Beyond Equity: Impact investors can rethink how we invest, not just what we invest in



ImpactAlpha, February 21 – At Village Capital, we talk a lot about investor blind spots. In the world of impact investing, I’d argue that one of the biggest blind spots sits at the earliest stage of companies’ growth.

Early-stage businesses make a lot of sense for impact investors. Seed, pre-seed and Series A companies are at the frontier of innovation. When a company is still young, its leaders are still laying the groundwork for its revenue model, impact thesis and theory of change. At the early stage, TONIIC writes, “entrepreneurs and investors tend to hold very similar values: they are both seeking innovation and disruption for the greater good.”

Many impact investors, asset managers, foundations, and high net-worth individuals seem challenged to stomach the risk that comes with this market-building stage. If we’re going to dispel the “myth of the investable deal” in early-stage impact investing, we’ll need more than just angel networks. We’ll need investors and the broader ecosystem to focus on critical gaps at the earlier part of the capital stack.

Startups are looking beyond venture capital for money that matches their mission

Investors operating at the early stage have largely been doing so with the tools that got us here – “2/20” structures, 10-year funds and equity as the default type of capital – not the tools that will get us there. My challenge to these investors, and to any LP or asset manager who wants to support impactful companies, is to be open to rethinking when and how they invest, not just what they invest in.

Beyond equity

Over the past year, our team at Village Capital has been on a journey to find workable, practical solutions to the constraints of “one size fits all” capital structures. The first and most fundamental takeaway: look beyond equity. Many impact investors support entrepreneurs with equity investments by default, because that’s how it’s always been done. Over-reliance on equity can be a mistake.

A lot of businesses working in sectors like healthcare, education, financial health, and sustainable food – sectors that have the potential to positively impact livelihoods – don’t have a typical software-as-a-service business model with a clear path to exit in five to seven years. Many are working in highly regulated and complex sectors, and high growth may take 10 years of market-building, a time period that far exceeds the patience of an investor operating a 10-year fund. This was once true for the tech sector during its own phase of market-building in the late 90s. My former boss, Steve Case, always talked about AOL as a “10-year overnight success.”

The Opportunity Alpha: Year in Review

Equity encourages businesses to scale with as few resources as possible, as quickly as possible – what Tim O’Reilly calls “blitzscaling.” Blitzscaling has been the demise of a lot of companies, since scale can come at the expense of broader economic value and business sustainability. That’s part of the reason that more and more startups are saying “no” to venture capital, as Erin Griffith recently reported.

Blitzscaling culture can be particularly harmful for impactful companies that need to keep an eye on more than one bottom line as they grow. Scale can easily undermine the patience that is required to address critical challenges in sectors of our economy such as health, education, food and housing.

One alternative to equity? Revenue-share structures. As I wrote recently, an increasing number of investors, many of them impact investors, are beginning to make deals that involve a capital investment that is repaid from a share in the revenue of a growing business. Indie.vc (not a self-identified impact investor) recently raised their second $30 million fund that invests through a “profit-sharing” structure. Candide Group, RevUp Capital, and investor network Transform Finance are exploring new types of ownership structures that are more appropriate for a wider range of early-stage businesses.

Helping companies tap ‘alternative capital’ for sustainable growth

A recent report from the Dutch Good Growth Fund provides concrete ideas around a blended approach to accelerating the early stage finance ecosystem in emerging markets. Many of the ideas also are applicable to the challenges faced by impact oriented companies in more advanced economies as well.

Segmenting businesses

Blitzscaling culture has another downside: when you have a hammer (equity) everything looks like a nail (a future multi-national, billion-dollar company, market-altering business). That’s not always the case, and that’s okay.

It’s tempting for an investor to assume that every great idea has the potential to scale across the world and affect billions of people. The reality is that lots of businesses fall into what Bryce Roberts of Indie.vc calls “the gap that sits squarely between lifestyle businesses and monopolies in the making.”

Bryce Roberts and Tim O’Reilly: VCs that help startups raise revenues, not rounds

Omidyar Network and the Collaborative for Frontier Finance recently released a report with a useful scheme for segmenting small and growing businesses into four categories, or “families”: high-growth ventures; niche ventures; dynamic enterprises; and livelihood-sustaining enterprises.

Investors may default to thinking about high-growth ventures with disruptive business models, high potential for scale, and led by ambitious entrepreneurs with significant risk tolerance.

There are so many businesses that present promising opportunities for investors that sit in the gap that Bryce Roberts describes. Niche ventures create innovative products and services that target specific markets or customer segments. They have the potential for scale, but may have other priorities.

The four “missing middles” among small and growing businesses

Dynamic enterprises operate in more traditional industries like retail, manufacturing and trading, deploying proven business models. These businesses have room to grow and present investors with an opportunity to deploy capital towards enterprises that are often a critical source of low- and middle-skilled job creation.  

Such segmentation help investors “more effectively diagnose the distinct financing needs and gaps faced by different types of enterprises, and in turn better focus on scaling the financing solutions that are most needed to empower enterprises of all types to meaningfully contribute to inclusive economic growth.” While the framework was developed for use in frontier markets, the segmentation applies globally.

Impact investing is becoming more mainstream, and that’s a double-edged sword. As more organizations bring their money to the table, they will also bring their values. As Bain Capital grows their $390 million Double Impact fund and private equity firm TPG Growth allocates their $2 billion Rise Fund, they are going to want to swing for the fences.

TPG Growth moves to raise second Rise Fund, and this time the target is $3 billion

We should absolutely celebrate the movement of significant capital towards impact investing. We should also remember that impact investors have an opportunity to do things differently.


Allie Burns is the CEO of Village Capital.

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