Date: 2024-11-12 Page is: DBtxt003.php txt00004796 | |||||||||
Social Finance | |||||||||
Burgess COMMENTARY Thank you ... great conversation. Peter Burgess | |||||||||
The “Original Sin”: Why Impact Investing is Getting Stuck, and How We Can Fix It Last week, my friend Paul Hudnut posted a follow-up from a conversation we had around what Paul calls the “original sin” of impact investing: liquidity. In Paul’s words, “what if, in the end, (impact investing) doesn’t matter?” Investors put money into companies and enterprises grow; however, the only way investors get money back is if the company has a “liquidity event”—which is, most commonly, an initial public offering, an acquisition by a larger backer, or another event that gives cash back to the original investors—a requirement for the whole “investing” thing to work. Yet liquidity is where most impact investing gets stuck—investors often won’t invest upfront because they don’t see liquidity options even in successful companies; at the same time, companies that do have “liquidity events” often worry impact investors because they lose mission. Conferences and articles are littered with examples such such as SKS Microfinance, who critics claimed lost sight of quality/impact control driving for ultimate growth, or Ben and Jerry’s, who got acquired by Unilever at an attractive financial return for investors, but might have sacrificed some of their social mission to do so. We have to get this liquidity question right. The investor question of “how am I going to eventually get my cash back?” has killed more innovation from day one, in my experience, than any other investor concern. Many would-be impact investors just throw up their hands and don’t get involved—and I don’t blame them for having questions. A few weeks ago, Paul and I were talking about an event that gives me hope. This fall, New Belgium Brewery (on whose board Paul serves) initiated a leveraged buy-out of initial investor shares that brought the company into employee ownership (formally known as ESOP). Initial investors were able to get a return on investment, and the employees who built the company are now in control of the mission of the company going forward. Amazing stuff, but not as easy as it sounds. Paul mentioned that employee ownership of the company was important to the founders and initial investors in the company from the start, and they designed the company’s financial and investment structure intentionally–and well in advance–to accomplish this. So I asked Paul several weeks ago, “What would it take to design a company from day one for this?” Several hours later, we talked through a few options—one of which, a “redemption clause” option, Paul outlined in this blog post. For what it’s worth, here is my two cents on how to tackle the liquidity question for impact investors. Impact Investment Structures: A Procrustean Bed (As background, I studied the classics throughout school. This is important, though, so bear with me.) In ancient Greek and Roman culture, the xenia, or relationship between a guest and a host, was sacred. People’s character was measured by how well they could host—in fact, a guest-host relationship gone wrong between the Greeks and the Trojans is what started the Trojan War. According to legend, Procrustes had built a reputation for being a miraculously good host. The reason: his guest’s beds, somehow, always fit them perfectly. What we learn in digging into the story, though, is that the way he made this work was barbaric: instead of custom-fitting beds to guests, he would measure his guests when they arrived at the house to one bed. If their legs were too long, he would chop them off; if their legs were too short, he would put them in a stretcher until they fit the bed. Right now, impact investors are doing the same thing. This liquidity challenge is not one of substance, but one of structure. We’re using term sheets, investment structures, and corporate strategies designed in the “start-up world” for consumer technology in Silicon Valley, but they don’t apply with companies seeking impact and financial returns in Ahmedabad, Nairobi, São Paulo, or, for that matter, Louisville. But if we break out of the Procrustean bed of Silicon Valley venture equity for liquidity, we can see a few solutions: I. Redemption Rights/Revenue-Shares (the idea outlined in Paul’s blog post) This was the original idea I discussed with Paul, and it has potential. Two iterations:
Both investors and entrepreneurs are ill-educated on this: yes, investors think that Silicon Valley consumer tech equity is the only way to invest, but to an entrepreneur, straight equity seems free when it’s offered (or equivalent to grants at least). More experienced ones know that equity is the most expensive cash you can take, but the majority of ventures out there don’t have this kind of experience.
II. Later-stage Buyout Fund (“The Godot Fund”) Brian Trelstad of Bridges Ventures said that he had heard so many versions of this that it was like “Waiting for Godot.” The basic concept of what Brian terms “The Godot Fund”: a Berkshire Hathaway for the impact investing sector—that would buy secondary shares in companies that would provide liquidity to initial investors. Seems easy, right? Not so much:
Over to you, Paul, and others reading this! Ross Baird is the Executive Director of Village Capital. |