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Wednesday, July 28, 2010

Truly Patient Capital - How We Can Create Systemic Change – Part 2


In our last post we introduced our Pareto Holdings concept. Pareto is a socially oriented holding company that swaps Preferred Stock shares in nescient (but profitable) impact ventures for its own Common Shares. The thought is that a large holding company’s Common Shares will be increasingly more liquid than a single investors Preferred Shares in an early stage company.

If you missed that post, here’s the link. We ended the last post before fully describing how stakeholders will benefit from Pareto. So we will pick up with that here.

Pareto Holdings – Who Will Benefit

The point of Pareto Holdings is not to make a financial killing. The point is to create systemic change by proving that patient capital is sustainable, profitable and powerful. To achieve that, it must be efficient, pragmatic and focused. With that said, managers cannot forget who the beneficiaries are and why they needed Pareto in the first place.

Benefit for Entrepreneurs

Impact Entrepreneurs are in a difficult position. They seek profits but must consider impact. They target those in need but not to exploit their lack of options. In many cases they take on risks and expenses well beyond those accounted for by their direct competitors (see our post on Impact Maximization for more on that).

The current models for financing Impact Entrepreneurs are not growing as quickly as the number of entrepreneurs with exceptional socially motivated start-ups. Philanthropic dollars are adapting but will never meet the growing gap. Traditional investors are also adapting, but their expectations and focus on massive returns will keep them from providing the support that is needed. 

Pareto could help meet the gap by encouraging more philanthropically minded investors and organizations to become Impact Angel (or seed stage) Investors. Currently, these players have no compelling options to bring them from the sidelines. Impactful equity investments present for-profit models that don’t fit traditional grant making qualifications and are far too risky for traditional Mission Related Investments[1]. The holding company model could create a third, more compelling reason for them to join in.

More importantly, Pareto could also change the relationship between investors and entrepreneurs. A long-term profit sharing focus is much more in-line with the day-to-day concerns of a business owner. Early stage investors are rightly focused on scale. It is much more important than profits in that it increases the likelihood of an exit event and they depend on exits for liquidity and profits. As a holding company, Pareto’s interests are proportionate to each company’s size and the focus is to make holdings sustainable and profitable over the long-term. That means impact entrepreneurs will start with the important focus on scale, then shift gears and focus on profits as they come under the umbrella of the Holding company.

Benefits for Impact Investors

Seed stage impact investors (or Impact Angels), the few that currently exist, are also in a difficult situation. They want to leverage their wealth to create lasting change. They want something more sustainable than charity but with more positive impact than traditional businesses. They want to help young ventures become successful enterprises but they don’t want them to forget their social missions in the process.  They want to be active investors.

Pareto was designed with their dilemma in mind (after all, they are our clients). Impact Angels are the fuel for the emerging industry and we won’t get far without more of them. Yet convincing more to join the ranks is very difficult because there are no compelling exit strategies that meet their desired outcomes.  The holding company model, with a proven commitment to positive impact, will create exits that meet their goal of getting a return on investment while keeping a careful eye on the original mission.

Benefits for Institutional Investors & Foundations

Exits are not the only benefit that Pareto will provide. Individuals and institutions currently lack liquid investments that are high impact (the do-good kind). Pareto will sell shares to impact investors that benefit from the diversity and stability of a large portfolio while maintaining a deep commitment to improving the lives of those less fortunate.  Pareto’s support for Full Cost Accounting methods, direct impact and long-term growth will make it easy for investors to assess the impact of their funds (and easy to explain to their clients).

Pareto Holdings – Making It Happen

This is a very BIG idea and we are still a small company. As entrepreneurs our first inclination is to run out and try to make this happen on our own. As sensible human beings, we know better. We need to bat this idea around with other BIG thinkers in the industry so that it can take shape. In business the devil is in the details and Pareto has a lot of details.  We need experts to weigh-in, warn us of potential pitfalls, and point us in the right direction. Finally, we need momentum. New ideas are hard to get moving, but once they do, momentum alone will take them far. As a small company, there is probably nothing more difficult for us to do than create momentum. All we can do is keep talking, keep writing and hope that some of you join us.


[1] Mission Related Investments (MRI) are a tool used by foundations to make mission oriented investments that seek returns. A quick guide (with links to guides) can be found here: http://bit.ly/cHT0lh

Friday, July 23, 2010

Weekly Review - July 18th - 24th


Every week at Invested Development, we scan the web for articles that relate to what we do and what we like. This week we read a lot about start-ups a little about laptops.

These guys might not have the statistics right (Dunn & Bradstreet estimates that over 80% of start-ups are not in business after 5 years), but the advice is solid. Recruiting a strong Board of Advisors is essential and will make an entrepreneurs life a lot easier if they are good. We would only add one additional selection criteria to the list. Make sure they your Board members are willing to speak-up and push back and that you respect them enough to listen.

If you couple this reading with the previous article you will understand our reservations about the present incarnation of this bill. Imagine the pressure the entrepreneurs will face. Beyond the normal pride-crushing, credit-killing, 401K depleting, friend-and-family-fracturing hell that many failing entrepreneurs go through, these guys will also face the prospect of deportation (along with their families).

Microfinance is a big part of start-up firms in emerging markets (and to much smaller extent in the U.S.) It is also the precursor to Impact Investing and still commands the lion’s share of socially responsible investments (SRI) made in emerging markets. So it is now surprise that we think questioning the morality of investors making money of microfinance as relevant. Contrary to what you might think, we don’t agree with the author’s defense of microfinance investors making big bucks (or his childish portrayal of loan sharks as violent thugs – see this post about Gurski’s Loan Sharks). The issue is not profits, but the growing distance between customer and decision maker.

This is starting to feel like the search for the Holy Grail (remember, they never found it), but we like the initiative. This is also interesting because it is not a private sector, free market initiative. It looks like the state did a great job of spearheading the R&D, and is ready to outsource manufacturing. Let’s just hope they don’t try to take on distribution themselves or that $35 might be more like $300 delivered.

Wednesday, July 21, 2010

Truly Patient Capital - How We Can Create Systemic Change – Part 1

Over the last few posts we have been sharing our thoughts on the industry in general.  We started ID last year because there was a need in the market for seed investment capital for impact-oriented startups. We thought the solution was simple. Let’s do what they did in Silicon Valley! Then came reality.
Silicon Valley has throngs of experienced industry executives with deep pockets fresh off their latest IPO. They not only throw money at countless start-ups but share years of experience and can open up Rolodex as thick as the Palo Alto Yellow Pages. Impact investing has good intentions and money.
No problem, we thought, we can create a business and pair our industry experience and contacts with would-be Angel Investors capital. Problem solved! Well, maybe not. Invested Development began with just that mission and is still doing that today. But one year later, we have realized that despite a lot of progress, we can’t possibly change the game with our current model alone.

The Problem

Although a few Impact Angel Investors and non-profit investors have emerged to provide seed funding for socially motivated start-ups, we need to attract many, many more. Impact investing is getting hyped and the money will continue to trickle in. As an industry, Impact Investing has grown by 22% per year since 2001. Conservative estimates suggest the market will reach $500 billion over the next 10 years[1].  These are impressive numbers, not to be downplayed, but let’s put it in perspective. We are still talking about 1% of total assets under management.  And even then, most of that money is institutional Socially Responsible Investments with a do-no-harm, social screening[2] mantra; not a do-good promotion of companies that put their social missions first[3].  Systemic change will require that we do more of the latter.

One Solution – Pareto Holdings

Pareto Holdings is a concept that we have been throwing around here for the past six months. In a nutshell, it is a socially oriented holding company that swaps Preferred Stock shares in nescient (but profitable) social ventures for its own Common Shares. The thought is that a large holding company’s Common Shares will be increasingly more liquid than a single investors Preferred Shares in an early stage company. Overtime, the steady stream of dividend disbursements (and profit sharing) will create an attractive, steady, and reliable return for institutional investors and progressive government funds (a.k.a. the Dutch Lottery system). The end result is steep reduction in liquidity risk for Impact Angel Investors and added velocity to their investment cycle.
I won’t pretend that we have run the necessary models, dug into the necessary details or even interrogated the underpinning assumptions sufficiently. But we have put a good bit of thought into why it’s needed and who will benefit from it.

How It Will Work

The general concept is that Impact Angels face liquidity risk well beyond their projected returns (odd how you can project returns without a clear liquidity event… but we’ll save that for a different post). Additionally, even theoretical exits in this industry are plus-minus.  Scaling an enterprise is much easier when you can attract a buyer, but attracting a buyer often means jeopardizing your social mission. Pareto solves both issues by creating an exit scenario that is more predictable (largely focused on the company having profits) and socially palatable (missions will stay intact because Pareto investors are motivated by that part as well).
Let’s outline a few more details on how it will work:
Preferred Stock: For Pareto Holdings to generate cash, it will rely on cash dividends (or profit sharing) from Preferred Stock shares in young, but profitable, social ventures. Shares will likely be negotiated as straight, perpetual preferred stocks with guaranteed or floating dividends (however, this will take considerably more research and projections).
Share Exchange: Angel investors often receive Preferred Stock shares for their seed investments. These shares lack voting rights but guarantee dividends once the company becomes profitable. However, most Angel investors are not interested in the dividend income. They are more focused on exiting the investment, regaining liquidity, and re-investing that capital into new start-ups.  Pareto will assist them by exchanging highly liquid Common Shares in Pareto Holdings for their less liquid (but dividend yielding) Preferred Stock in qualified social ventures.
Dividend Cash Flow: By creating a pool of dividend yielding shares, Pareto Holdings will create a diversified, consistent and profitable model for long-term social investments.  The benefits gained from negotiated dividend terms, priority (dividend and liquidation) and perpetuity will offset the rare upside risk of not holding common shares or convertible debt instruments.
Traded Shares: Overtime, Pareto Holdings will create a large enough pool to yield secure and sound returns for socially oriented investors seeking liquid investments with a proven commitment to impact investing.

The why and how are probably enough to digest in a single post. I’ll follow up in our next post with more on Pareto and how each stakeholder will benefit. 
[1]  Monitor Institute - “Investing for Social & Environmental Impact”, 2009
[3] For more on the difference between do-no-harm and do-good, read our previous two posts Investing in Development and Impact Maximization

Friday, July 16, 2010

Weekly Review - July 11th - July 17th

Every week at Invested Development, we scan the web for articles that relate to what we do and what we like. This week we read a lot about alternative energy with some mobile tech thrown in for good measure:


If you follow our work at all you know that there is not shortage of solutions to rural electrification in Africa. This is another illustration of how NGO’s are currently leading the effort for off-grid solutions, but market solutions are not far behind. For every Barefoot College, there is a Barefoot Power (or EGG-energy). Investment should continue to grow in the area. The problem is big enough for a lot of players and large state-level solutions are just not going to happen, as a Kenyan Minister of Energy is quoted saying “National power grid connections require huge capital investments with the scattered nature of rural settlements that require off grid stations making this unattainable in the near future.”

This one slipped by us last week, but it’s worth highlighting now. It is amazing that even in an emerging market with tremendous poverty, like India, handset providers are starting to compete on more than price. A handset with a built in mosquito repellant! Now that is genius.

It might sound like a disparaging joke (i.e. “ever heard of the [name your oft derided group] invention? A solar light bulb!”) but in the end it might just be brilliant. Solar lamps have become vogue (we reported of the recent $5 million investment in solar lamp maker d.light design) but this might be a more practical solution. The fixtures are standard. In areas with limited electricity it is especially a boon as they are likely already wired for electricity.

Ontarios is probably taking a step in the right direction, even if this is horribly unpopular and imperfect. A few weeks back we blogged about the importance of Full Cost Accounting, or companies incorporating all the costs of production into the products. Until the IRS or WTO require the practice, it will be up to Cities to make sure companies incorporate the cost of their products full life-cycles.

Sunday, July 11, 2010

Weekly Review - July 4th - July 10th

Every week at Invested Development, we scan the web for articles that relate to what we do and what we like. This week we read a lot about big pictures issues in development and cross border investing:

Thanks to the World Bank, investors finally have a simple, informative website with just about all they need to know about a countries regulations on direct foreign investment. Of course, knowing is just half the battle. Now we have to work on making it cheaper to actually do it. Until we can inspire and scale local Angel Investors, we need aggressively push down the costs of cross border investing.

The Douglas Adams reference alone was enough to make us read this! The feedback loop created by capitalism is by far it’s greatest asset, and Aid/charities greatest detriment. It can be dangerous to take this line of thought too far and we have to make sure not to use it as an excuse to ignore suffering.

Nathaniel Whittemore’s articles are becoming a staple of our Weekly Review’s, and with good reason. He gets it. A lot of people try to silo entrepreneurs, but this is a great example of how even traditional entrepreneurs can have tremendous social impact. Business can bring people together, even in one of the most divided regions in the world.

Danone (Dannon in the U.S) are the guys who bought Stoneybrook Farms, and it looks like the influences are going upsteam, not down as people feared. This made us think about how companies like Stoneybrook and Ben & Jerry’s have managed to keep their missions after acquisition. Luckily, the Trusteeship Institute has created an amazing video library of successful mission driven entrepreneurs talking about keeping their values post acquisition. 

Friday, July 2, 2010

Weekly Review - June 28th - July 2nd

As every week, our team looked for the best articles on the web concerning social entrepreneurship and impact investing. Today we share with you interesting ideas and initiatives from Change.org, NextBillion etc.

And happy 4th of July!!

An honest look back at three lessons learned by Waste Ventures in their failure to secure a 2010 Echoing Green Fellowship.  If we have heard it once, we have heard it a thousand times – sometimes failure teaches more than success.  All entrepreneurs can benefit from these lessons whether they are talking with investors, looking to secure a partnership or competing for a fellowship.

Rishabh Kaul of Next Billion details his work with Sarvajal, a company utilizing a microfranchising model to provide clean drinking water in Gujurat, India.  Rishabh spent a month working and living with Sarvajal franchisees in order to better understand the issues they face day to day. This article underscores the importance of understanding microfranchising models from the top down in order for francisees and franchisors to realize the most mutual benefit.

Kerri Feazell shares three ways a non-profit designation can hamstring an organization.  The validity of the points themselves have generated lots of discussion in the comments section.  Yet, we feel this continues to demonstrate the need for legal structures (B-corp, L3C) that split the difference between for-profit and non-profit.

Nathaniel Whittenmore comments on a New York Times article regarding the commercialization of university research.  Undoubtedly we need to do better in taking some of the groundbreaking research being done today to market.  Hopefully this initiative from the National Science Foundation’s Partnership for Innovation can lead the way.