Yesterday’s post ended with the question — How do we help #impinv achieve scale when microfinance still lacks scale after 17 years? Here are six ideas that could help grow the size, range and capacity of impact investment managers and intermediaries:
1. Most #impinv managers are new, given that the investment theme itself is new. Don’t use this to justify sub-sustainable fund sizes – find other ways to mitigate new manager risk instead. If you want to reduce the operating risk of a new management team: look for organization cultures that tap high-level mentoring; provide reasonable cost access to financial and reporting systems; include industry association dues in operating budgets and require meaningful, active participation by fund staff; commit to enough funding to keep the investment manager off the capital raising circuit so they can focus on portfolio, etc. The fund and fee structures must be sustainable otherwise the sustainability of portfolio companies and potential returns are both threatened;
2. Reduce reliance on closed-end long-term equity funds and create instead a secondary market-marker to manage liquidity at an industry level. This would free funds from holding scarce capital idle in a liquidity reserve, but enable investors to adjust portfolio holdings as needed. Development Finance Institutions (DFIs) could use guarantee funding to minimize the cash requirements of the market-maker and really leverage private capital. The structure could borrow from Omtrix’ Emergency Liquidity Facility (ELF) – funds and firms register and pre-qualify so that when liquidity is needed, little additional data is needed to respond;
3. Think in terms of multi-round funds (or multi-product firms). Investments that perform will get access to growth capital, your portfolio quality automatically increases over time and you have greater flexibility to pursue the best exit rather than the possible exit. Poor performers, obviously, don’t get follow-on investments, but good performers are less likely to fail or stagnate if we recognize current market gaps and plan for growth funding from day one. There’s no point in creating a robust global network of angel investors if there aren’t early stage and growth investors ready to step in as portfolio companies grow.
4. Think in terms of “investment ready” intermediaries rather than “funds”. We know what front and back office policies, processes and systems are needed. We also know that the quality of the human talent we hire (and how that talent works as a team) plays a significant role in investment management performance. Putting those two sets of requirements together before portfolio investment begins should reduce new manager risk and enhance your performance returns – but it takes capital to do this. Until there are sources of funding for new intermediation business models, most impact investments will cost too much and/or deliver too little.
5. Look for capital markets solutions to issues of scale and tenor. If we create well-capitalized, well-managed intermediaries, these intermediaries can offer long-term bonds/notes to long-term investors (like pension funds and insurance companies) using credit enhancements to ensure an acceptable risk/return profile for investors. The intermediary could then offer a wide range of debt, quasi-equity and equity to impact portfolio companies that are otherwise too small, or local market constrained, to obtain funding on similar terms (if at all). In other words, since most ventures with social impact are too small to access capital markets, we should create scalable and scaled intermediaries that have the necessary size and credibility to tap capital markets funding.
6. Don’t screw the middle class to “help” the poor. The talented investment professionals managing your impact investments are highly educated and highly skilled. They deserve to be paid reasonable wages and benefits, with a potential upside return on good performance. Cutting out expenses like health and life insurance may lower costs, but it won’t garner staff loyalty. Keeping wages at sub-market levels will likewise reduce costs, but may lead staff to moonlight to cover family expenses (bad for performance) or make them vulnerable to poaching by new competitors looking for experienced talent. Your people are your most valuable asset. Nurture and reward talent in ways that boost all of you multiple bottom-line returns.
The corollary to the above relates to how we structure investments in VSIs. If you are offering a zero return/no dividend policy to investors, you may be keeping funding within the VSI, but you are, in fact, losing money for your investors due to the impact of inflation over time. For the middle class, VSIs that don’t offer a return can only be funded from charitable giving budgets, since saving for your kid’s college education or your own retirement requires earning a positive real rate of return on investments. I’d like to be able to invest in VSIs, not just give money away, as would many of my friends who fall within the definition of middle class. That means we’re looking for for-profit, multiple bottom-line investments that we can access despite being too poor to qualify as an “accredited investor”.
400 Americans control more wealth than the 150 million poorest Americans – but that still leaves more than 100 million individuals in the US alone who could participate in impact investments, given appropriate instruments. Zero return social investment structures exclude this middle class market. Do we want to create an elitist system in which only the wealthy can invest in a way that makes people and planet better off? The SEC’s consideration of changes to crowd-funding and private placement regulations is a step in the right direction, as is the movement to incorporate ESG (environmental, social and governance) criteria into all investment, not just so-called “impact” investment.
What kinds of changes do you think are needed to get the issue of scalable impact investment intermediaries on the table? Are you part of a firm trying to grow? Looking to create a scalable structure? Struggling with capital markets access issues? Please share your concerns and experiences as comments, or let me know if you’d like to write a guest post on any of these themes!