Now's the time for alternative impact investments - 3 part series
The days of chasing the VC model for impact must end. Investors need to embrace new models of investing for impact with better aligned incentives and returns.
The investment ecosystem has changed drastically over the last decade, even before seismic volatility shook the portfolios of most investors with COVID lockdowns. The effectiveness of the traditional 60/40 portfolio of bonds and stocks may no longer hold in this landscape, which provides room for other alternative investment strategies as an additional source of diversification. It also creates the opportunity to unlock capital to support early-stage, purpose-driven entrepreneurs with a social and/or environmental objective ingrained in their business and vision.
In this three part series I’ll explore:
The unintended consequences of VC model on Impact investments
The opportunity presented by alternative investment structures
A dive into the financial tools investors can use to diversify their impact portfolios
The Unintended Consequences of Venture Capital on Impact Investments
Though venture capital was considered a key alternative investment strategy in rolling out impact investments after the term was first coined by the Rockefeller Foundation in 2008, there were certainly several unintended consequences that transpired as a result. One of the earliest challenges was how we were approaching an impact investment. Given the definition solely focused on “intent”, if one investor approached a deal fully caring about deforestation, while another approached it primarily focused on financial returns, the deal would be considered an impact investment for the first investor, but not for the second, creating a notable mismatch in expectations.
Based on the trillions of dollars that have been poured into impact investing within the last 15 years, we also witnessed numerous professionals migrating into impact investing from very traditional finance backgrounds. Unsurprisingly, many of these individuals experienced feelings of emptiness, hollowness, and lack of fulfillment from pursuing traditional finance careers. Instead, they desired to support social and environmental objectives in their work after noticing the extractive nature of industries that not only harmed the economy and planet, but individual people too. Unfortunately many of these early founders and financiers trained in the traditional system brought with them the assumptions and frameworks that serve late stage capitalism and generate the negative impacts that social enterprise and impact investing seek to solve.
The reification of venture capital as a “fix all” solution correspondingly took place after the 2008 financial crisis. This was not by accident as the venture capital industry in Silicon Valley poured millions of dollars in public relations campaigns to turn founders and investors into celebrities. During this time, increased focus on the“high flyers”, including 100x exits, massive wins, and the intentional reinvestment by venture capitalists back into their own system, generating the next generation of angel investors and founders.
We also saw several organizations, such as Y Combinator, with remarkably talented cohorts that landed them huge acclaim and success. There was a host of accelerators long before Y Combinator that had similar business and cohort models, but ultimately failed because they didn’t have the luck and timing of including founders of Reddit, Dropbox, Weebly, Stripe, and Airbnb in their early cohorts.
In this pursuit of the VC model for impact, there was also a porting over of traditional venture terms onto impact investing deals. We saw this in several earlier angel investments between 2009-2011. One of the significant downsides of this was that, unlike most tech companies, the majority of social enterprises did not have a fast or clear trajectory for exit. There wasn’t a way for the investor to get their cash back immediately.
Back in 2011-2012, I worked with the International Finance Corporation and had the privilege of interviewing hundreds of impact investors in the field. I still remember some of my conversations with folks where the lack of exits meant that early investor capital was locked up. Several second, third, and fourth generations of entrepreneurs may have had better innovations, user-centric designs, and improved technologies but did not have access to the capital needed to grow and scale their businesses in the way that it was called for.
In parallel to this happening, the freezing up of bank lending was also taking place. More banks become tighter and more conservative with their requirements of lending capital, especially after the financial crisis. When you speak with small business owners who founded their companies in the early 90s, there is this common understanding that you can always access a business loan to finance your venture. This is especially not true today, specifically if you are a woman, entrepreneur of color, or an individual with a minority background. Witnessing that divide has further entrenched the racial and gender disparity that exists today where the privileged few are getting access to the capital they need to grow and scale their organizations - too often create a negative impact. Ventures that are more often run by women and entrepreneurs of color and are focused on social or environmental benefit do not have access to the same capital. As a good entrepreneur would say, when you look at that gap, there is also an opportunity.
Stay tuned for part 2 in this series the Opportunity Presented by Alternative Return Vehicles