The paradox in impact investing is that a large percentage new and inexperienced impact investors are hurting the very companies that they want to help. Neophyte impact investors have not yet figured out the difference between philanthropy and Impact investing, resulting in a confusion that causes serious damage to the Impact business community.
Here’s how Impact Investors can help Impact startups.
There is a big difference between philanthropy and Impact investing. The organizations receiving funding are focused on doing good in the world and it doesn’t matter whether they are for-profit of not for them to do good. In fact, many for-profits outperform non-profits on execution and core metrics for outcomes. Impact investors should understand their motivations for investing and they should have clear financial and non-financial metrics that they use to create their investment thesis.
A non-profit, by definition, does not make a profit. It is also owned by no one and when it has come to its end or fulfilled its mission, all assets must be donated to another non-profit. Value creation is strictly focused on mission and core metrics include outputs as well as key ratios between operational costs vs. direct program delivery.
Social and Environmental Impact investing, on the other hand, creates value on three ways. The business generates a profit. It creates measurable positive social and/or environmental outcomes, plus it creates positive economic outcomes for investors and founders. The fact that the company creates these positive economic outputs doesn’t in any way diminish the company’s need for capital nor does it diminish the impact created by the company’s operations.
To help clarify how investors and CEOs should think about impact investing vs. philanthropy, I’ve put together a sampling of six common arguments that some, mostly new, impact investors put forward, and some responses to those arguments which I hope will clarify the power of impact investing and a more productive attitude towards profitability and liquidity events.
Six Common Arguments from New Impact Investors
Argument: “I don’t want to invest in a company that is just interested in selling out, so I advise companies I invest in to never have an exit strategy.”
Even non-impact investors are wary of investing in a CEO who appears to be in it just for the money, or is planning for the quick flip. These CEOs likely w
on’t have the grit it takes to overcome the many obstacles in their way and will quit half way through, losing everyone’s investment. There’s a fine line between the quick flip mentality and the strategic CEO who is looking for ways to maximize value and leverage that to increase outcomes for all.
CEOs who hear this argument sometimes change their strategy to exclude an exit strategy, which often means that the net impact the company will have is DIMINISHED because of the short sighted demands of the Impact investor who wants to feel good about themselves in the way that philanthropy makes people feel good. By focusing on data oriented approaches to strategy, investors can come to understand the exit as a way to expand outcomes, not diminish them.
Argument:” If the companies I invest in are acquired, the acquirer may have different values, thus hurting the beneficial impact that the company creates.”
This argument suffers from a lack of understanding how exit strategies and execution work. The exit strategy entails identifying the best acquirers for whom the company will provide the greatest value. This exercise naturally involves understanding the values of the potential acquirer and seeking to build relationships with acquirers who share the impact company’s values and will likely expand on them after acquisition.
So, a company that does not have an exit strategy is more likely to be acquired by a company who has misaligned values and may fail to carry on and expand the mission of the company. Rather than decreasing the risk of a values misalignment, the impact investor increases the chances of misalignment by refusing to support talk of an exit strategy.
Argument: “Impact companies should just focus on creating a positive impact and growing a significant company and not on an exit.”
This is one of the weakest arguments against an impact company’s focus on exit, and it is one that is commonly waged against tech startup CEOs, leading to confusion and underperformance in many cases.
Let’s start by remembering the Second Habit of the Seven Habits of Highly Successful People – “Begin with the end in mind.” This habit is just as important for impact companies as it is for people. Those who focus on the end and develop a clear path to get there are 65% more effective in achieving those goals than those that try to “just build a big company.”
Impact companies create value in three ways, and I don’t just mean the Triple Bottom Line. Impact companies create value through creating a valuable good or service
which is able to compete in the market and create revenues and profits. Impact companies create value because their goods or services themselves create positive social or environmental outcomes
. Finally, Impact companies with exit strategies understand how to create value for their acquirers,
and those acquirers are often willing to pay a multiple of revenue to get it.
Any company needs to understand its core value proposition for its customer. What smart Impact CEOs and their investors will do is to ask what the value proposition is for its second customer too – the customer who buys the whole company. That value proposition is not always the same as the value proposition for the first customer and having a clear understanding of those differing value propositions can be the difference between success and the walking dead.
So, companies with an exit strategy are 1) more likely than others to be successful and 2) will create wealth for investors and founders which can 3) be reinvested into new Impact companies to create an evergreen cycle of positive social and environmental impact.
Argument: “You can’t control the exit, so it’s a mistake to try to pretend that you can.”
People who don’t believe they can control the exit, may also believe they can’t control the market or the customers for their products. They might just as well stay in bed – they can’t control anything and are fairly weak leaders of companies.
Great Impact leaders create their futures. They may not be able to control all aspects, but they can create an environment in which their thesis succeeds. Great leaders will drive towards scenarios that align with their values and
business goals. Just because you can’t control every externality does NOT mean that you must throw up your hands and refuse to plan for the future. It is exactly because of the uncertainty of the future, that exit planning is imperative.
Argument: “Social and Environmental Impact companies are not acquirable, so they should just focus on impact.”
Companies should BEGIN with the end in mind and create all three Impact value propositions (profit, impact, exit). Companies that create profit and
impact should be highly acquirable, and by thinking about it from the beginning, value of all three kinds can be baked into the core strategy.
When it comes time for exit, it’s not a cop-out or sell-out of values. I think of it more like a “commencement.” Just like when someone goes through Commencement at the end of high school, it doesn’t mean that they’ve ended their path towards education, but rather it means that they’re graduating to a higher level of execution by going on to university. Few would say that commencement in any way diminishes the quality of the person going through graduation.
So too with a company going through an exit. By being acquired the company can further its mission tenfold or more by leveraging the capital, sales channels, R&D, brand and other resources that the acquirer can bring to the Impact company. The net result is the opposite of a cop-out, but is rather a commencement of something even bigger and the Impact investor should be right next to the Impact CEO, helping them to achieve that end.
Investors who believe that making a profit is bad should stick to philanthropy. If they need to lose money to feel good about themselves, philanthropy is a quick path to 100% financial loss. Even a zero interest loan to a non-profit results in a profit of zero which is 100% more than a philanthropic gift. Investors who have a problem with Impact companies being profitable should stick to philanthropy rather than dragging down promising Impact startup CEOs and limiting the evergreen effect of reinvestment.
The more that Impact investors focus on achieving positive social and environmental outcomes along with value creation, the more capital will be available to support Impact startups and the more good will be done in the world.
Impact investing is at an inflection point and is growing at an astronomical rate. The global market for impact investments is expected to top $300 Billion by 2020. Capital is chasing Impact deals because of a new breed of Fund managers who apply the discipline and expectations of venture capital to Impact. The more we see of this kind of investing, the better the Impact Investing space will be for everyone.