“You are so right. But I can’t say that while I’m raising capital.”
How many times have I heard this from frolleagues trying to launch emerging markets investment funds for microfinance, SME, impact, energy and technology? A lot! In fact, almost every impact investment fund manager (or would-be fund manager) I know feels one way about the market in private but chooses to present their opportunity following traditional “wisdom” and protocol.
In other words, they’re selling sunshine, butterflies and feel-good fairy tales because they believe that’s what they need to do to attract investors. Technically, they are absolutely correct. Practically speaking, whenever we choose to sell the vision rather than the fundamentals, we pave the way for unhappy investors, sub-optimal returns and a future black mark on the slate of impact investing. If enough people buy into a vision that can’t be realized, the entire “impact investing” industry will crash and burn, leaving only a memory of our collective desire to link people, profits and planet productively.
“It’s just not done that way in mainstream finance” is the corollary to “I can’t say that in public” and another phrase that I hear often. So what? When we worked on the first LatAm credit card receivables securitization at Barclays/BZW, no one had done that before, but it opened the way for a needed financing tool. By definition, something innovative is something you’ve never done before! You know the old saying: if we always do the same things we’ve done before, we’ll always get the same results we’ve gotten in the past.
Impact investment, particularly for early-stage, privately held ventures with social impact (VSIs), requires financial innovation. We need to develop new vehicles, instruments, fee structures and operating protocols that align stakeholder interests and enhance performance.
A while ago, I had a long talk with Santiago Gallinal, who manages Fondo Emprender in Uruguay. At the time, Santiago was gearing up to raise fund two, so we spent a bit of time discussing his methodology, modus operandi, challenges and so on. I really liked Santiago’s hands-on, practical approach and he’s a hero in my book. Why? Because given a (market appropriate) US$10 million first fund size, how much value add is a management fee of 1-2% going to buy? How do you pay the manager at all once the lawyers, accountants, stamp taxes and so on are covered? Fund 2 for early stage came in at US$1.1 million and is fully invested in 20 start-ups. If you’re looking for a different kind of impact opportunity in the Southern Cone, you should check out a third fund in the works, aiming for US$20-30 million – and think about what the management fee on that fund ought to look like.
Let’s get real, people. “Best practice” management fees for billion dollar private equity funds are totally irrelevant for small impact investment funds. Sure, there is an implicit promise in the fee structure that would eventually, at exit, compensate Santiago and his colleagues for their current privations. In the meanwhile, we expect managers like Santiago to forego a reasonable living wage or saving for retirement, or sending their kids to college and so on. At the same time, when we push for artificially low fees, we’re saying that its o.k. to cut corners on governance or portfolio management or impact measurement if the management fees won’t stretch that far. Really? I’m definitely not ok with that premise.
You can’t innovate if you won’t stand up for what you believe to be true. Before you start talking to investors, work out your first year’s operating budget. IN DETAIL. Then figure out what kind of a management fee you’d need to make that budget a reality and how you might change the carry or incentive structure to make that more palatable to investors. When someone pushes back on your proposed fee, you should be able to explain to them what’s going to fall by the wayside. Will you need to participate in all of your Board meetings by phone instead of in person? Will you need to use external consultants in the absence of dedicated staff? How will the budget cuts you make affect your ability to help grow innovative VSIs and achieve interesting exits?
Yes, there are absolutely going to be investors that run in the other direction if you share your true beliefs about the challenges and risks specific to your strategy. Let them run! You want investors that understand the risks and the opportunities and are willing to get behind a solid plan to mitigate the one and capitalize on the other. Investor education is important, but selling the vision and mission isn’t education.
Don’t help build a bubble in the hope that you’ll exit your investments before it bursts. Be true to yourself. Be committed to your strategy and operating plan. And always have a Plan B
By Lauren A. Burnhill aka @LaurenOPV