A new study by researchers at Santa Clara University's Center for Science, Technology, and Society sheds light on the current investment methods and profit expectations of 45 "impact investors," who invest in social-entrepreneur ventures around the world. The study aims to be a first step toward creating a more coordinated, venture-capital-style system for such social-venture startups.
View the full report. Coordinating Impact Capital, A New Approach to Investing in Small and Growing Businesses,
Here in the U.S., any first-year business student can tell you how the venture-capital process works for business startups: Seed or "angel" money is followed by early-stage VC investors who percolate successful ventures, followed by up-round VC investors and possibly "mezzanine" financiers. It's a very "vertical" process that's capped off, if one is lucky, by an initial public stock offering or an acquisition by a deep-pocketed company.
But that's not how it works for social-entrepreneur startups – those businesses around the world that are trying to solve stubborn social problems like food security or energy access and maybe one day make a profit as well.
There, the flow of investment capital is much more disconnected, inconsistent, and lacking in clear metrics to get the next phase. In other words, it's very "horizontal," notes John Kohler, a retired venture capitalist now working as a fellow with Santa Clara University's Center for Science, Technology, and Society. Kohler and a team headed by Jessica Sawhney, a recent Clinton Fellow, have now completed the first-of-its-kind report.
"Wouldn't it be great if, when a socially beneficial business received its first grant, it already knew where the next round would likely come from, and what benchmarks would be required to secure follow-on capital?" asked Kohler. "Currently, it's all over the map."
For the study, Kohler, Sawhney and a team of student researchers interviewed more than 45 funds, examining where they invested, size and type of investment vehicle used, time horizon preferred and outcomes that were expected for each of several classes of capital: grants, "soft" loans, debt, quasi-equity and equity investors.
Among the findings of the study:
• Almost all respondents stated they would like to participate in syndicated investments, either around a financing event or horizontally along a phased investment structure - but they needed to learn more about potential collaborators.
• All investors in this area are extending their time horizon for an exit or liquidity event, with 53 percent of respondents now expecting to wait between 5 - 10 years and another 13 percent indicating beyond 10 years.
• 58 percent of the investors are "single sourced" from a foundation, a family business or an NGO. Participation by corporations and financial industry firms is still relatively light.
• Funds that reported a global focus expected higher rates of return than regional or country-specific funds.
• Some impact investing funds are forming their own in-house pools of capital to invest in different phases of social investments - indicating a need for venture-capital-like "horizontal capital aggregation" for the whole community.
• Over 80 percent of investors reported that they do not use capacity development organizations to assist their portfolio companies. Yet the 50 percent who practiced monthly or greater contact with their investments expected a strikingly higher rate of return. This indicates benefits from "high touch" portfolio management, even if with a CDO.
• Despite evidence that urban-poor regions are better risks for investors than rural-poor, a surprisingly high percentage of investors were agnostic in measuring or choosing urban vs. rural areas for investment.
• Funds who invested for "impact" say they invest more in the entrepreneur and the idea, while financial investors focused on solid business models and execution by the social enterprise.
"This study gets us one step closer to identifying a business life-cycle for social ventures," said Kohler, "as well as to gather ready-made pools of capital into a syndication structure that accelerates social enterprise development more efficiently."
The authors plan to implement a pilot program in the near future to put into practice some of the suggestions from the study.