Ten years ago, my partners and I at SustainVC decided to act on a provocative, nascent investment thesis: Invest in early-stage companies solving big problems, overlooked by traditional Silicon Valley investors…and create not only positive impact but also positive returns.
We’ve raised and invested $12 million in solutions to climate and sustainability, equality and empowerment, and health and education in the U.S. We have invested in places like Buffalo, where UltraCell is building a plant to make low-cost home insulation from recycled cardboard; Chicago, where Edovo reduces recidivism by producing educational content delivered to inmates via e-tablets while incarcerated; and Austin, Texas, where Aunt Bertha’s searchable SaaS platform efficiently connects people in need with services provided by local non-profits.
And we’re just getting started. Our portfolio of 32 early-stage companies has validated our original belief in the power of for-profit investing to solve social and environmental issues facing the world. And B Lab has named us a “Best for the World” fund.
Up until now, SustainVC has managed a series of small impact investment funds that invest as little as $100,000 and as much as $500,000 in equity in early-stage companies with between $100,000 and $5 million in revenues in the U.S (and Canada). Going forward, having proved out the model, SustainVC intends to grow the size and reach of our investments in the early-stage impact arena.
Ten years ago — before “impact investing” was even a term — we had lots of untested questions:
- “Is it really possible to generate market rates of return and provide meaningful social benefit?”
- “How will we construct an impact portfolio…and measure social benefit?”
- “What term will we even use to even describe what we are doing?”
A decade on, we now have some answers…and some lessons. We thought it’d be a good time to share some of both.
1. Positive impact AND positive returns? You betcha!
Funds investing for social and environmental purposes CAN have positive impact AND positive returns. Our portfolio companies have already positively touched over 5.5 million lives:
- 1.1 million students reached by our ed-tech companies;
- 1.9 million low-income Americans benefited by our tech platforms; and
- 2.5 million lives benefited or saved by our healthcare companies.
In addition, our companies offset over 100 million pounds of CO2 per year, employ 866 people…and almost half of our companies are women- or minority-led.
By investing in overlooked sectors we’ve also achieved strong financial returns. SustainVC has four highly successful realizations to date and 22 rapidly-growing companies remaining in the portfolio.
2. Financial-first or impact-first? It’s BOTH!
We weight social and financial returns equally. At SustainVC, all our investments must achieve both high impact and traditional early-stage market rates of return. We seek companies where their important social missions enhance the companies’ chances of business success.
The products and services produced by companies pursuing solutions to large, pressing social and environmental challenges are in high demand — and for companies with well-conceived, scalable business models, high demand translates into high revenue growth. Faster growing revenues allows the companies to reach sustainability more quickly and increase their impact “reach.” The virtuous circle leads to high impact and high returns.
3. You want me to measure…what? Impact? How do I do that!?
Measuring social impact is not only possible…it is essential for selecting and managing a portfolio of early-stage impact companies.
After evaluating several impact management systems under development at the time, we ended up adopting — and become a guinea pig for — the GIIRS (Global Impact Investment Rating System) rating system. But as good as it is, to us GIIRS is just one “data point.” Many early-stage companies have not fully developed their management teams and processes, and as a result may score poorly on the GIIRS rating system in certain areas. Prospective impact can only be gleaned through due diligence conducted by experienced professionals.
Post-closing we then “in-spect what we ex-pect” by tracking impact metrics specific to each company — tons of CO2 offset for an environmental company, for example, or numbers of low-income people helped through one of our SaaS platform companies. Then, with the help of CASE i3 at the Fuqua School of Business at Duke University, we roll up those individual impact metrics into aggregate metrics we can then report across all our companies — including broader “general” categories such as employment growth at our companies, or number of women- and minority-led companies.
4. Going, going…staying?!
Social ventures have higher staying power than their non-impact early-stage peers. Unlike traditional startups that focus just on financial return and are quick to wind-down if financial expectations are not met, impact companies have access to alternative forms of capital — sometimes in surprisingly high amounts due to their important social missions.
Social ventures can tap a growing ecosystem of funding to support their mission, including government grants, favorable loans, flexible payment terms and below-market rate investment. Employees aligned with the mission of social ventures are also willing to forgo competitive salaries for a period of time to reduce cash burn rate.
Case in point — we’ve lost only six of the 32 companies over the 10 years — a low loss ratio by traditional angel/early-stage investing statistics.
One great example of access to alternative capital is Ocean Renewable Power Co. that has been able to draw $50 million in non-dilutive funding from the Department of Energy and State governments. The agencies were backing the firm’s leadership in renewable electricity production and job creation in low-income communities where ORPC systems are generally installed.
5. Diversify, diversify, diversify…and did I say diversify?
Like in traditional investing, portfolio diversification is key. Despite rigorous due diligence, fund managers can’t only pick winners.
The key to success is to have a diversified portfolio such that the few big wins offset the inevitable losses that are present in any early-stage portfolio. Diversification benefits start with a minimum of 10 companies, but are greatly improved with 20 companies or more.
6. Know thy co-investors!
In impact investing it is important to understand the different due diligence and post-closing capabilities of co-investors.
Experienced, like-minded co-investors make portfolio management easier. In impact investing, co-investors are often non-profits, foundations or family offices that may have differing goals and expectations. Bringing different types of capital to a deal can be an advantage but requires closer portfolio management and clear communication.
7. The three “R’s”: risk, return…and revenue.
Pre-revenue companies take a lot more investor time and should be kept to a smaller percentage of the portfolio.
Meaningful upside investment return potential exists in financing companies in the vastly underserved market segment of companies with $0-$5 million in revenues with financing requirements that are too large for friends and family but are too small for traditional, larger, venture firms.
Portfolio managers, however, will have to spend a disproportionate amount of time with pre-revenue companies as they finalize product development and develop go-to-market strategies. This is particularly acute for companies with long paths to development — such as drug discovery companies needing to wind their ways through the vagaries of FDA approval processes.
By contrast, companies with even a few hundred thousand dollars of revenue make portfolio management easier and investment risk lower. A well-constructed portfolio needs to appropriately balance the potential higher return with these clear “time and risk” factors.
8. “We’ve perfected the product. Now we just need…um, $25 million.”
High capital expenditure business models can be difficult to finance, so be selective. Some companies after their R&D stages require large amount of capital to deploy their products — such as building a power plant based on a renewable resource, or building a large manufacturing facility to get needed economies of scale.
Finding what is commonly referred to as “project financing” for a new innovation is usually challenging. As a result, any well-conceived portfolio should have a low percentage of “high capex” companies in it, as compared to more “scalable” business models over time. As a fund manager, expect to spend a lot of time helping raise money for your innovative companies in need project financing.
9. Aim high…and make sure you have the gunpowder to fire the cannon.
It’s important to have dry powder for the life of the fund to double-down on the emerging winners and have defensive capital when needed. This improves overall portfolio financial returns. Portfolio managers also need to have capital to invest during critical times of company stress — such as during product transitions, or general off-plan performance. Companies with access to follow-on capital are clearly at an advantage over companies without this ready access.
10. You made the investment — now the work begins.
True value-added time spent with portfolio companies leads to better follow-on investment decisions and higher positive impact and positive returns. Some early-stage investors follow a “sprinkle lots of small amounts of money around and hope for the best” hands-off portfolio management strategy. We have found that it is much more effective to continue to be actively engaged with portfolio companies.
More value can be added along the way, such as through active board participation and bringing networking resources to bear. The more you’re involved the better follow-on investment decisions can be made. And sometimes the follow-on investments have more impact on the overall financial return of the investment than the original upfront investment.
Bonus lesson: It all starts…and ends…with the jockey.
Management is the most crucial element. We have examples in our portfolio of great management teams tackling social and environmental issues through a tough business model and excelling. We also unfortunately have examples of simpler business models finding little success due to poorer execution by management.
As a result, we continue to weight “quality of management” the highest of all our investment criteria. One sign of high-quality management is their ability to collaborate — including actively seeking support and guidance from investors. Great managers leverage help from multiple sources and use it well, increasing their likelihood of success.
Sky Lance is the founder and managing principal of SustainVC LLC. Previously, Sky was co-founder of Windjammer Capital Investors, a private equity firm with over $2 billion under management. In addition to Sky, SustainVC principals include Tom Balderston, Justin Desrosiers and Eric Chapman. SustainVC has offices in Boston, Philadelphia and Durham, N.C.