19 Sep Why we believe foundations have everything to invest in impact ventures
Impact investing starts with a certain mindset and the awareness that money, if invested in a sustainable manner, cannot only increase in the traditional sense but can contribute to solving pressing social and ecological problems.
In our case the journey began with one entrepreneurial family, ready to align its values and understanding of doing business with the investment activities of the foundation. From then on, we as a foundation have been almost exclusively focused on finding answers to the question of how to promote young mission-driven ventures financially, but also non-financially, to take them through the challenging early lifecycle stages with the ultimate goal to scale their impact and increase the capacity to pay the investment back. Here are some of the lessons we have learned over the years:
Using the already existing network
Foundations do not need to reinvent the wheel when setting up additional structures for direct investments. They can use their close-knit pool of experts such as lawyers, accountants as well as social impact advisors to support the core activities around direct investments such as deal sourcing, due diligence and portfolio management. This decreases the initial implementation costs and puts foundations in an excellent position to start looking into direct investment opportunities.
Considering a combination of financial and non-financial support
The combination of financial assistance in the form of equity, mezzanine or debt investment and non-financial assistance is crucial to help start-ups navigate the early lifecycle stages. Impact ventures have suboptimal return profiles, particularly at the early stage. The provision of technical support thus helps to refine the business model, enhances the conditions for scaling and increases the start-ups’ attractiveness for follow-on rounds of funding. In this regard, foundations are excellent partners in regard to non-financial support. Within their operational focus, foundations have an in-depth knowledge of the root causes of a certain social or ecological issue. Sharing this knowledge with the impact ventures might lead to better results, e.g. improved livelihoods of refugees, as the ventures can turn this knowledge into new or slightly adapted services or products.
Starting with smaller ticket sizes
It is always a challenge to fully convince the foundation’s board members of direct investments in impact ventures; even if the internal decision was made to go down this road, often skepticism remains. In our case it therefore was essential to start with smaller ticket size investments between EUR 50k to EUR 200k. First of all, two to three of these investments allowed the staff and board members to learn more about the chances and risks of such investments, with a fairly small amount of money in comparison to the foundation’s total assets. At the same time, the we stepped into the gap of financing available for early-stage enterprises to launch their operations in the market and prepare for scaling by providing smaller ticket size investments. Experts often speak about the ‘missing middle’ in reference to the lack of smaller ticket sizes available to early-stage (social) enterprises and by offering ticket sizes between EUR 50k to EUR 200k we are working on addressing this problem.
Co-investing with others
Especially in the beginning, it helped us to co-invest with other more experienced conscious individual or institutional investors because it accelerated the foundation’s learning process and minimized the high transaction costs, such as deal flow and due diligence costs, associated with smaller ticket size investments. Furthermore, co-investing with others builds confidence in the company within the market and among future investors. Last but not least, is has proven to be an effective strategy to increase the size of the investments, as it reduces the risk profile associated with the prospective investee.
Certainly, such an impact investment approach might not work for every foundation due to the increased risks early start-up investments can bear. Nevertheless, it is worth considering the adoption of direct investments into a foundation’s investment strategy, for several reasons. Direct investments in young impact ventures can teach foundations how to deploy their capital in line with their social mission beyond or in addition to traditional philanthropic means. They make it possible for foundations to recycle money and use it for other projects once the impact venture has repaid the investment. Moreover, foundations have the best structural preconditions for such an approach because they have a long tradition of providing non-financial support to their grantees and maintain a diverse network of experts. Last but not least, foundations, unlike more ‘traditional’ types of investors, are driven by a social mission. That makes them the perfect match for impact ventures because it is easier for foundations to understand the holistic (the social and/or ecological as well as financial) return of an impact investment.