterprises, funding companies that offer products and services for women, or expanding employment opportunities for women.

Organizations like the Calvert Foundation and Root Capital have launched initiatives to promote gender-focused investments. To quote Jackie VanderBrug, a former managing director of Criterion Ventures and now SVP at U.S. Trust: “Women are key assets in combating poverty, building their communities, and creating new pathways to a more just and sustainable world. Investing in women’s education, economic welfare, health, and overall well-being produces powerful results that benefit families, communities, and entire societies. When women become economic agents and leaders, social change accelerates and returns multiply.”

Foreign investment in developing countries dropped 16% in 2014. This has resulted in a $2.5 trillion funding gap, which has made it nearly impossible for these countries to cope with lingering problems like food and water shortages, limited healthcare access, and failing infrastructure.

Similarly, the clean energy sector is experiencing a major shortfall. The International Energy Agency calculates that an additional $36 trillion will be needed over the next 35 years to curb the most extreme effects of climate change. Since philanthropic activity alone cannot bridge the gap, advisors must educate themselves and their clients on impact investing. Our globalized economy has made it possible to engender social change and produce a healthy return on investment. Whether we can find solutions to the most pressing global challenges will depend on the commitment and foresight of investors.

By Marguerita M. Cheng is the Chief Executive Officer at Blue Ocean Global Wealth and Blue Ocean Global Technology.

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It’s no secret impact investing is mainstreaming quickly, with large, commercial investors like Zurich, Blackrock, and UBS taking significant strides. Yet the question remains: just how rapidly is the market changing, and what are the implications?

The venture capital industry creates value that far outweighs the dollars allocated to it. But ten year returns to investors haven’t reflected that fact.

Innovation presents opportunities to solve customer problems more effectively and efficiently. But creating solutions that don’t yet exist involves a high degree of uncertainty. Usually, you need to spend a considerable amount of time and money before you know your efforts are going to pan out. That’s where risk capital comes into play; private investors invest money with the hopes of earning outsized returns to account for the level of risk they’re taking

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Source: PricewaterhouseCoopers/National Venture Capital Association

Venture Capital is one of the most important sources of risk capital around. Limited Partners (LPs) commit money to venture capital funds managed by General Partners (GPs). In aggregate, US GPs put roughly $25 billion to work every year. That might sound like a lot of money, but it’s less than 0.2% of US GDP.

Yet that 0.2% has been key in creating companies that account for 21% of the US GDP, and over 11% of private sector jobs (read the report). A tiny fraction of GDP invested by venture firms every year has been instrumental in creating more than one-fifth of the value in our economy.

Of course, venture financing isn’t the only funding source most of these successful companies have used to get where they are. After getting their venture dollars, many have taken in money from banks, mezzanine funds, and public offerings. But for most of these companies, it was venture financing that made them big; by the time they qualify for later-stage funding events, their valuations are often huge.

Clearly, venture capital investing results in tremendous asset value creation, particularly when compared to the dollar inputs.

But where is the payback for investors?

The problem is that LPs are capturing very little of the value created. Over the past ten years, the average venture LP would have generated better returns investing in an index fund such as the S&P 500. Ten year returnsfor early stage venture were 3.9% as of 2013, while returns for the S&P 500 for the same period were 8%. And that’s before adjusting for risk, which makes venture returns appear even more lackluster.

I have heard two common objections to this line of reasoning, and they go something like this (followed by my rebuttals):

“If you look at the past 25 years, the numbers look much better for venture. This has just been a bad 10 years.”

Ten years is a pretty long time. And we’re talking about how venture tracks against a broad market index; it’s not like we’re expecting absolute returns to be awesome. Going back 25 years lumps in the dot-com boom, and I’m not convinced there’s any real likelihood we’re going to see another valuation and liquidity explosion like that again. Rather, I see evidence of fundamental structural changes in the venture industry that are causing these poor returns.

“It’s all about the top performing firms; you need to focus on the incredible returns they make.”

If we’re talking about what a typical LP should expect, averages are what matter. Perhaps if you’re an existing investor in one of the old-school top-tier venture firms, this argument is meaningful for you. Frankly, it’s probably the opposite for most LPs; they don’t have a snowball’s chance in hell of getting into one of those top funds. Even then, you might want to think twice; it’s not clear historical performance for those funds is a good predictor of future outcomes.

The Kauffman Foundation (a non-profit dedicated to education and entrepreneurship) wrote a scathing report in 2012 entitled, “We have met the enemy… and he is us.” The foundation is a large and experienced venture investor, with (at the time) $249 million of their total $1.83 billion investments allocated to 100 different venture firms. Here are a few choice things they had to say:

• 62 of 100 firms failed to exceed returns available from the public markets, after accounting for fees and carry
• 69 out of 100 did not achieve sufficient returns to justify investment
• venture fund GPs have little actual money at risk in their own funds: an average of 1%
• the “2 and 20” model means that GPs are assured of high levels of personal income, regardless of the performance of their investments
• venture funds were taking on average far more than 10 years to return liquidity (when they did)

In summary, they said: “Returns data is very clear: it doesn’t make sense to invest in anything but a tiny group of ten or twenty top-performing VC funds.”

Market forces impacting venture

A combination of structural factors, historical trends, and market dynamics are creating tremendous pressure on the venture capital industry.

The “2 and 20” structure

The vast majority of venture firms work on some (minor) variation of the 2 and 20 structure whereby the fund managers get 2% per year of the committed funds for salaries and operating expenses (“management fee”), as well as 20% of the net value created (“carry”). Since most funds last ten years, that means 20% of investment dollars (2% times 10 years) never even reach the portfolio companies. Sometimes the annual percentage amount drops after the active investing period. Still, net of higher annual percentages (2.5% is fairly common) and long investing periods, the reality is that somewhere around 20% of investor dollars are taken off the top.

There is nothing intrinsically wrong, or even irrational, about the 2 and 20 model; it’s fairly common in other segments of the finance industry such as hedge funds and traditional private equity (although read here and here to see how those industries may be changing). There’s also nothing wrong with investors making multi-million dollar salaries. But in the face of such poor venture returns, it is hard to justify the current economic structure.

Ironically, it’s the 2 and 20 structure that is in part responsible for a chain of events that have contributed to the decline in venture returns over the years. As time goes on, it seems that the fundamental economics of the venture model are putting the entire industry at risk.

A rising tide

The dot-com era was an extraordinary period of value creation, and many savvy venture capitalists made the most of it. As the IPO market exploded, so did the returns for the venture funds who were smart enough to be in the right deals at the right time.

During the five-year period between 1996 and 2000, the US markets saw 1,227 venture backed IPOs. And the VCs were cleaning up, with a median ownership stake of 40%. Perhaps more importantly, IPO returns averaged a stunning 88% during 1999 and 2000 (read the study).

Opening the floodgates

With venture funds practically minting money, the financing floodgates opened. Billions of dollars poured into venture capital funds, and many new funds formed. By the peak of the bubble in the year 2000, there were1,022 active US venture capital firms.

And it wasn’t just the number of firms that ballooned; the average size also grew rapidly. And the size of the firms grew much faster than the number of GPs. According to data from the NCVA, average capital per principal rose from about $3 million in 1980 to roughly $30 million by the late 2000s–roughly 10x growth.

Why did dollars managed per partner grow so much? It’s almost certainly due to the incentives associated with the 2 and 20 structure. The more dollars per partner, the more management fee, and potentially, the more carry. Increasing the size of a fund pro rata with the number of partners wouldn’t be in their interests. And if the LPs were willing to invest more money on those terms, it’s only natural that the GPs were happy to oblige.

The requirement for massive exits

Deborah Gage wrote in her 2012 Wall Street Journal article that the common rule of thumb for venture outcomes is 30-40% completely fail, another 30-40% return the original investment, and 10-20% produce substantial returns. However, her article then points out that research into over 2,000 venture backed companies by Shikhar Ghosh suggest numbers that are somewhat more stark:

• 30-40% return nothing to investors
• 75% don’t return investor capital
• 95% don’t achieve a specific growth rate or break even date

That suggests that it’s closer to 1 deal in 20 that returns a meaningful amount of money, and another 3 in 20 that return capital.

Let’s do a little bit of venture math

What sort of return would the one big winner require to make the fund? First, the fund and it’s goals:

• $125 million fund that makes 20 investments
• Typical 2 and 20 structure, with 2% average over 10 year fund lifespan
• Due to follow-on investments in the good deals that, each accounts for 10% of fund, rather than the expected 5%
• The fund needs to return at least 2x overall to investors to ensure they can raise another fund
• With 20% carry, they need to return 2.5x, or $312.5 million to hit their goal

Investment dollars, and expected outcomes:

• They’re investing $100 million net of 20% management fee
• 3 so-so deals return an average of 2x each
• 8 deals return an average of 1x each
• 8 deals are a total wipeout

Here’s how the math works out:

• The goal is 2.5 times $125 million, or $312.5 million
• $40 million into 8 deals generates $0
• $40 million into 8 deals generates $40 million
• $20 million into 3 deals generates $40 million

Without the big winner, they’ve returned $80 million out of a target of $312.5 million, which is $232 million short.

So, what return does their “fund-making” investment need to achieve? With $10 million invested in the big winner, they need a $232 million (23x) return to make their target minimum. More likely, they’re actually targeting a 3x overall fund return, which would imply that they need more than a 43x return in that one deal to make their numbers.

Wow. And to put that in perspective, those returns imply much higher enterprise valuations. Assuming the VCs own a third of the company at the time of liquidity (and ignoring a presumed 1x liquidation preference), we’re talking about an enterprise valuation of $696 million for that one company to achieve the overall 2x return on their fund.

That’s the sort of math that forces most venture capitalists to seek massive exits to make their fund economics make sense.

A weak IPO market

During the massive growth of the venture industry in the 1990s, funds relied in large part on the booming IPO market to achieve these extraordinary liquidity multiples. The returns for some funds of that era are truly astonishing. But the turn of the century brought a whole new economic reality to the venture market. The IPO market dried up extremely quickly, and has only slowly begun to recover over the past few years.

Even with recent improvements, however, the IPO market is nothing like what it was during the boom times, and likely never will be again. The number of issuances is down, and the economics for the investors are far different than they were previously. No more 40% stakes in the companies at IPO, or reasonable expectations for 88% returns from the IPO.

Rather suddenly, venture capitalists had all but lost their most important liquidity generation tool.

Venture’s new reality

The result is larger funds, higher valuations, and later stage investments, which in turn require even bigger liquidity multiples. Without a highly active IPO market, that’s a significant challenge.

More capital per partner means bigger investments

When a fund grows at a rate three times faster than partner growth, it’s not as if each partner can source three time as many quality deals, and perform diligence three times as efficiently. An obvious solution is to put more money to work in each deal, rather than simply increasing the overall number of deals.

That probably explains the trend towards larger deal sizes, and in particular more “loading up” on existing investments in the form of follow-on financings. Peter Delevett’s article in the San Jose Mercury Newsquotes entrepreneur Tony Jamous, who says, “There’s so much money right now in the market that it’s my challenge to actually keep it a small round.”

Revenue generating is the new seed stage

Just because GPs are investing more dollars in each deal doesn’t necessarily mean that they’re acquiring more of the company. Venture investing is not about making control investments; it’s about backing a team. Given the prospect of follow-on rounds, it simply doesn’t make sense to take too much of a company in early venture rounds; otherwise, you’re setting yourself up for a recapitalization when the entrepreneurs find themselves squeezed into a small corner of the cap table.

The obvious way to put more money into a company, while maintaining a suitable portion of the cap table, is to invest in companies that are worth more. That, in turn, implies investing in companies that have reduced risk by making more progress.

That’s why so many venture firms are investing later stage, where risk is lower, and valuations are justifiably higher. Later stage investments are also easier to diligence because there’s more of a track record. Ernst and Young’s Turning the Corner report from 2013 said it pretty succinctly: “VC funds are adjusting their investing strategies, preferring to invest in companies that are generating revenue and focusing less on product development, pre-revenue businesses.”

And Paul Graham, founder of Y Combinator, is clearly seeing it in the market, too, referring to “…what used to be the series A stage before series As turned into de facto series B rounds.”

Venture investors are investing later in the risk curve, meaning they have mostly vacated what used to be seed stage, and seed stage investments now are more similar to what Series A investments used to be. That in turn pushes Series B and later rounds further along the risk continuum.

Bigger investments often mean higher valuations

As traditional venture capitalists move away from true seed stage investing, they’re beginning to clump at the later stages, with more investment dollars targeting a relatively stable supply of viable startup investments. That stable supply and increased demand tend to push valuations higher.

That’s further exacerbated by the generally high levels of LP investments over the past decade. Despite relatively poor returns, Limited Partners continue to pour money into the industry, albeit with what appears to be an increasing emphasis on a smaller set of funds with the best track records. The excess capital active in the later stages of the venture market have resulted in a war for tech companies with demonstrable traction, resulting in even further valuation inflation.

The venture valuation bubble

For a number of years, I’ve struggled to reconcile the evidence of frothy venture valuations with the inability of amazing entrepreneurs to acquire funding. I suspect the best explanation is that both are true; seed stage investments are irrationally hard to achieve, while mid-stage deals are overly competitive.

Revisiting Paul Graham’s June 2013 essay on Startup Investing Trends (referenced earlier):

“Right now, VCs often knowingly invest too much money at the series A stage. They do it because they feel they need to get a big chunk of each series A company to compensate for the opportunity cost of the board seat it consumes. Which means when there is a lot of competition for a deal, the number that moves is the valuation (and thus amount invested) rather than the percentage of the company being sold. Which means, especially in the case of more promising startups, that series A investors often make companies take more money than they want.”

There is tremendous pressure in the venture industry to invest more money, at higher valuations, in more mature companies.

Higher investment valuations require higher exit valuations

We have already discussed the economic imperative for venture firms to seek massive exits. What happens when those already lofty multiples are rebased on a significantly higher initial investment valuation? It simply means that the size of the liquidity events required to achieve success are all that much larger.

The entrepreneurs are feeling it, too. Peter Delevett’s article in the San Jose Mercury News goes on to quote venture investor Craig Hanson: “In other words, too much money now makes it harder for the VC firms and entrepreneurs to strike it rich later.”

Swinging for the fences

IPOs are typically the best way for venture funds to achieve massive liquidity, but they remain elusive targets. Even when the IPO markets are working, there is a finite supply of companies that are suited to an IPO. Bruce Booth wrote a 2012 piece about venture capital, saying “… it’s not the lower frequency of winners in general, but the lower frequency of outsized winners, that has dampened returns in the asset class.”

This is creating a dilemma for venture capitalists. Their strongest economic imperative is to maximize the capital under management per partner. Success for most is more about raising and layering funds than generating income through carry. That’s not to say that they don’t hope for massive payouts from carry, but the changes in the market have made it increasingly difficult to achieve that.

Here’s a colorful way to think of it: the home run king is under pressure to beat a field of top-notch batters. But this season, they moved the fence out 100 yards farther than before. A miss is as good as a mile; the only thing he can do is swing with all of his heart.

For many venture funds, their singular goal is to invest in those very few mega deals that deliver crushing returns. Anything less simply won’t move the needle.

The future of venture capital

While venture capital is certainly here to stay, it’s clearly an industry in flux. Investors and fund managers are beginning to adapt. Meanwhile, exciting new models are beginning to emerge.

Venture capital is here to stay

Venture capital is by no means going away. It’s an important, multi-billion dollar industry, filled with talented, intelligent, and often charismatic people. Many of them are experienced entrepreneurs accustomed to dealing with change and uncertainty. The likelihood is that they’ll figure out a way to thrive, and that in turn implies that they will be able to continue to make money for their investors.

There are also some trends that will likely change some of the industry dynamics for the better. Those include:

• While the past 10 years have been bitter for many venture capitalists, there is recent evidence of an upward trend.
• The overhang in LP capital commitments is mostly worked out, and there is some evidence capital inflows are moderating to a more sustainable pace.
• The NVCA estimates there were 462 active US venture firms, down from 1,022 in the bubble of 2000; that is likely a reduction to quality, and a more appropriate overall market size.
• There is evidence that the IPO markets are reviving, improving potential liquidity opportunities.
• The underlying value created by many venture investments is real in a way that probably wasn’t true to the same extent during the dot-com era.
• There is evidence that LPs are focusing more on track records of the actual investing partners, which is probably a more efficient rubric for selection.
• There is some evidence that GPs are willing and interested to engage in a dialog about how to evolve the economics and structure of their funds.

But it is an industry in flux

I think Wade Brooks sums it up nicely in his TechCrunch article when he says, “early stage venture investing does not occur in an efficient market.” Returns to investors over the past ten years have been inadequate, and the Limited Partners are beginning to change their behavior. And the fundamental economics will not be tenable for many funds; I expect continued fallout, and further winnowing of funds.

New models emerging

Perhaps most importantly, there are new investment models emerging. These may be hybrid models where venture capitalists add value in new ways, such as Andreessen Horowitz. Or, in the case of 500 Startups, revolutions in the ways that professional investors select and invest in companies. In some cases, it may be fundamentally different approaches to investing, such as crowdfunding. Meanwhile, we can’t forget Angel investing, which offers the chance to capture enormous value, albeit with certain caveats.

And, of course, there’s the new approach that we’re taking here at Founder Equity, which we believe offers the chance to create more value, more quickly, and with reduced risk. We look forward to sharing more with you as we continue our journey.

By Joe Dwyer