Do well by doing good…
An up-and-coming trend for investors is “impact investing.” The core concept here is that it is possible for businesses to address important problems of the world while also following a for-profit business model.
The term impact investing spans a wide range of investing theses.
Philanthropy lies at one extreme end of that spectrum, as it can be thought of as an investment with a guaranteed 0x financial return (i.e., no return), but with an expectation of a positive impact.
At the other end of the spectrum are investments like cleantech, which aim to have a positive impact in the world while returning a market-rate return.
Other impact investments lie in between, providing a return lower than the average market return in exchange for a desired level of impact.
In all these cases, the traditional thesis does not quite fit. A general impact investment thesis is more like:
- Sufficient opportunity
- Viable plan
- Team to execute
First, the opportunity must be sufficient to provide a reasonable return on investment. Second, the plan need not be high growth, just viable, as in ultimately profitable after a reasonable amount of investment. And third, the team must not only be good, but must have a passion for the mission underlying the company.
Matching the mission, impact, and return on investment between team and investors can be quick tricky. Ultimately, that balancing act makes it complicated to find the right impact investors for a given startup.
Impact vs. Return
That “reasonable” return on investment is chosen by each individual investor, most often in conjunction with the expected impact of the organization. This can vary from a market-rate return to a zero-interest loan.
For example, here are three real impactful startups (with some of the names of the organizations changed):
- Community Sourced Capital: A crowdlending platform providing 0% interest loans to small businesses from their own customer base, filling in the gap of business lending that banks have left behind.
- Evrnu: Producing new, premium textile fiber from used, unreusable cotton clothing; for the first time in history, making cotton as recyclable as paper, aluminum, or steel.
- Happy Valley Farms: Purchasing and leasing organic farmland in the U.S. Midwest, ensuring the next wave of farmers has access to good farmland, pre-certified for organic farming.
- Obamastove: A manufacturer of clean-burning cookstoves in Ethiopia, which use fifty percent less fuel and produce no visible smoke.
These impacts vary tremendously. For Community Sourced Capital, supporting local businesses through bank-like services makes their likely cost of capital (the entrepreneurial flip side of return on capital) similar in scale to a bank’s.
Evrnu is a high-tech company. If it succeeds, it will likely make its investors more than a 10x return. Thus, despite the huge potential impact, it will likely raise money at normal market rates.
Happy Valley Farms is a niche real estate company, but one that is focused on the “feel good” for supporting organic farmers. The Slow Money investment movement funds such companies, typically using debt priced down at rates at or below government debt. These are rates that can be below the rate of inflation and thus partially philanthropic.
Obamastove operates within a market where many competitors are nonprofits; giving stoves away for free or subsidized by philanthropy is an everyday practice. Meanwhile, there are few equity investors in Ethiopia, and banks charge all companies interest rates on the order of fifteen to twenty-five percent (or higher). With the “feel good” story of helping the poorest of the poor afford stoves, Obamastove is likely to find global investors willing to provide low-interest loans.
Non-dilutive Capital
One other major difference between impactful and traditional startups is that the impact often attract grants and philanthropy. The impactful companies I work with at Fledge are all organized as for-profit companies, and yet many have received grants from foundations and donations from individuals.
For startups hungry for cash, these sources of capital are wonderful, as they are not legally investments and thus do not dilute the ownership on the cap table. We thus often call this money non-dilutive capital.
