Early on in my MBA program, a Finance professor demonstrated that the expected value of a lottery ticket is negative. I’ve avoided the lottery ever since, but the appeal of doing something good with a potential upside is undeniable. In all likelihood, my expected financial return on crowdfunded equity would be negative too, but my non-financial return (moral, intellectual and social) would have meaning for me and I suspect for others as well.

Crowdfunding equity for small businesses would be a fantastic way to jumpstart the US economy with a more sharing and collaborative approach to risk and opportunity. So why aren’t we there yet? Risk and exit seem to be the two main barriers.

Exits are a challenge because there is no secondary market for small unlisted company debt, so it’s much easier to make an investment than to sell one should you need or want to. Commodity exchanges emerged in the 19th century to facilitate trade, share risk and address the issues of liquidity and secondary markets. Their continued existence in the 21st century suggests that there is a valid economic rationale behind the functions of a well-governed exchange platform. Isn’t it possible that we could find an exchange-based solution to the challenge of providing liquidity for equity crowdfunding investments? I’ve certainly got a few thoughts of how that might work and I know of several companies working on creating broad impact investment platforms with similar objectives.

Clearing houses, market-makers and liquidity facilities could all be structured to support small business equity products and reduce the exit challenge that equity crowdfunders would otherwise face. Would it be easy? No. Is that a good reason to walk away from the challenge? Nope, not in my book. Most good things in life seem to require effort and hard work. Why should creating new funding mechanisms for #small-business be any different?

The issue of risk is more complex, since the solution relates to mindset and behavior more than to market mechanisms, per se. Our innate paternalism is holding us back when it comes to regulating crowdfunded equity. We are more concerned with protecting Jane and Joe Normal from their own baser instincts, than we are about creating economic opportunity by sharing risk and reward more effectively. Is this truly a rational position to take?

Jane and Joe Normal buy lottery tickets that have a negative expected value. When the Powerball jackpot is high, they divert money from day-to-day needs and buy even more tickets in the hope of an outsize reward. Sometimes they go to Atlantic City or Las Vegas and gamble away hard earned money, even though they haven’t yet funded their IRA or 401(k) for the year. Joe is pre-diabetic, but he can’t always be bothered to follow his doctor’s instructions to exercise and eat a healthy diet. Jane drives a bit aggressively, and likes to speed even in residential areas and school zones. Clearly, taking risks is something they live with and perhaps even enjoy. These are the people who we’re going to protect from investing in America’s small businesses?

If Jane and Joe get excited about investing in a local greengrocer that brings #sustainable food to an urban food desert, shouldn’t we want them to have the option of crowdfunding some equity to make that happen? And wouldn’t it be fair to give them some of the upside if things work out?

An innovation economy can’t be sustained by donations. Most Americans don’t have enough in the bank to give endlessly to good causes. Investment, even when high risk and low return, has a different profile. If I invest $1000 in 10 crowd funded businesses, it’s quite likely that I’ll be writing off $800-900 on #startups that fail to launch or scale. That 10th business, however, might just change the world. If it were to achieve the much vaunted 10X exit, my $100 investment would return $1000. OK, net-net, I’ve still lost money – but I’ve not lost as much money and I’ve played a small part in creating a successful business. In addition, I have the option of holding my shares for a longer time period and potentially recovering all of my losses and then some. I’ve also potentially increased US tax revenues, since my investment isn’t deductible but (at least for now) my charitable contribution would be.

So, who are we protecting from what when we get all paternalistic about crowdfunding equity? Can we stop people from making stupid financial decisions? Clearly not, or we wouldn’t be talking about the need to switch from opt-in 401-k programs to opt-out versions.

A colleague of mine argued that the lottery funds public goods and that’s why it’s ok that we let people gamble in this fashion. Although it seems that there are multiple cases of state lottery funding being diverted toward programs other than the education or social services they were intended to support, or in which the cost of running a lottery wipes out most of the potential returns to social services, there doesn’t seem to be much hue and cry about lottery reform. How much of a driver is public good and would equity crowdfunding reduce lottery revenues? Would it reduce lottery revenues by a greater amount than it potentially increases private sector jobs, income and tax payments?

If we’re keeping the lottery, why not add equity crowdfunding as a way to boost private sector engagement in the economy and in local communities? Sure, we need to be clear about the risks and maybe even limit the maximum investment that can be made by a non-accredited investor. The real problem that we need to address, however, is not risk but liquidity. How can we sell these investments when we want or need to change our holdings? The issue of creating tradable equity investments and platforms through which those tradable investments could actually be bought and sold is a tricky one. There is a definite trade-off between regulatory compliance, full transparency and the cost of sharing information. How much information is enough to make an informed decision? How much information is enough when we know that the unknown unknowns — the uncertain and layered risks — cannot be accounted for in advance?

Many of the people I talk to insist that creating a secondary market for small business equity is too difficult or too costly. That may be true, but we won’t know for sure unless we think, model and test as many creative options as we can identify. We have both an obligation and a significant interest in finding ways to create funding and liquidity for America’s small businesses. Crowdfunding equity would let everyone play a part in shaping our economic future. Let’s stop worrying about how to protect grown adults from taking risks and focus on the best ways to help them take informed risks. We seem more concerned with avoiding potential loss than with creating potential gains. Why not put the mechanics of creating opportunity and sharing the rewards first?

What do you think? Can we make room for crowdfunded equity in our economic model or are we doomed to a world in which enterprise and philanthropy remain in different and distant silos?

By Lauren Burnhill aka @LaurenOPV

We’re rarely prepared, however, to tackle a chronic illness; something that requires attention, management and focus every day from diagnosis until the end of your life. When you look at the numbers, it’s a bit astonishing how little we discuss managing chronic illnesses: 3 million Americans with type 1 diabetes; 1.5 million Americans with lupus; 1.3 million Americans with rheumatoid arthritis; 1.2 million Americans with HIV and so on. Forgive me if I haven’t mentioned a disease that you or a loved one struggle with – there are many!

The diagnosis of a chronic illness is sometimes referred to as a ”lifestyle altering” diagnosis because there is no cure or end game in sight. Active management of the illness and symptoms is required to avoid “worst case” outcomes and here’s where the Impact Investment silver lining comes in.

Dealing with a chronic illness forces long-term and incremental thinking. The decisions made today will perceptibly impact physical well-being tomorrow. The decisions made this week will impact how productive one will be next week. Ultimately, the decisions made now will impact longevity, later-in-life well-being and functionality. Will an extra hour at work today be worth lower productivity tomorrow? Or does the decision-making equation need further thought? Breaking complex activities up into bite size pieces may be more productive than trying to “power through” when you’re tired or in pain.

Many people have a hard time making good choices when the consequences are long-term/future oriented. Compliance failure is a major issue in chronic disease management. Short-term thinkers stop taking their meds when they feel better, or if the meds (or the delivery system, since many are injectable) are unpleasant, and then run into expensive health care problems down the line. A more pleasant today often wins out over compromising today to prevent a future outcome that may or may not occur. When you have a chronic illness, you have to make all of the right decisions every day. Skipping one or two things may save time (or seem less unpleasant), but the consequences make themselves felt, literally, in your overall health and productivity. Bottom line? This is a risk management issue and one that reveals that human beings are perhaps as focused on short-term results in general as are the stock markets we impact investors complain about.

Individuals who recognize the trade-offs between current compliance and long-term risk management are ahead of the game, whether dealing with chronic illness or impact investment. The silver lining has four elements: awareness/sensitivity; risk management; engaged productivity and patience.

Awareness: Our lives in the Western world include a range of ‘creature comforts’ like electricity, running water, 24 hour emergency care clinics etc. that it’s easy to take for granted. The types of difficult choices we have to make regularly when managing chronic illness are analogous to the kinds of choices faced by poor and low-income populations and can heighten our sensitivity. Regardless of how profound the sacrifices are, the necessity of making conscious sacrifices in our own lives makes it easier to understand some of the trade-offs faced by our target market. Buy medication for yourself, or school books for your children? Put your job at risk by taking time off for treatment or try to hang onto your income source?

Additionally, the fact that many chronic illnesses force us to slow down or just to accomplish things differently adds realism to the opportunity cost of time. Many early proponents of microfinance looked only at interest rate costs when evaluating microlending programs. A much smaller number recognized that there is a high cost when the poor must leave work, travel to the nearest bank branch, wait in line and then travel home. If you lose a day of work and income to apply for a loan, the interest rate you pay represents only a portion of the true cost. Similarly, if you lose a few days of work because you overloaded your travel schedule, the true cost of your field work is much higher than the plane and hotel expenses.

Risk Management: We all know that early stage investing, and especially multiple bottom-line early stage investing in emerging markets, involve a wide range of risks. We have a tendency to assume that because we are doing good work at the base of the pyramid, we can avoid some of the risks that affect mainstream economies – which means that we often respond to risk after a crisis rather than before. Virtually none of the microfinance debt providers had inter-creditor arrangements in place before the global financial crisis. Standard practice in most types of international lending, microfinance didn’t think about inter-creditor issues until after the impact of the crisis began to make itself felt at the level of microfinance institutions. The more aware we are of risk, and how risk management can make us better or worse off in the future, the more pro-active we can be as investors. The same skills that enable you to manage the risk-reward trade-offs of a chronic illness will serve you well as an impact investor. Let’s talk about what could go wrong today, while everything is sunshine and roses, so that if we do run into problems, we’re already prepared to take corrective action.

Engaged productivity: Learning to delegate is hard. Learning to delegate in a way that empowers and enhances your staffs’ abilities is even harder. Before I had to manage chronic illness, doing something myself – or redoing something I had delegated and wasn’t happy with – was a major temptation. Now, however, I am aware that my energy is a scarce resource. I know, on a different level, that delegating things that can or should be done by others is important. In addition, ensuring that you have the tools, resource and motivation to handle delegated work effectively and efficiently becomes a mandatory element of the equation for me. If I redo your work, something on my priority list won’t get done. So, if I’m not happy with what you’re doing, I need to help you do it better. Period, end of sentence. Managing a chronic illness creates a significant incentive to delegate wisely and avoid micro-management. Surprising how responding to a resource constraint can produce a positive outcome!

Patience: The need for “patient” early-stage capital is often mentioned as critical for the success of social enterprise and impact investment. While this is indeed true, our notions of “patient” vary significantly. For some, it means permitting a “grace period” before borrowers must begin to repay capital. For others, it means longer tenors on debt – although usually not too long! Patience, however, disappears when we touch on impact measurement. It seems that we’re willing to leave our money “at risk” as long as we feel it’s doing good. In order to feel that we’re doing good, we want indicators and numbers around the social and environmental returns we anticipate alongside the usual financial returns.

While that sounds reasonable, if we’re talking base of the pyramid, we need to recognize that poverty is a complex condition with multiple causes and numerous obstacles to achieving greater socio-economic well-being. For immigrants, it usually takes a generation of hard work to perceive improved socio-economic well-being. Why do we think that any of our activities or interventions can break the cycle of poverty in a year, or even 24 months? Don’t get me wrong, I’m not saying there’s nothing you can measure in the early stage of a social enterprise life-cycle. What I am saying is that you are unlikely to find a wide range of robust indicators that are statistically meaningful and cost-effective during that early stage. When we are forced to be patient in our own lives, every day, all the time, it changes our personal views on patience. If we can wrap our brains around the realities faced by our target market, we can use that awareness to design new financial instruments, new compensation structures, new pricing policies etc that more effectively align stakeholder interests.

Living with a chronic illness is no fun – and perhaps even less fun when the appropriate risk management strategies are added to our daily lives. By the same token, living in poverty is never fun. Too often, we latch onto initiatives that will make poor people’s lives a little less miserable, rather than aiming for ways to make their lives progressively better. When it’s your health on the table, you’re quite likely to look for ways to make your life better and you’ll probably get creative in doing so – acupuncture, yoga, homeopathy, meditation – the range of complementary or alternative strategies you pursue is limited only by your beliefs (and potentially by the size of your wallet). Capture that creativity and willingness to sequentially try new things until something works – apply that to impact investment – and voilá: the illness you struggle with on a daily basis has just become a source of inspiration, creativity and management savvy.

Work smarter, live longer: One last word on managing chronic illness. As a society, we place a premium on good health, boundless energy, pulling all-nighters in school and working round the clock in the office. We place such high value on health and energy that most people are reluctant to admit to a chronic illness, much less ask for “concessions” that might enable greater productivity or a longer life-span. We can achieve more by working around our limitations than we can by ignoring them and hoping that the consequences can be addressed “later”. Many of us worry that if we can’t work the same way and the same hours as others, we’ll be perceived as unproductive or that people will think we’re not team players. The reality is, if you play to your strengths, you’ll produce better results than if you just play along with the crowd regardless of your needs and abilities.

“Don’t ask, don’t tell” wasn’t a great strategy for the military and it’s not a great strategy for talent management either. If you have a chronic illness, do or ask for whatever it takes to maintain your health and morale. If you have a staffer managing a chronic illness, empower that individual to approach their situation in the most proactive and productive way possible. We get older every day, and sadly, our world gets more toxic too. Let’s grow our empathy and flexibility at the same pace. Today, the person whose well-being and talent you enable and support may be a staffer, colleague or parent. Tomorrow, that person might be you.

By Lauren Burnhill aka @LaurenOPV

What’s Wrong? I’m not the only one saying that pricing, particularly in equity markets, is off-base. In March of 2012, the Economist featured two articles on defining and understanding risk premiums from a general investor perspective and in the context of planning for retirement. In the January 24, 2013 edition of The Economist, the Buttonwood column takes a look at calculating equity risk premiums (ERPs), including some notions around how to adjust for the changing nature of the global economy. On February 9th, the Buttonwood column Beware of the Bias warns us that our views of equity returns are too optimistic. The technical research on ERPs gets a bit mind-bendingly mathematical for me, but it seems safe to say that ERP valuation frameworks are in need of a re-boot.

Setting aside the question of a realistic ERP, our next challenge is that mainstream finance isn’t pricing for a finite-resource planet, or for sustainability in general. When I got my MBA from Wharton, we had to do a group advanced study project instead of a thesis. At that time, emerging markets were just beginning to come in vogue, but domestic investors were concerned about pricing and transparency issues. My group, under the aegis of a Citibank Risk Management director, set about to create an econometric pricing model for emerging market secondary debt. Guess what one factor had the most influence on daily share price? Would you believe yesterday’s share price? Yup, that’s what our model found. Past performance does influence pricing decisions, consciously or unconsciously. For more scientific – and very well-written – insights into this kind of hidden bias, have a look at Nobel Prize winner Daniel Kahnemann’s brilliant  book Thinking, Fast and Slow.

My second piece of anecdotal evidence derives from my days in project finance investment banking. My team worked on long-term cross-border project finance transactions in Latin America, primarily telecommunications, oil & gas, energy and mining, all of which threw off dollar revenues that could often be captured offshore, reducing all kinds of currency and political risk. Most banks were pricing long-term project finance debt fairly conservatively, because the Latin American debt crisis of the mid 1980s was a leading influence on risk perception. Initially, we priced bids based on the prevailing LIBOR interest rates and financial projections, reserve requirements, the nature of risk-mitigating features (fixed priced engineering and procurement contracts, airtight off-take agreements etc) and other market and sovereign risk factors.

As competition for Latin American deals increased, we began our pricing exercises the same way, but then adjusted the results (fees and interest rates) based on what we thought our competitors would bid so that we would be more likely to win. More competition meant lower pricing margins, regardless of the level of underlying risk and almost purely as a result of competitive pressure. At lower interest rates, we were less willing to hold chunks of our deals on balance sheet. Much as with the more recent collapse in collateralized mortgage and debt obligations (CMOs and CDOs), diligence standards tend to loosen when the paper will end up on someone else’s books. Eventually, we stopped bidding on many deals because our models were showing higher risk levels than competitive deal pricing would support. Head office wasn’t keen on using the balance sheet for long-term deals with risk pricing gaps, which made us less competitive when we did put in a bid. Mismatched risk and pricing meant that less financing was available for the market as a whole. Artificially low interest rates may benefit the few who get funded, but less financial access for everyone else is an unfortunate consequence.

What’s Missing? If pricing in general is “broken”, it’s doubly broken for impact investment. Not only do we need to wrap our heads around new risk paradigms when pricing debt or equity, we also need to figure out appropriate ways to incorporate premiums or discounts related to social and environmental impact aka returns aka performance.

We price impact investments the same way we price traditional financial instruments, in terms of cost of funds, risk and margin, mostly without factoring in positive or negative environmental, social and governance (ESG) factors Arguably, a social enterprise that loses 100% of financial capital could still generate social or environmental returns in the process. If you accept that premise, then we should be producing higher valuations on double and triple bottom-line companies than on traditional profit-maximizers, ceteris paribus. Another perspective is that if we recognize that so-called good business can be bad for the environment, we should value pro-environment and sustainable businesses more highly than resource gluttons and polluters.

Pricing Issues for Investors: Impact investors need to understand that higher returns in the social impact space often require longer time frames – for the base of the pyramid (BoP) focused social enterprises, we’re more likely talking 8-10 years as opposed to 3-4 years. Management fees need to be assessed not by whether they match the notional standards of 2% on equity funds and somewhere around 1% on debt funds, but by whether they will cover the cost of implementing the manager’s value-add strategy. Many impact equity managers believe they must live with a 2% management fee, even though their fund is quite small. One of the ways they adapt is by hiring analysts and junior staff instead of bringing in more expensive – and more experienced – partners or senior staff. Achieving impact investment upside requires human capital as well as financial capital.

Making impact investments – at home or abroad – is challenging work. Targeting new and innovative business models to reach lower income populations means understanding all of the traditional startup business needs, as well as sector or industry structure and then adding on impact measurement and reporting and governance. Off the shelf solutions rarely work, they require adaptation and the impact investment manager is a big factor in how easily or rapidly this occurs. Make sure your managers have enough budget to do the job right! If you think it’s important that they participate in regional venture capital associations or industry associations, the membership dues need to be in the annual budget. If you want quarterly reporting, the manager needs the finance staff and systems to deliver those reports.

Pricing Issues for Managers: Managers, on the other hand, need to grasp the concept that their people really are – or at last can be – their greatest asset. They need to fight for appropriate staffing and salaries and they need to develop budgets that will allow them to add value to their portfolio companies as well. In order to achieve a sustainable impact investment industry for the long run, business planning should include team building and hiring senior talent. Investment in management information systems – even when an outsourcing strategy is planned – has to be part of the operating budget too. I’ve seen a couple of good funds run into trouble when poor reporting practices undermined investor confidence, caused a lot of second guessing around deals in the pipeline and ultimately led to termination of the management agreement. The thing about transparency is that it’s much easier – and cheaper – to talk about than it is to provide.

Given that impact managers probably need more fee income up front, the allocation of eventual upside should probably NOT follow the standard 80-20 allocation of carried interest. The fee level needs to cover the budget, but recognize that fees reduce investment capital and potentially upside returns to investors. I’d go so far as to say that if the management fee is higher than 2%, the carried interest assigned to the manager should be lower than 20%. The carry should take a hair cut to reflect the appropriately larger up front running costs.

My other issue with carried interests as performance incentive is that they are based exclusively on financial hurdle rates. If an impact manager commits to deliver financial AND social returns, shouldn’t part of her reward reflect social performance as well? My guess is that whatever the agreed upon carry, 100% payout of that carry should require meeting or exceeding both the financial hurdle and some type of social impact indicator(s) as well.

Pricing for the BoP: What about the target market, you ask? What about those people at the BoP – how do you price products fairly? Different question, but the quick response is that if cost of funds and fees are set equitably and rationally, the cost basis for pricing should be lower than for a single bottom line enterprise. If you’re investing directly, rather than through a fund, one nifty way to ensure that the target market benefits from increased growth and efficiency is to link DECREASES in product pricing to INCREASES in operating efficiency. The goal here is not necessarily to offer the lowest possible price, but to offer reasonable, sustainable pricing for appropriate, high quality goods and services. You wouldn’t be happy if your “affordable coffee” turned out to be mostly chicory, but I bet you’d be thrilled if the price of fair-trade coffee decreased over time!

Why you should care about pricing: As I noted above, when we price financial products in a way that overlooks critical risks and non-financial returns, we end up reducing access to finance. 40 years ago, when microfinance existed solely in the form of subsidized loans and grants made through non-profits, private capital stayed away.  Non-profits in countries like Bolivia started lending at market and experiencing higher repayment rates than those of the subsidized loan providers. In light of this success, continued growth meant finding ever larger amounts of funding. Commercial capital, however, was willing to invest in microfinance only when it became clear that both the legal and financial structures of emerging microfinance institutions (MFIs) could produce attractive investment returns.

What Next? Lending to and investing in enterprises is a fundamentally different business than lending to and investing in financial institutions. The experiences and best practices of microfinance cannot be imported wholesale into impact investment. We need to develop new instruments, structures, policies and practices that are appropriate for impact investment if we want to attract and retain large amounts of capital. Many talented, dedicated and passionate individuals and organizations are working toward this goal, but we’ll all need to practice understanding each other’s perspectives, goals, values and needs to get there. In my governance work this week, I ran across an interesting article on good governance by William George, former CEO of Medtronic and a highly experienced Board member. Our views on governance, Mr. George notes, are shaped by what seat we hold at the table. Worth keeping in mind as we try to develop innovative and equitable pricing formulas!

By Lauren A. Burnhill aka @LaurenOPV

One of the key things that makes equity different from debt is the upside. For impact investment, indeed for all socially responsible investment, the big question is how much upside can we reasonably expect to see and how should it be allocated across relevant stakeholders? What is a “reasonable” upside? Last year SAC Capital earned a 13% return net of fees. If one of the largest, most successful hedge funds on the planet is returning 13%, is it realistic to assume than an impact investment fund can achieve a 25% IRR? When our target upside far exceeds the margins on the businesses we invest in, the end results are not going to be pretty.

For the sake of argument, let’s assume we do our homework on the types of businesses we want to invest in and reach a target upside that looks feasible. What does this upside need to cover? Certainly it needs to include growth capital / expansion capital for the company since we want these ventures to ‘scale up’ and reach large market constituencies. The upside absolutely needs to include a return to investors since without their capital, the upside wouldn’t materialize. In addition, we need to provide fair performance-linked compensation for the company’s managers and employees.

What is fair? How do we set compensation levels or formulate compensation plans? Are founders, managers and employees all treated equitably? How much of the upside should flow to the people who create it versus the people who finance its creation?

What’s the time frame for generating upside? Are we taking this into account when we’re discussing compensation for managers and returns for investors? If you’re expecting a four year investment cycle, an 80%-20% split (investors/fund managers) probably sounds good. If, on the other hand, you know the social enterprises in your portfolio will follow an eight year investment cycle, is 80%-20% still a good way to align incentives? Are you assuming that a low management fee is offset by this 20% carry? If you are, does it bother you that our fund manager is potentially going to hire less experienced talent to make his budget work? Wouldn’t you think that getting the right human capital in place – and giving them appropriate incentives – would lead to better value creation and stronger performance?

In mainstream finance, you wouldn’t strike out on your own to launch a fund until you’d made enough money to do that comfortably. In fact, you probably couldn’t strike out on your own because we assume that if someone hasn’t made a chunk of money then they aren’t a good manager. What about the people who have come up through social finance and economic development, always accepting sub-market compensation so that they could accomplish meaningful things? For some of us, maximizing our learning and the value of our contribution to society has been more important than getting rich. Unfortunately, even though this is a conscious decision, our lack of capital prevents us from claiming a seat at the table, no matter how strong our track records and qualifications may be.

Once upon a time, banks liked to make loans because they produced a steady stream of interest income. With lending rates higher than the interest rates paid on savings accounts, a well-run bank with a good loan book could be fairly certain of having a stable, positive net margin. A steady stream of income is generally a good thing for businesses and investors alike, but somewhere along the line we lost track of this notion. Trading income may be highly volatile but thanks to market inefficiencies (among other things) it can also be quite large compared to interest income on lending. Given the short-term focus in publicly traded markets, it isn’t surprising that many banks would rather bet on upside returns from trading than focus on business lending that produces steady income streams but no upside.

When we look at investment, even socially responsible investments that aim to benefit the “base of the pyramid” (BoP), we tend to hope not just for upside but for an outsize return. The outsize returns we hear about (Google, Apple, etc) are really white swan events, They are the exceptions rather than the norm. And yet, we’re trying to create investment structures that produce white swans rather than investment structures that realistically and appropriately account for the risks and rewards of what we are trying to accomplish. We think a lot about what our investment cycle should look like (short!) and much less about what the business life cycle of our portfolio companies implies with respect to returns and sustainability.

When we think of “the investment problem” as distinct from the “business life cycle” challenge, we lose perspective. First, we overlook the need to understand the level of financial return the underlying business can reasonably expect to achieve over the long-term. That smallholder value chain project in agriculture may substantially improve the socio-economic well-being of thousands of farmers and their families, but you’re unlikely to have any IPO exits or windfall gains. If your target return was 30% and the project return is 15%, you (or your investors) will probably be less satisfied than if the target was a 10% return and you achieved 15%.

Add the goal of offering affordable goods and services to low and lower income populations back into the question of upside and return. Are our investment structures capable of producing this kind of outcome or do our current  funding practices and allocation of upside translate into higher prices for our target market? I love formulas that link improved operating efficiency to reductions in the price of goods or services offered to the company’s customers. In other words, the more efficient the organization becomes, the less it charges its customers. Get that right and you can generate stable financial returns while continuously growing your social returns.  That’s a win-win in my book.

Second, we forget that our social, and potentially our environmental returns, are indeed returns on our investments. The result of an impact investment is not, for example, an X% IRR. It is a X% IRR plus an X or XX% SROI plus potentially an environmental ROI as well. Seen in the light of two or three bottom lines, the pie is much bigger than we assume when we think only of the financial return. If the pie is bigger, perhaps we can be kinder, more reasonable, more rational in how we allocate upside. I’ve seen investors negotiate brilliant deals (for themselves) that killed the underlying venture by preventing other potential stakeholders from coming into the deal because there is no upside left for them. And I’ve seen companies that kill themselves by refusing to ‘dilute’ their ownership and upside even though they need capital to grow. Any way you look at it, 100% of nothing is a lousy return on investment!

Third, when we are blinded by the prospect of a brilliant upside, we get lazy about doing our homework. The limited availability of data related specifically to impact investment, i.e, investment that is meant to produce both financial and social returns, becomes an excuse for believing in white swans. There are a number of meaningful efforts under way to gather and analyze impact investment data so as to provide directly comparable benchmarks. I applaud and support these initiatives, but the fact remains that good longitudinal data requires time. We won’t have 10 year benchmarks until we’ve been doing and tracking our impact investments for 10 years.

In the meanwhile, we can make more of an effort to explore proxy data as a means of understanding potential financial returns. If you want to invest in a network of health care clinics that serve the BoP, it should be helpful to start by understanding the costs and operating structures of health care clinic networks that do not explicitly target social returns. Is your network going to have higher costs? If so, what specific costs do you think will be higher and why is that the case? Will they always be higher or is cost structure something that will benefit (eventually) from economies of scale? Or is it perhaps that your margins will be lower because you need to charge less for the services you offer? Maybe both of these factors will have an impact on your BoP healthcare network but you won’t necessarily figure that out if you start by setting a target return based entirely on what you want out of the deal rather than what the deal can offer.

I think one of the most significant hurdles we face in impact investment is not some inherent limit on financial returns but rather our mindsets. We’re still thinking of social returns as some kind of bonus on our financial returns rather than a key outcome of our investment activities. We assume that ventures with social impact are inherently riskier than standard commercial ventures. I’d suggest that a social start-up may be less risky than a purely commercial start-up. Both have a high risk of failing, but the former may create some lasting social value before it goes under. The small farmers who’ve learned about irrigation, business management and global trade practices retain that knowledge even if the processing plant doesn’t get built or can’t operate sustainably.

Although I’m primarily focused on equity capital, much of the above is relevant to term lending for impact investment as well. The first step in aligning interests is to understand our own motivations and core values. The second step is understanding the motivations and core values of other stakeholders. Where things get really tricky is step three, figuring out how to optimize financial and social returns to all stakeholders. There is no single correct answer to how to approach this challenge, but if we can apply a collaborative, cooperative and flexible mindset to finding solutions, we’ll be headed down the right path.

The good news is that an increasing number of experienced, talented, values-driven professionals are working on finding innovative and appropriate solutions to the challenges of sustainable, responsible investing. If you’ve been successful in creating new structures, practices and policies that support double or triple bottom line investing, please share your story! Comments are always welcome – and if you’d like to provide a bit more detail, ping me on Twitter @LaurenOPV, or send me an email (Lauren.OPV at gmail dot com) – my blog is your blog

Lauren Burnhill aka @LaurenOPV

For the most part, the application of business disciplines to economic ,and now social, development efforts is a good thing. No matter how pure our motivation, our efficiency can be enhanced by well-run operations and well-managed back office systems and processes. There are limits, however, to applying ‘standard business practice’ to innovative social business models. When I read that “impact investment is the next VC”, my heart sinks. While there are elements in the VC model that can be applied to #impinv, the wholesale application of VC to social enterprise would be more of a death knell than a cause for celebration.

I’m down with asking social enterprises to run their operations in efficient, business-like fashion. Nevertheless, when we try to cram mainstream financial behavior into social investment, we are trying to apply “conventional wisdom” to creative problem-solving to no good end. First, conventional wisdom isn’t necessarily very wise, or even “best practice”. It’s just a reflection of the behaviors we have become comfortable with. Second, if we truly want positively disruptive innovation, we need to consciously rethink what’s been done already versus what is possible if we collaborate toward desired goals.

Over the next few months, I’ll be writing about different elements of “aligning interests”. How do hidden biases in the pricing process influence outcomes? Do compensation practices reinforce goal-seeking or dampen performance? How do we incorporate concepts of fairness and sustainability into an industry (finance) that only vaguely values these ideas? Are there ways to segment impact investment so that risks and rewards are appropriately distributed in a pro growth manner?

Let me leave you with something to consider. Supporters of impact investment are quick to insist that market returns can be obtained, despite the fact that no one really knows what “market” is. Past performance, after all, is no indication of future results. There is, however, a huge gaping hole in the concept of market returns on #ImpInv that results from our approach to human capital.

Anytime you insist on paying #ImpInv fund managers sub-market compensation to keep fees low, you are introducing a subsidy into the system at the expense of the very individuals you expect to deliver exceptional returns. That’s just dumb! Without the right human capital, your investment dollars are worth very little.

Is it fair to expect an #impinv manager to accept sub-market compensation just because you’re giving them a carried interest somewhere down the road? Is the standard VC upside carry formula of 80% to investors and 20% to the manager reasonable in the context of impact investment? Is this still true when we speak of base-of-the-pyramid (BoP) business models in emerging markets? How much of a fund’s true operating cost is covered by the proposed management fee? Low fees may make you happier as an investor, given the uncertainty surrounding financial returns, but does this make sense? Think of it this way: if your mechanic told you that your brakes were shot and that new brakes for your car would cost $500, would you pay the $500, or would you give him $250 and tell him to do his best?

by Lauren Burnhill aka @LaurenOPV
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1. More Early Stage Hoopla: Having correctly identified that one of the problems facing social enterprises and triple bottom line enterprises is the lack of early stage financial support, 2012 saw a plethora of incubators, accelerators, seed funds and angel networks inaugurated around the globe. New venture philanthropy models are starting to emerge around early stage social investment as well. All to the good, however, the social enterprise financing gap extends far beyond seed and early stage funding needs. If we don’t add a focus on growth financing, we risk creating a “fiscal cliff” of our own: more promising new ventures will launch only to wither and die in the absence of follow-on investment.

2. Gender Equity Initiatives and Investment Hook Up: Gender lens investing at the enterprise level gathered steam in 2012, but women seeking to build new financial services models were largely excluded. In 2013, I hope we’ll see more women entrepreneurs finding financing, more women coaching and mentoring female entrepreneurs, more women sitting on corporate Boards and more women structuring and managing investment portfolios. Golden Seeds, Calvert Foundation’s WIN-WIN, Criterion Institute’s “Women Effect Investments” program, startup Pique Ventures, pre-incubator Make a Wave — all embody different aspects of this trend.

3.  Regulatory Cost, Complexity and Uncertainty: The development of new business models and the mobilization of new investment will move slowly as stakeholders wait for the SEC to issue enabling regulations related to Dodd-Frank and the JOBS act. For smaller enterprises and startups, especially those with double and triple bottom lines, compliance costs, both human and financial, are problematic. Mary Schapiro’s resignation as Chairperson of the SEC is likely to create further delays in issuing regulation. Patience and courage will be watchwords for all of us.

4. Crowdfunding Hits a Hiccup: Regulatory uncertainty, as noted above, plays a powerful role in constraining the development of crowdfunding. During 2012, crowdfunding donations through Kickstarter, IndieGoGo and others raised millions of dollars for new enterprise. For video gamers, dance troupes and app programmers, the results have been fantastic. Medical devices that can change the face of global healthcare, renewable energy ventures that target household level behavior and other social and environmental concerns have found it hard to build on-line constituencies and raise needed funding. A fragmented, nascent marketplace combined with regulatory uncertainty will inhibit the development of critical mass in the near term.

5. Platform Mania: We all recognize that impact investment spans a range of disciplines (community investment, socially responsible investment, small business, green investment, health, housing etc). In order to identify, screen and finance interesting ventures, we need appropriate marketplaces and engaged investor communities. In 2011 and 2012, numerous platform initiatives were launched in an effort to bring entrepreneurs and investors into shared communities. As I watch the increasing fragmentation of stock exchanges and trading platforms in mainstream finance, I can’t help but wondering how platform mania will play out for impact investment. Linkages, partnerships and aggregation will be needed in order to create a robust marketplace. Otherwise, we’ll see lots of small, isolated silos in search of scale. Time scarcity is a big challenge. Many impact investment managers are covering six or more sectors but lack the capacity to participate in that many online communities. Even multi-sector platforms (Mission Markets, Impact Assets, Gates Global Impact etc) find it difficult to mobilize investors and investable instruments simultaneously.

If the trends above reflect my views of what’s happening in the impact investment space, they nevertheless fail to capture my hopes and dreams. The trend I’d like to see most is convergence. By this I mean a growing understanding that all investment has social and environmental impacts as well as financial results. While the earth needs more ventures that create positive social and environmental outcomes, we also need to bring this awareness of shared space and resources into mainstream investments. Although you wouldn’t argue that Coca-Cola should be a social enterprise, you might agree that the company’s decision to reduce water use and energy consumption is a wise choice for the firm and for society as a whole. All enterprises have a triple bottom line even though social and environmental impact are often viewed as “externalities”. ESG, SRI, impact investment, community development are all part of the same paradigm. Figuring out how to balance triple bottom line concerns and optimizing overall impact versus financial profitability alone will ultimately be the key to sustainable economic development, a healthy planet and happy global citizens.

How do you think Impact Investment will develop in 2013? What trends are you thinking or worrying about today? Inquiring minds want to know

by Lauren Burnhill aka @LaurenOPV

In India, you have to deal with the question of scale whether you want to or not. The geography and the population are just too vast to think small. When we talk about scale in pro-development or anti-poverty sectors, the challenges of managing growth move from a question of corporate success to more profound philosophical questions. In no sector are these tensions more evident than in microfinance. If a pro-poor microfinance institution (MFI) wants to make larger loans to its successful clients, is that smart business or “mission drift”? If an MFI offers good benefits and a professional development track for staff, is it practicing smart human capital management or exploiting poor clients?

I recently had the good fortune to travel to India to talk about Board of Directors’ level Risk Governance for MFIs. That happy invitation from the IFC grew to include a panel on Human Capital Management at the Microfinance India Summit 2012, which took place immediately after the Risk Governance workshop. I haven’t set foot in India for several years and was curious to see how the “crisis in Andhra Pradesh” (October 2010) had played out over time.

Here’s the current situation. The Indian economy “only” grew by 6.5% in 2011, dropping to 5.8% estimated for 2012. Including both self-help groups (SHG) and commercial microfinance, more than 68 million Indian microentrepreneurs received financing in the year 2011-2012. If one includes small loans made by commercial banks, that number rises to 168 million, according to the Microfinance India State of the Sector report for 2012. The long-awaited Microfinance Institutions (Development and Regulation) Bill was tabled by Parliament in May 2012 and remains in limbo. At least one significant regulatory change has taken place, namely that MFIs organized as non-bank financial corporations (NBFCs) must register with at least one credit information company. Highmark Microfinance Credit Bureau was established in March 2011 and recent information shows that 74 institutions regularly provide data. Highmark’s database now covers 80 million loans to over 45 million clients, making it easier for MFIs to monitor potential over-indebtedness of their clients.

By the numbers, Indian microfinance is alive and growing rapidly, but in practice, the industry is plagued with doubt and uncertainty. Greater emphasis is being placed on monitoring social performance, alongside financial performance, but the multiplicity of potential standards and indicators makes it difficult for Boards and MFIs to chart their paths. According to the Microfinance Information Exchange (MIX), only 23% of 71 registered MFIs have submitted 2010 and/or 2011 client poverty measurements. Available data shows that the majority of Indian MFI clients earn less than US$2 a day. Indian MFIs are thus reaching the poorest segments of the market, but they must now figure out how to measure and monitor the social impact of their microfinance products and then communicate this information to current and potential investors.

Clearly, the fact that the IFC’s Access to Finance Advisory Group was offering a full day on Risk Governance for MFI Board Members is a sign that risk management and good governance have risen higher on the poverty alleviation priority list. For too many years, we’ve assumed that the ability to get increasing amounts of cash into the hands of microentrepreneurs and then get it all back (or at least most of it) later was sufficient evidence that an MFI was well-run and producing social impact.

As it turns out, the ability to make money on microlending is key to institutional sustainability, but says nothing about an MFI’s ability to foster social change or to grow and thrive in a complex and uncertain environment. Risk management – first understanding what the risks are and then figuring out what, if anything, can be done about them – has been gradually filtering into the organizational structures of leading MFIs, impelled perhaps by the regulatory requirements facing newly chartered Microfinance Banks. Risk management culture needs to include the Board of Directors too, hence the emergence of “risk governance”.

Based on participant feedback, I’d have to conclude that India is making wider use of Independent Directors on MFI Boards than either Latin America or Africa, the two regions with which I am most familiar. This is a good thing and important for sound governance in an increasingly commercial but fundamentally “double bottom line” sector. At the same time, I sensed frustration that “directors don’t know enough about microfinance”. Little in the way of training and education for Board Members seemed to be on offer, and appropriate compensation for Board Members remains an issue. The sheer size of the Indian marketplace, however, means competition for good Directors will increase and ensures that MFIs will figure out how to compensate Board members for their time and services sooner rather than later.

What struck me first when I reached the Microfinance India Summit was the slogan that had been chosen: “Rebuilding the Sector, Brick by Brick”. Some of the panelists I listened to spoke of “Microfinance 2.0″ by which they meant whatever comes next for the microfinance industry. Intriguingly, the world’s largest funder of microfinance, German development agency KfW, had slated it’s Access to Finance workshop shortly after the India Summit – but there the talk was of “Microfinance 3.0″. What’s going on here? Everyone seems to be looking for an industry “reboot”, but just how much and what kind of a reboot remains murky.

In reconnecting with colleagues at the summit, I was impressed by how the microfinance market, broadly defined, had deepened and matured since my last visit. Local specialized service providers are helping MFIs with fundraising, organizational development and strategic planning. Leading local rating agency M-CRIL is even serving markets beyond India these days. The SMART Campaign started by the World Bank and ACCION’s Center for Financial Inclusion gave birth to SMART Campaign India, which released a new MFI consumer protection toolkit at the Summit. Kudos to my former staffer Hema Bansal for her excellent work in making this happen!

Microfinance will continue to play an important role in the Indian economy. Market size estimates range from 300 million to 600 million potential clients which leaves considerable room for MFI growth. Branchless banking, mobile payment systems and Business Correspondent networks are exploring new ways of reaching both urban and rural poor. Self-reflection and the notion that “rebuilding brick by brick” is both feasible and desirable should contribute to healthy, consumer-friendly growth for the microfinance industry. At least, I hope this is where things are heading.

What are you seeing in Indian microfinance? I’d love to hear comments and insights from those who’ve spent more time in country than I have!

 We live in an uncertain world and I think this is part of why “chaotic organization culture” has become acceptable and expected. We can’t eliminate uncertainty – hence the emergence of risk management and risk governance, both of which rely heavily on precedent, probabilities, scenario planning and performance monitoring. The willingness to look uncertainty in the face and consider the possible implications are how we move from chaos to productivity. When we do this, we can keep creativity and innovation in the mix by building an environment in which these characteristics are encouraged and thrive.

 To create this resilient and empowering environment, we structure meetings and ensure that everyone speaks and is comfortable speaking out. We draw on people’s strengths and encourage them to grow professionally. When we make mistakes — which we all do — we own up to them ASAP and take corrective or adaptive measures calmly and without throwing anyone under the bus. If you screw up on my watch, the failure is mine as a manager as much as it is yours. Let’s just deal with the problem, learn from the experience and move on.

 Claiming that chaos is the natural order of things is a cop out. It’s like watching a superstorm approach your home and throwing your hands in the air saying “It’s too big and unpredictable for me to do anything. Forget getting water, canned food and flashlights, that won’t help”. Really? Big and unpredictable, yes, but passive response reduces your chance of surviving and thriving. My preparations in the days before superstorm Sandy went unneeded, but you can be certain I’ll be ready again next time. Not just with food and water, but with a disaster escape plan. How large might the damage area be? How far would I need to go to find shelter, food, water, power? Who could I stay with at those distances? Can I get there? Will my 4×4 drive be enough to navigate downed trees, damaged roads, etc? If I can’t evacuate by car, what’s my next best travel plan?

 In business and in my personal life, I tend to be calm when disaster strikes. I may not like the options available to me, but I know what they are and I’m ready to act. In a chaos culture, disaster (or garden variety adversity) catches us unprepared. We gnash our teeth, we flounder and we respond fast and impulsively or not at all. Sometimes that works despite the melodrama, sometimes it doesn’t. If you’re an adrenalin junkie, you may even enjoy the melodrama, but are you optimizing anything in this scenario?

 Goldman Sachs was — for a change — a literal beacon of good risk management and governance after superstorm Sandy. NYU Hospital, on the other hand, shows what precedent, complacency and blind compliance with regulations will get you. Granted, once slammed, NYU came through with flying colors and no loss of life. It just shouldn’t have happened.

Let me insert a side note here on voluntary versus involuntary chaos and risk governance. Voluntary chaos is a startup, or any other entity, that can’t be bothered to think through policies, processes and systems growth. Involuntary chaos involves natural disasters, but also not-for-profit and social enterprises that are underfunded given the magnitude of their mission and correspondingly short on management and staff talent to move the organization from hand-to-mouth to sustainability.

The Boards of tech startups are encouraged to look at the potential sustainability and resilience of their portfolio companies in the context of risk management and risk governance. As the saying goes, forewarned is forearmed.

The Boards of non-profits and social enterprises are encouraged to remember that employees are their human capital. Nurture them, organize them properly and your return on capital (human and financial) goes up. In addition, investing in business planning, including exploring those wild card “Black Swan” contingency scenarios, is critical to achieving your organization’s mission. It’s not all about keeping expenses low, it’s about having the right kinds of expenses.

 People are assets. We want them to perform. At the same time, they are human beings who deserve to be treated equitably and with dignity. An empowering and well-managed culture of innovation is the way to create value. Defaulting to chaos may create the occasional big winner, but it also contributes to tremendous failure with high human and financial cost. As a society, we can and must do better.

 Lauren A. Burnhill – @LaurenOPV

The proponents of Prop 7 ran (over and over again) an ad asking us to vote for Prop 7 to “keep $500 million in gambling revenue in Maryland, not West Virginia”. In other words, a classic “beggar Peter to pay Paul” strategy. West Virginia has plenty of problems of its own, it doesn’t need to lose $500 million and thousands of jobs to Maryland.

More to the point, I really don’t want to see Marylanders gamble away $500 million in casinos anywhere! One night of fun and your money is gone. Where’s the upside in that? As long as we’re ok with the notion of gambling and risk, let’s put money into crowdfunding equity instead. $100 here, $50 there – not a lot at the poker tables, but collectively enough to spark new businesses. Expect that you’ll probably lose your money — most startups fail — but then again, you and the US economy just might hit it big. Put your $100 on the table, follow the crowdfunding campaign and the company launch and see what happens. If nothing else, you’ve gotten months more entertainment from your money than a night at the casino could provide.

The SEC is worried that operationalizing crowdfunding equity represents too much risk for Joe or Jane Citizen. If Joe and Jane want to take risks that don’t harm others, why should the regulators say no? Alcohol and tobacco are legal, gambling is legal in some states and food consumption, even to the point of obesity, is legal too. Betting on business ventures, however, would be too risky. What kind of twisted logic is this?

Let’s face it. If we’re really going to kickstart economic development, job creation and social change through new business models, lots of things are going to fail to thrive in the process. If we want to foster a culture of innovation, however, we need to fund more businesses with the understanding that only a handful will survive and expand. We also need to kill the failures quickly and move on. No use crying over spilled milk, as the saying goes.

The flip side to asking regulators to let adults invest in small startups is that socially responsible startups must be mindful of the trust implicit in an equity investment and “take care of the little guy” in follow-on capital raises. Aside from being the right thing to do, ensuring that crowdfunding investors aren’t diluted into oblivion is a good way to demonstrate that social responsibility isn’t just something you talk about, it’s a value that you apply to all of your business actions.

Regulators should frame compliance regulations around the information that management and shareholders need to understand company operations, the software and human capital that these resource-constrained startups will have available and the overall cost of compliance. A perfect compliance system that’s too expensive and costly for new businesses may protect retail investors, but it does so at the expense of business and job creation. Balancing well-meaning, although perhaps misplaced, paternalism with the reality of economic conditions could bring a new level of practicality to compliance and transparency.

Yes, I know, many of you would prefer that I not lump casino gambling and crowdfunding equity into the same risk bucket. Let me be clear, these are two very different animals, although both are high risk. The upside to casino gambling is a bunch of low wage jobs that offer no professional advancement. The upside to crowdfunded equity includes a financial return to the retail investor, more jobs and an ongoing stream of business tax revenues. I can’t pretend that crowdfunding equity isn’t risky, but only by taking the right kind of risks can we hope for continuous innovation and robust economic development.

Lauren A. Burnhill, @LaurenOPV

Scale isn’t easy. In a New York Times interview, Ken Rees, CEO of @ThinkFinance, explains how the skills that served him well as CEO of a small company made it harder for him to succeed as CEO of a larger company. Noting that startup CEOs have to do everything, he comments that he was used to “being a bulldozer” and had to learn “how to be a bus-driver” instead. Ken is smart and self-aware enough to overcome the challenge of scale, but that isn’t always the case. In some ways, the principles we ascribe to social entrepreneurship make it harder than average for small firms to attract both the human and financial capital they need to scale.

I’ve written before on the topic of scale versus replication. Given the vast cultural, political and economic differences across countries and regions, it’s easy to make a case that adapted replication could outperform ‘scaling up’ as a model for achieving rapid dissemination of responsible social business models.

The pros and cons of different growth models came to mind recently as I was reading in @Wired about Germany’s Samwer brothers, titled “Inside the Clone Factory”. The Samwer brothers are replicators par excellence, but the specific case that caught my eye is the saga of Birchbox and the Samwer brother’s clone Glossybox.

In 2010, Katia Beauchamp created Birchbox, a subscription service that sends monthly boxes containing a curated mix of beauty, health and grooming products. Early in 2011, the Samwer brothers launched Glossybox, which follows a very similar model. Clearly the subscription sample model has appeal, since the second half of 2011 also saw the launch of Joliebox and MonCoffretBeaute in France, Glamourum in Spain and Carmine in the UK. Flash forward to 2012 and we find Joliebox acquiring Glamourum in February and Birchbox acquiring Joliebox in September, while Glossybox acquired MonCoffretBeaute.  Giving a slight twist to the model, Klutchclub, which sends out boxes of healthy and sustainable products was also founded in 2011.

Katia and Birchbox were the innovators and they’ve worked hard to build scale. Glossybox and others are replicators and like it or not, their existence creates scale of a different type. Not only are copycat models thriving, the recent spate of acquisitions suggests that “buy” can be as good a path to growth as “build”. On the minus side, replicators can make it hard for innovators to survive and grow. On the plus side, replicating a viable model can help alleviate some of the difficult changes of achieving scale.

Child wellness programs have a strong positive impact on overall poverty reduction and economic empowerment. If this were a model for delivering nutritional and health-related products to expectant and new mothers, we’d want to see the model deployed as broadly as possible on a global basis. Would we be better off helping the innovating company achieve scale? Or should we be investing in as many viable copycat businesses as we can find? Which tactic would result in faster coverage of “the target market”? Do we have a hidden bias against mergers and acquisitions as a path to growth when it comes to social business?  Does pushing scale help our innovators or does our desire for scale overwhelm the specifics of individual businesses or entrepreneurs?

Achieving scale is a macro level goal that may or may not be relevant to the success of a particular enterprise. Let’s separate our desire to achieve massive social change from our views of what an appropriate social business model should look like. Figuring out what goods and services are useful and desirable at the base of the pyramid is one problem. Deciding how to widely distribute those goods and services may be an entirely different one.

by Lauren A. Burnhill aka @LaurenOPV

The IFC invests in a large number of new private equity, venture capital and special purpose investment funds. It claims to have backed around 10% of all emerging markets funds coming to market since the 1980s. I wouldn’t be surprised to find out that the percentage of new #EM funds backed by IFC is higher than 10% when all the sector, global and special purpose fund structures   are tallied up. Since 2000, about 50% of approvals were for first funds run by new managers. As of late 2012, IFC’s private equity portfolio stood about US$ 3 billion committed to about 180 funds.

At 2012 presentations to the World Pensions Council in February 2012 and the African VC Association in April 2012, David Wilton, Chief Investment Officer, Manager Global Private Equity, IFC presented the information shown below. You can read his latest paper Why Emerging Markets Private Equity? September 2012 for more interesting tidbits.

IRR on Funds between January 1, 2000 and June 30, 2011

* IFC data on approximately US$ 3.6 billion of fund investment
*** Data for Cambridge Associates includes all PE Fund types excluding Forestry, Infrastructure, Real Estate, and Secondary Funds.

IFC gives a couple of reasons for first fund out-performance, key amongst which is early-mover advantage. The first guys and gals to define a new investment niche can cherry pick amongst capital-starved enterprises. I happen to think that there is generally so much capital scarcity in emerging markets that smart investment managers can always find good deals. Regardless of whether this last statement is true, first funds looking at new non-exchange traded markets have an early-mover advantage over later entrants.

The IFC also notes that fund manager skills are key to achieving top tier performance. Although it is tempting to think that “manager” refers to the firm, for the most part it refers to key investment decision-makers. Do the people at the top have the skill set to find, make and manage investments while running a transparent, compliant and insightful fund? Where outsourcing will make up the skills gap, are proposed third-party providers top tier? If you have these two pieces of the puzzle, the fact that the firm is new may not be a relevant decision factor. If you have the right people, you have a human capital advantage.

I have one more piece of the puzzle for you. Investors spend less out-of-pocket  on first funds. The investment world effectively penalizes new managers via somewhat arbitrarily determined “best practice” management fee structures. On paper, at least, less money spent on the manager equates to more money flowing back into shareholder returns. New managers are expected to pay the bills (their own, the fund’s and the firm’s) during development and fundraising, and then deliver a complex hands-on strategy on a budget unrelated to the cost of developing portfolio and delivering  performance.

First funds are generally on the small side too, which is seen as a risk mitigant despite further complicating the issue of fees and budgets. Sure, the new managers typically are eligible for some kind of carried interest upside, but that’s not going to come into play for five to eight years. In the interim, some of your best talent is going to need to moonlight to cover family expenses, buy their kid a new bicycle or save for education or retirement. Wouldn’t you rather they be able to devote all their waking energy to your portfolio )

By the time funds two or three are on the horizon, successful managers are working on changing the investment terms to reduce the pain they’ve been feeling. I’ve had successful fund managers tell me that fees on the next fund were going up because their wives will divorce them if they’re not able to send their kids to private schools. Don’t think that this is a luxury issue! In many emerging markets, private school is necessary if you want your child to have decent job prospects later in life. Impact investment managers shouldn’t have to penalize their families as a way of proving a business model. For now, however, net net, later funds are likely to have a higher cost and diminished early mover advantage, both of which will produce lower returns to investors.

If you want consistently high performance, work on setting appropriate fees and operating budgets, and aligning manager/shareholder incentives on all funds, but especially the first one. In the meanwhile, if you just want high performance from your next investment, think about taking a stake in a new impact investment fund. A lot of top tier human capital is eying new market opportunities and they need your commitment to turn their vision into real-world returns.

By Lauren A. Burnhill aka @LaurenOPV

Our fears prompt us to spend billions on what still amounts to mostly security theater. We’re not screening port cargo or much air cargo, but you and I are getting a lot of scrutiny when we travel by air. We seem to think, or perhaps hope, that armed guards and TSA agents can keep us safe from evil. Evil has sadly proven quite resilient and creative throughout history, especially when mixed in with seemingly noble intentions. The Spanish Inquisition comes to mind here, as do inadvertently permanent “refugee camps” in the modern world.

In learning Qi Gong, Tai Chi and the Tao Te Ching, we are confronted with a fundamental paradox: how do you feel safe in an unsafe world? How do we reconcile the fact that bad things happen to good people, often unexpectedly? The Taoists would have us cultivate “cheerful indifference”, a sort of “it is what it is” approach to life. That translates, at least in my mind, to the notion of releasing expectations even as you strive to fulfill your goals. Our efforts may – or may not – lead to the outcomes we hope for.

We can accept and adapt to the outcomes we get, or we can get upset and resentful. We can choose to believe that the universe is treating us and only us unfairly, or we can choose to believe that we each deserve a bit of kindness and consideration from our fellow human beings. When we lead with kindness we make the world feel like a better place, even though some days it doesn’t seem like a very good place at all.

Here’s an example. You may be telling me that my flight isn’t going to leave for hours, but the odds are quite high that you are telling me this because it’s your job to do so and not because you are infused with a sadistic desire to ruin my travel schedule. I can be polite and ask you to check for alternate routes or I can throw a temper tantrum that raises everyone’s blood pressure. Which strategy sounds more win-win to you?

In the spirit of making small changes that have a big impact, try a little extra dose of random kindness this week. We can’t change the past, but I have hope that we can create a brighter future.

By Lauren A. Burnhill aka @LaurenOPV

I’ll start with a confession. I’ve worked in social finance forever, so my social consciousness is fairly high. I am not, however, much of an environmental crusader. I’ve got the S and G in ESG, not so much the E. For a long time, I rationalized my behavior with the notion that we can each only do so much. Working on economic development with focus and intent would therefore be a higher use of my particular skills than trying to go green. Mostly I work with financial institutions, which aren’t big polluters, so I figured getting them to put ESG policies in place was a good enough goal.

Over time, I came to appreciate that you can’t achieve sustainable improvement in socio-economic well-being if you ignore the environment. For example, let’s say we create a brand new covered marketplace for local food and craft street vendors to sell their wares. If we over look waste disposal, water use and so forth, we risk creating an economic “success” that’s an environmental disaster.

What to do? For me, the key was to start small. I am not very eco-conscious. I rent, so I can’t install solar water heaters, compost my waste or collect rainwater. My building recycles, so that was about the extent of what I was doing for the environment. I felt bad about that, but at the same time, my day job is about saving the world so maybe it was ok that on my own time I wasn’t doing much to make the planet a better place.

I decided to try making some small changes to see if my conscience would stop nagging. I live just over the DC line in Maryland, but when DC enacted a 5 cent bag tax (bring your own or pay up), I decided it was time to give up plastic bags. I didn’t think this would actually make much of a difference, but at least I was doing something positive for the environment. At the end of a year, I realized that I had eliminated a phenomenal amount of plastic bags from my life and a corresponding number of trips to drop those plastic bags off for recycling. Fantastic. Little things do make a difference, so now what?

Truth be told, my biggest green issue is water. Here in the US – at least coastal big city US – we take it for granted that when we turn on the tap, water that’s safe to drink will flow endlessly. It’s not like that for much of the world. I remember a friend telling about turning the faucet on in Guyana and having half of a frog land in the basin. You can believe that thereafter she boiled every bit of water used in food prep. I’ve also worked in places where there was no faucet. You want water, you grab a container and go get it from a central well. And there are plenty of people living in places where getting water means walking several kilometers in each direction, each day. Think about how access to water changes our daily routines and allows us to be more productive!

I stopped taking long showers – even though I’m a water sign and I LOVE taking long showers. I turn off the water while I’m lathering up face and hands in the morning. This turned out to have a dual benefit. Apparently my former water-wasting technique also used too much soap. I’m happy to report that my soap budget has decreased alongside my water use.

One thing was really bugging me though. How do I reduce – or at least justify in my own mind – the amount of water it takes to clean food containers for recycling? We do recycle in Montgomery County, but do we recycle enough to make all that water use worthwhile? I honestly don’t know. But last night while making dinner, I had a revelation.

Instead of grabbing a spoon to get the last bit of tomato sauce out of the bottom of the bottle, I grabbed a flexible spatula and removed all the sauce from the walls of the bottle as well as the bottom. Then I applied my ‘clean for recycling’ methodology of adding one drop of soap and filling the bottle half way, putting the lid on and shaking vigorously. Pre-spatula, I’d have to rinse the bottle once or twice before getting to this step. Post spatula, I had eliminated two rinsings and lots of running water, yet still had a clean bottle to put in the recycling bin.

So my spatula reduces water use which is a good thing for the planet, but it has one other benefit too. Cleaning bowls and bottles with the spatula before putting them in the sink decreases food waste. Since we waste an appalling 40 % of food produced in the US, this is another small but worthwhile lifestyle change. My spatula wielding prowess netted me another 1/4 cup of tomato sauce. Nothing to write home about in and of itself, but we’re talking 13 cups of tomato sauce over the course of a year, and that’s just one food item.

Every tiny change we make in our lifestyles contributes to the well-being of our planet and the sustainability of our natural resources.We can all find small changes that don’t hurt to make but do contribute to the greater good. Buy a spatula and see for yourself

Lauren A. Burnhill aka @LaurenOPV

1. PROJECT FINANCE: The beauty of project finance is that it requires the practitioner to identify risk factors and use financial structuring to mitigate these risks within a “fully funded” structure. I’ve seen some VC/PE types negotiate brilliant deals that were, in fact, so favorable to that particular investor that the entry of other investors was made impossible and the entire deal (and at times the entire company) collapsed. Impact investment isn’t just about getting good terms for your investment, it’s about crafting an investment structure that will enable your portfolio company to achieve its goals.

2. CREDIT ANALYSIS: Whether you are looking at debt or equity instruments, understanding the financial condition and business prospects of a potential portfolio company requires strong analytical skills and “context”. The clients served by a Microfinance Institution might be the same as the clients served by a health clinic venture, but the credit dynamics of the two organizations are quite different. In an ideal world, you’d have the opportunity to work on a range of equity and debt instruments in both the financial and corporate sectors.

3. INTERNATIONAL RELATIONS: Solid grounding in international economics, politics and history provide important context for the impact investments you hope to make. Language skills and the opportunity to study and live abroad also offer value in a professional setting. If you can throw in some anthropology and sociology, these disciplines can also provide insights into the complexity of social change. Sector knowledge, such as affordable health and housing, renewable energy, water and sanitation, can add substance to your impact investment work.

4. RELATIONSHIP BUILDING AND COMMUNICATION: Too often we assume that a shared vision or mission statement is adequate basis for a working relationship. In reality, building a connection with your portfolio company that enables you to understand operations and strategy, as well as add value in these areas requires investing in interpersonal relationships. Your ability to communicate – informally or formally, in writing or in an oral presentation – can enhance or hinder your efforts to finance transformative ventures.

5. CREATIVITY: Although you can’t teach creativity, you can nurture it. Allow yourself to “think outside of the box”. Consider wild and crazy new ideas. Look at the investment proposal on your desk and imagine how different structures, terms, conditions or strategic considerations might shift the risk/reward profile. My VC friends insist that pipeline is a problem because there isn’t enough deal flow for “pattern recognition”. After 25 years in social finance, I can tell you that there are rarely patterns you can identify regardless of how many deals you look at. The real opportunity lies in the ability to recognize a great idea (and/or a great management team) and figure out how to make it financeable.

By Lauren A. Burnhill aka @LaurenOPV

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

In some cultures and/or religions, progress is a more circular concept. How you behave in this life determines your rebirth and pathway in the next life. Reincarnation suggests that we have multiple chances, indeed, multiple lifetimes to evolve. “Whatever happens” one of my Buddhist friends said to me once “I’m not coming back as a cockroach”. Vivid imagery, but his point was that he wouldn’t try to get away with something today that might come back and bite him in the long long-run. You’ve heard the expression “what goes around, comes around”? Isn’t this a way of describing progress as an upward spiral?

Progress can be an exclusive concept – my well-being (or my family’s), my advancement, my wealth and worth, but not necessarily yours. Alternatively, progress can be inclusive. My individual advancement might be nice, but it doesn’t necessarily signal progress. Greater socio-economic well-being in the community, the country or on the planet would be inclusive concepts of progress.

Why am I thinking back to a graduate school class in social change and development 20+ years later? In a word, sustainability. The 21st century economic model relies on the concept of perpetual growth, assuming that this is desirable and feasible. According to my grandmother, my great grandfather used to sell salt in NY for people to put on the ice in their “ice boxes” to make it last and keep food fresh. Waves of immigration at the turn of the 20th century triggered a temporary boom in the ice and salt business. Briefly, great grandpa was “the King of Salt” (at least to his neighborhood!) and then the refrigerator was invented. Great grandpa’s clients didn’t all run out and buy new refrigerators over night, but over a number of years his business stalled, then shrank, then died entirely, or so I was told. Innovation and invention created a paradigm shift that reduced growth from wow to zero in a short time span.

Encouraged to eat more fish for our health, many of us began to do so. Commercial fishing ventures boomed and as some species became scarcer, farm fishing was introduced. And still we were encouraged to eat more fish. A new documentary End of the Line asks us to imagine a world without fish, noting that as much as 90% of large fish species may already be overfished and only 3% of the world’s oceans are marine protected areas. Clearly, we can’t keep eating more fish at the same pace forever nor can the boom in commercial fishing continue unabated. How do we rethink nutrition, fisheries and oceanic exploration in a constructive way?

Sustainable growth means first and foremost a change in mindset. We cannot assume that high and unfettered growth is good or even feasible for society. An increasing array of disposable consumer goods seems exciting at first, but we’re generating tremendous amounts of waste as well. “Built to last” means fewer repeat sales than “planned obsolescence” but better resource use. Can built to last companies achieve sustainable growth rates? Will markets penalize companies that push consumption without sustainability?

Capital markets evolved to facilitate economic growth and development, but over time, greed and gaming (theory and practice) have changed market dynamics. If there are limits to growth, inevitably there will be constraints on financial returns as well. How quickly will we become knowledgeable about and comfortable with the idea that every financial return is accompanied by social and environmental returns that may be positive, negative or neutral but never absent? What’s the relationship between “sustainable” on the one hand and “fair” or “equitable” on the other?

I’m pleasantly surprised by visible signs that the world is becoming more attuned to sustainability in general and more specifically to the various flavors of multiple bottom line investing (SRI, ESG, Impact Investing, Venture Philanthropy, etc).

I’m also deeply concerned by the all too prevalent notion that we need or should take away from one group to make another better off. Sub-market compensation of the people who choose to work with non-profits, social enterprises, the poor and disenfranchised is routine, unfair and foolish. Sure, there are people whose personal beliefs encourage them to be of service to others even (or perhaps especially) at a cost to themselves. And there are others who can afford to work for peanuts because of family wealth or other forms of support. The fact that we can generally hire at sub-market salaries doesn’t make it smart to do so. If I don’t pay you a fair living wage, how do you convince a small business in a poor country that it needs to pay fair living wages? Do unto others, people! Let’s aim for a “win-win” outcome rather than “zero sum”.

Depriving Peter because he wants to help Paul is no more sustainable in the long run than assuming unending double digit growth in financial returns. Long-term sustainability will require different choices around consumption and investment  and lots of behavioral and mindset changes.  Our paradigms for progress, happiness, success and well-being are in need of an update. Think positive. Think practical. Think collaboration and cooperation. Think some more about goals, values, hopes and dreams. Then go out and do something!

By Lauren A. Burnhill aka @LaurenOPV

Last week I promised some numbers and this week, I’ll try to deliver. In order to model job creation for incubators and alternatives, I had to make a lot of assumptions and I tried to keep these as simple and conservative as possible. The two tables below are intended to provide a job creation “guesstimate” for a traditional incubator model and for my “flip the incubator” proposal. My apologies for the clunky formatting – this is my first attempt at importing tables into WordPress.

In all honesty, the Flip Model assumes the existence of long-term social investors (foundations, family offices and HNWIs willing to provide patient capital) and/or government sponsors looking to provide lasting job creation and economic development. Ideally, a public-private partnership would form around each Flip Model, but that’s putting the cart way ahead of the horse.

If you are running a private incubator, I don’t suggest trying to flip your model unless you have patient sponsors with deep pockets. Flip won’t be sustainable in two or three years. My guess is that we need 7 to 10 years to reach break-even. Why? The answer is that we’re maximizing sustainable job creation rather than financial returns, which means slower growth, lower repayment “quotas” and longer-term relationships with Flip participants.

To get started, I’ve assumed that the incubator model produces four types of companies: home-runs, doubles, singles and failures (“dogs”). Half of the incubator supported companies were treated as dogs and half distributed across the three profitable categories. As you can see in the table below, this model created 2,450 jobs at a direct cost of US$81.63 per job. Indirect cost is higher because somebody has to run the incubator! The direct cost is only what is invested in incubator portfolio companies. Excellent cost per job, but a fairly low number of jobs created, given how many we need to be creating on a monthly basis.

Incubator Model
10 companies per cycle X 2 cycles = 20 companies
$10,000 per company; $200,000 investment over two cycles

For the Flip Model, I assumed only three types of companies: Stars, which grow from micro to small (or small to medium, depending on what market you’re looking at) and account for only 5% of the portfolio; Sustainable Ventures that produce consistent low to moderate level profits (70% of the portfolio) and Failed Ventures that represent a quarter of the portfolio. Note that fewer companies “fail” in this model because the definition of success includes small businesses that return a stable single digit return and not just businesses that can scale up. The cost per job created, US$ 443, is higher for the Flip Model, but the upside is that we’ve created 79,000 jobs instead of 2, 450!

Flip Model
5,000 companies per cycle X 2 cycles = 10,000 companies
Consulting per company = $2,500, $25 million investment over 2 cycles
Seed Capital per company = $1,000; $10 million investment over 2 cycles

It cost us US$ 443 to create each of 79,000 jobs using the Flip Model, which is five times what it cost to create a job in our notional incubator. On the other hand, we have 32 times as many people employed at the end of two Flip cycles.

I can’t even pretend that I have reasonable assumptions around tax payments, but let’s assume that each ongoing business pays some nominal amount of business tax and each employee also pays personal taxes. The table below shows that even if all Incubator and Flip businesses and employees are paying very low levels of income tax, the differential between the two models is signficant. Even assuming that Incubator companies pay twice as much in taxes as Flip companies (assuming the former are larger or more successful), the Incubator is throwing off $7.4 million in tax payments and the Flip is throwing off $158 million or 21 times that amount. In other words, the $35 million invested in Flip is generating $158 million in tax revenues on an annual basis while enabling 79,000 to enjoy a sustainable livelihood.

Even if you argue that Incubator companies will be much more successful and should pay five times more in business taxes (ie $10,000 per year instead of $2000), the Flip still generates almost 6 times more revenue for the public sector. We’d have to bump business taxes up to over $60,000 per company in order for incubator contributions to economic development to equal those of the Flip model.

Should we abandon the incubator model? Of course not! Can we create other models that nurture sustainable social enterprises and local economic development? I sure hope so!!

I mentioned a couple of weeks ago the incubator and business plan competition mantra of citing how many businesses were rejected in the process of selecting 10 potential winners. Seriously, is supporting 10 of 10,000 socially responsible investments the best model we’ve got?

I’ve been mulling over how to create a scaled model for supporting social enterprise and this post reflects my ‘stream of consciousness” thought process. This isn’t a model that’s ready to roll, but it could be a starting point for some interesting discussion. Or at least, that’s what I’m hoping!

Let’s assume that amongst the 9,990 “rejects” from a biz plan competition or incubator there are two types of businesses: potentially disruptive innovations that fail to capture the judges’ interest; and lifestyle businesses that may be innovative only in terms of the markets served. I’d guess that if we threw out all the wannabe disruptors, we’d still have 5,000 business opportunities from ventures where the owner is passionate about and understands his/her target market. Return prospects are probably low, but as long as they are positive, a sustainable local business can emerge.

Since we’re aiming for sustainable local impact rather than scale, let’s set a high survival rate as a KPI. Realistically speaking, we know not all of these businesses will survive. However, even if 25% of our 5,000 company portfolio goes under, we’ve lost 1,000 businesses, but 4,000 businesses are going concerns. If they each create three jobs apiece, that’s 12,000 jobs!

As I’ll reveal below, the Flip model actually creates far more than 12,000 jobs, but let’s step back for a big picture moment first. Returning to the “improving quality of life” value, if we’re going to finance lots of small lifestyle businesses, they won’t be able to use scale to lower costs – but we can! At the apex level, we have the volume to negotiate things like affordable group health care pools, pension savings products, materials purchasing, net zero (green) real estate options and so forth. If our portfolio companies are our “community”, we can bring this community into the global marketplace without requiring individual businesses to scale up beyond their comfort zone. The end of this post includes some examples of what I mean, but I’m going to assume conservatively that we create 10 new direct jobs in health, housing, finance and education for every 10,000 small business jobs created.

I’ve got another social return on my “Flip the Incubator” KPI list. As part of supporting these 5,000 portfolio companies, we’re going to have to organize advisory and consulting services through local universities, consulting firms, think tanks, business support and community development organizations. Instead of giving each company $10,000 as seed capital, let’s give them a small grant, say $1000 and also a credit of $2,500 that they can use for consulting and advisory support. That $12.5 million price tag is not only adding value to the 4,000 companies that survive, it is also supporting the knowledge and service organizations who are adding that value. Here I suspect we are not creating as many new jobs as we are stabilizing existing jobs. If each business served contributes to stabilizing 3 advisory-type jobs, that’s another 12,000 sustainable jobs coming out of this single cycle of the Flip model.

If we also “franchise” (i.e., make replicable) lifestyle businesses by documenting and delivering best practice information in accessible practical ways as part of our Flip learning cycle, our outreach and survival rates will improve over time. I can see some really innovative research being done so that towns and villages can have general stores, hair salons, health clinics, wellness services, someplace to eat and someplace that creates access to finance, distance health and tele-education. Since we won’t be stopping at 5,000 businesses but aiming to reach millions around the world, there should be good job creation prospects on the research and policy side of the industry too. At a 5% level of impact, 250 new positions would be created as part of this first flip.

I could go on. The 4,000 businesses that survive will buy goods and services from other businesses and the families of the business proprietors will more regularly consume a better basket of foods and services, making this a double home run. The businesses and the owner’s families are also paying taxes which creates a financial return to society and the economy, not just to investors. These contributions may be small, but if they are sustainable and stable, even low-growth businesses can play an important role.

Aside from the obvious benefit of financing large numbers of sustainable social enterprises, there’s sound financial theory behind this notion as well. Spreading risk – in terms of money, health or otherwise – across larger populations is known as diversification and it’s a proven risk management tool! We don’t want to mandate what the butcher, baker or candlestick maker should do, but we can create educational tools/opportunities and product offerings that make it easy and affordable for them to “do the right thing”. I sit on the Board of a regional microinsurance company called Paralife. Amongst other things, Paralife creates insurance products that large companies can offer to their small-scale suppliers and distributors either on a fee basis or as a loyalty reward.

One global corporate recently piloted a family protection insurance plan as a loyalty reward for the small store owners who sell its products. The post pilot survey results indicated that a super-majority of small store-owners placed a higher value on this family protection than they did on cash bonuses. In planning the ramp-up to cover more store owners, we discovered that many wanted to offer the family protection insurance to their own customers also. We’d figured that this was an opportunity for much further down the line, but we’d underestimated the value of family to our end clients. My point here is that while people aren’t always willing to do what’s best for them, when given reasonable and affordable options, many will in fact choose the right thing.

D.C. Central Kitchen’s “Healthy Corners” program also illustrates my point – it hasn’t been easy turning convenience stores in poor neighborhoods into “green grocers”, but this organization’s concerted efforts to bring healthy food into urban “food deserts” are beginning to produce desired outcomes.

Stay tuned! My next post will include two charts, one showing notional incubator job creation and the other showing Flip the Incubator job creation. Although my numbers include lots of assumptiions, I’ve tried to keep these conservative. My results are both positive (as of this iteration, roughly 36,000 Flip jobs created vs 2,450 via incubation) and negative (cost per job is lower in the incubation model). If you think you see flaws in the reasoning above, please post a comment!! The purpose of this exercise is to develop new and creative solutions, not to determine right or wrong. The world needs incubators, but I think that social enterprise and impact investment need other types of support as well.

With two client deadlines this week, I was working diligently and then bam! Windows updated itself at 1 am on Monday and Tuesday the computer would no longer start. Hours of various recovery efforts led to one conclusion – in order to meet my deadline, my computer needed to be replaced. Re-installing software and tweaking settings into the wee hours, I thought, this week for sure the blog won’t happen.

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Funny thing though, as I was catching up on magazine reading while waiting for programs to install, I  stumbled across a couple of things that I wanted to share with you all. We’ve been talking about replication versus scale, and I’ve pointed out that scale is difficult to achieve, suggesting that replicating #sustainable small business models might be a better way to achieve economic development and job creation goals.

The problems of scaling up are nicely highlighted in this month’s #Wired magazine piece “Drowning in Cash” by David Downs. David identifies five #Kickstarter projects that brought in much more funding than intended and discusses the headaches these firms experienced as a result. The fact that your target market is keen on your product doesn’t mean that successfully expanding your operations to meet that demand is a “slam dunk”. Building your human and organizational capacity doesn’t just happen, it requires conscious thought and planning.

Last week I somewhat jokingly suggested that we should find a way to franchise everything so that #replication could happen more effectively and efficiently. This month’s Washingtonian magazine had a great article on local hero Chef Geoff Tracy (“Everywhere at Once”) that hinted at a way to improve replication without franchising. Disclosure: I happen to like Chef Geoff’s restaurants: consistent quality and service at a reasonable price point. These aren’t “cheap eats”, but nor are they pompous over-priced tributes to the Chef’s ego.

What struck me most reading this article is the amount of time and effort that Geoff and his brother Chris have put into codifying every aspect of their operations so that expansion doesn’t threaten consistency. Chef Geoff didn’t set out to replicate anything. “Consistency” he says “is a lot harder than it looks. It might just be the hardest thing to achieve”. Much like hospitals increasingly use checklists to ensure top quality patient care, the initial goal here was to ensure that the customer’s dining experience is equally positive whether Chef Geoff was in house or not.

Today, Chef Geoff’s restaurants are graded regularly across 800 standards or “metrics” as we call them in the #ImpInv world. Incentive compensation is driven by these numbers as well. Wait staff scoring higher than 90/100 points receive a $250 bonus. For managers, a positive increase in profit rate vis-a-vis the previous quarter triggers a bonus of 40% of the increased profit. What a fantastic way to align behavior – help the company achieve its goals and you gain too! It wasn’t a topic in the article, but I’d bet Chef Geoff has lower turnover and higher employee loyalty than his competitors, which will help make his business more sustainable in the long run.

The unexpected bonus for the Tracy brothers is that their standards and scoring tools are enabling them to continue expanding from one restaurant to two, then three, and now a fourth is in the works as well. Figuring out the challenges to translating initial success into scale for a particular industry, developing tools and techniques for replicating that success and then testing and refining them over time, that’s the “secret sauce”. Replication as a path to #scale may not sound like a big deal, but for most businesses (excluding #disruptive technology #innovations), codifying success may be the best way to create sustainable #growth.