Tag Archives: #socfin

Why I hope Impact Investment is NOT the next VC

When I began working in the field of economic development, the relevant paradigm / theory of change was shifting from the “do good” Peace Corps model of JFK to the “private enterprise” model of the Reagan era. Having already seen firsthand that teaching a man to fish is useless if there aren’t fish in the water to catch, I was keen on applying private sector business solutions to public-private development challenges.

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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