Why impact investing goes beyond venture capital

Generation S

Why impact investing goes beyond venture capital

Investor pitch image by SeedRocket via Compfight cc.

I used to think that being an impact investor pretty much meant taking the skills and processes of venture capital and applying them for "good." Deal sourcing, due diligence, valuation -- all the basic steps seemed the same.

When I joined the University of Michigan's student-run impact investing fund Social Venture Fund, I expected to learn about investing while thinking about issues I care about. I think other people feel the same way. However, recent news coverage, like this Harvard Business Review article with tips on pitching to an impact investor, reflects a growing discussion about the differences between impact investing and traditional venture capital.

As a current MBA candidate, I've been thinking lately not about the "what," but the "how" -- the skills that will set an impact investor apart. Two years on the Social Venture Fund, including a year serving as its co-director, have taught me that impact investing does not require you to just do what a venture capitalist does; it requires you to do what a venture capitalist does, but better.   

A better salesman

All VCs have to go out on the road to raise money from investors. They sell their expertise, connections, industry knowledge, past success. Impact investors add on the challenge of selling the social value proposition, the fact that social results will really be achieved and the promise that financial and social returns can actually go hand in hand. Like most new impact funds, the three-year-old Social Venture Fund has exciting investments, including food company Jack and Jakes and education technology company LearnZillion, but it doesn't have an exit to its name. Impact investors must sell the business, plus more, all without the luxury of past results to point to.

Content with uncertainty

If a VC has to be comfortable taking risks by betting on yet unproven companies, an impact investor has to be even more so. On top of betting on often-unproven products and markets, impact investors operate in a fast-evolving and ambiguous field that has a broad range of goals. Everyone agrees on how to measure dollar-based ROI. Despite efforts on common metrics by the Global Impact Investing Network, the field is a long way from consensus on what "impact" is, let alone how to measure it.

A closer relationship with portfolio companies

Social entrepreneurs are more likely to be testing a novel business model, serving a nascent market or even attempting to create a new one. This translates into a greater need for counseling, connections and time from investors. In the Social Venture Fund, we're able to call on the expertise of our graduate student members and their professors from six different graduate schools at the University of Michigan to work on special projects with our portfolio companies. Other impact investors find myriad ways, from nonprofit arms to business incubating programs, to add strategic value to investments.  

Beyond just doing VC, better impact investing requires a few unique skills of the aspiring social-sustainable venture capitalist.

Patience: One variation of impact investing is called "Slow Money," with good reason. Social entrepreneurs may not always grow more slowly, but the combination of new business styles and an underdeveloped field of potential acquirers means that the exit horizon extends from around three to five years to around seven to 10 (yet another good reason to have a good relationship with your investments).

Multidisciplinary analytics: Many venture capitalists set themselves apart by developing an expertise in a particular product or industry. Impact investors don't have it so easy. In the Social Venture Fund, we are lucky to have students with work experience in each of our four areas of investment: health, education, environment and urban revitalization. But even if you were to pick just one of these areas to focus on, impact investing requires an ability to synthesize and find trade-offs between financial, operational, social and environmental factors. It pulls you into nonprofit, government and regulatory realms unusual for a traditional venture investor.

Creativity: To a large extent, the impact investing field is still "making it up" as they go along. It's clear that impact investing is not the same old VC, but it's not clear what that looks like yet. Successful investors will be creative in how they structure terms to incentivize desired performance or to enable unusual forms of exit. For example, finding ways to reward portfolio companies for achievement of social returns or setting up alternative-exit options for social entrepreneurs who wish to maintain long-term control of their company.

Gumption: There are no defined parameters for measuring social impact, so you've got to be willing to take a stand. To me, a dried fruit company Social Venture Fund received a pitch from last fall is just another snack maker. To others, it's a health venture providing alternatives to processed sugar. While I saw social value in reducing climate change risk, some people in my fund dismissed a startup that made lower-carbon disposable utensils as not "social" enough. Impact investors have to be willing to define the change they want to make in the world and quite literally, how much that change means to them in the form of financial tradeoff and/or additional risk.

However, impact investing is brave, not because it is a bet on a yet unproven asset class, but because it is a public questioning of the traditional assumptions about the objectives of for-profit businesses. It is a simple, but radical skin-in-the-game statement that we're leaving "value" on the table. Even with lack of consensus on what impact to go for, impact investing is an audacious claim that, "We can do better than this."

Investor pitch image by SeedRocket_ via Compfight cc