Good Generation

Key Ideas in this Post

• Impact investing is the latest hot topic in the do-good community around the world. At its core, the idea of actually “investing” in social-purpose organizations and achieve both “social and environmental” and “financial” returns for money, as an alternative and complement to philanthropy, gets people excited. Whether you think it’s just repackaging of old ideas or a legitimate paradigm shift, this “field” has undeniably gotten significant attention in the last five years.

• In Part 1 and Part 2 of this 5-part series, I proposed a 6-step mental checklist that may help you navigate your career in this field, and I started with elaborating on the first two items dealing with identifying opportunities and becoming more aware of your actual role on the job.

• In Part 3, I discussed the importance of  understanding what type of people and personalities manage impact investment funds to determine compatibility with your own style, but also to get a sense how your negotiation may be influenced by their background.

• In Part 4, I suggested that sensing whether or not your impact investor knows what types of organizations she wants to invest in was very informative because it will tell you a lot about your potential life and the long term viability of the fund you are considering.

• In this final Part 5, I will ask you to probe for the impact investor’s return expectations as an indication of how much they are in touch with reality and then ultimately how to assess yourself and your preferences before going into that interview.

*Disclaimer: for this post series, I will apply the term “impact investing” to a broader area of popular interpretations, which frequently is further confused by different terminology. Thus, I will deliberately include everything from socially responsible investing (SRI), environmental/social/governance investing (ESG), venture/engaged philanthropy, profit-for-purpose investing, to patient capital investing. Confused yet? Great, because cutting through that terminology mess is very much a part of the process as you’re looking for jobs!

Here’s my mental checklist to identify that job opportunity and how to think about it once you’ve been shortlisted for an interview. I will elaborate in this post about the last two items.

Impact Investing Career Checklist

1. Identify the opportunities (Part 1)
2. Assess your potential role (Part 2)
3. Understand who runs the show (Part 3)
4. Define target organizations they fund (Part 4)
5. Know their return expectations (Part 5)
6. Know yourself (Part 5)

5) Know their return expectations

• Besides knowing what type of companies your impact investor wants to support, you absolutely have to understand their return expectations. While social return by definition is vague and will change over time in most cases, financial return is not. Thus, be blunt and make sure you understand how much financial return investment funders are looking for given the type of companies they are interested in, which was explored in Part 4.

• Despite all the literature explaining that social enterprises and similar organizations are very much unlike their traditional for-profit counterparts, not just in their mere orientation towards primarily socially beneficial missions, it still astounds me when I meet impact investors who do not really understand this difference on a deeper level. They do not understand this because they still demand what I consider a very, very high financial return, which not even the Top 5% of social enterprises can realistically yield. This problem has various causes. One cause, in my opinion, is the overly zealous and self-confident marketing of fund managers that they can indeed provide great social and financial return, with the latter being recyclable into new investments. It just sounds so good, doesn’t it? “The time has finally come,” they claim. “Not only can we do good, but it will pay healthy financial rewards. Give us your money and we will prove it to you.” And then the news media gets all excited. I would even go so far to say that many impact investors are in fact being either cocky or even somewhat dishonest when they so nonchalantly state that they can sustainably look into a pipeline of deals that in fact provides outstanding social benefits coupled with market rate ROIs. It is my belief that the supply of such “social + profitable” companies is simply not there yet. We have plenty of companies with fantastically innovative social or environmental change models. Even models that can scale. But we have only a handful of companies that can also deliver good cash on cash within a shorter time horizon. For this reason, any large institutional investor who is led to invest in funds managing such firms that claim to be designed for “capital preservation” has to come in with sober expectations or end up potentially sorely disappointed in time.

• This is made more difficult because failure in social sector investing is not as easy to recover from, unlike failure in for-profit sector investing. In the latter, VCs take bets in many companies and don’t mind several failures because there is a large enough pool of firms to choose from, and their one Facebook or Google will more than pay for the the cost of all their failed investments put together. Statistically, it is possible to get ahead, albeit very difficult. However, in the social sector, there are not only no Facebook or Google-like “jackpot” companies possible anytime soon, but there simply are not enough investment-ready firms period. Ultimately, my concern is that even if impact investors successfully reel in loads of institutional investors at this stage in the industry’s development, having those investors then witness below-average returns could be detrimental to confidence in the quality of impact investing deals. But there is a more significant issue at stake here.

• I would argue that the key problem of impact investing today is that it attempts to play ball based on the rules of the traditional financial markets game. It has less to do with fund managers “selling out” than them trying too hard to speak a familiar language with capitalists, i.e., asset managers of “big money.” You can see hundreds of references and tips on the web about the importance for socially oriented firms to speaking “the language of business.” But I think it is not simply an issue of language. It is an issue of values. This attempt to bending over backwards to meet the risk/return adjusted expectations of traditional investors misses an important opportunity to re-position their view on what the returns of investing could mean besides money. Persuading people that social/environmental return is intrinsically of value and utility is the key. Building up the pool of those who appreciate this is arguably a more important role than catering to the pool of those who still want their cake and eat it. I would rather have a hundred smaller entities or individuals putting money in with the right return expectations than 1 big CALPERS institutional fund who may not invest based on the right values, and for whose billions we have no companies that can absorb the capital anyway. The trade-off, therefore, would be less money coming in less quickly. Why would that be okay? Because a fundamental shift in values cannot possibly be expected to occur quickly. Yes, the stories will be less dramatic and the numbers less juicy, but their growth will be a truer proxy for progress than what we see now.

• If we had to be honest, my bet would be that our pitch should sound more like this: “We have a company here with outstanding social benefits that it will produce for its target customers. We expect it to scale and multiply these benefits. Additionally, as an extra, bonus, it may yield some positive return, which will accrue to investors.” Instead, when impact investors try so hard to sell their companies as being good for conscience and good for profits all the same, it allows traditional investors to comfortably keep their deep-seated, financial-driven motivation – and then ask really hard questions that are no fun to answer! And that, I think, is the reason why philanthropy has kept its broad appeal for so long: because investors would rather not look at social benefit companies with an eye on risk-adjusted returns, and instead become “donors” in their spare time who give the money away with no expectation of getting it back and reap the emotional benefits.

• In summary, similar to my views expressed in Part 4, I believe impact investors who will be successful are those that are humble to realize the market is not there yet, but that it pays to start building relationships and patiently enter transactions on a very selective basis. This means they will be reasonable but not obsessed with growth and showing big numbers to the public about their results. You should avoid like the plague those impact investors who brag about having convinced huge institutional investors to put money in them, with the promise that they will receive competitive financial returns. The more difficult transformation that has to take shape is not to push social enterprises to scale and churn out more money, but to develop the new class of people who will allocate the money they had set aside for investment (not for donation) and persuade them to put it into impact investment portfolio firms. But they have to do this with the knowledge that getting money back is not the point but an extra. Thus, if not properly dealt with, this issue of return expectations not only potentially jeopardizes your fund’s credibility if its promises turn out exaggerated in the long term, but also will choke off deal flow if the floor for minimum returns is simply too high. As an employee of such a firm, also depending on the region you are covering, just be aware that you will end up turning down 99% of deals and spend most of your time writing investment memos with less than a handful of actual transactions taking place per year. Be aware those transactions may turn out to be small and philanthropic anyhow. I recite the number from Part 4 again here: Acumen Fund’s investment exposure over 10 years was under $80 million. Not billion. And that was a lot of hard work finding a lot of companies to spread that wealth around.

6) Know yourself

• At last, after assessing the impact investing job opportunities at hand, determining your potential role, and understanding thoroughly companies’ people, target investments, and return expectations, the final piece is to spend some time reflecting on how you and your personality may or may not be a fit with that company.

• As discussed in a previous post, you have to know how you would like to feel your impact. That helps you choose between types of organizations (doers vs. advisers) in the impact investing space. Also, if you are attracted to VC/PE-like firms in the social sector and you are someone with investment or finance industry experience, be aware what type of cultural and compensation differences you may be facing compared to at traditional funds. You might have been attracted to impact investing as a means to utilize your analytical, strategy, people and organizational skills in a way that will bring money to social innovators. Secretly, always off the record, you hoped for also getting a good paycheck and live with a cleaner conscience. But do not blindly expect this to be the golden opportunity to do “both good and well” for yourself (although this is what you will sell investors on). I am absolutely not denying the possibility that these opportunities combining both are out there, since it of course depends on everyone’s personal expectations. I am only cautioning those of you who assume perhaps too much that the people hired to manage such impact investing shops will care more about you and your career than their predecessors from nonprofit/foundation backgrounds. Just because the stereotype has it that this “new breed” of leaders brings in more passion for metrics, efficiency and processes, does not mean they will pay you for it the same way they used to in the for-profit sector.

• Similarly, pay attention to your needs. Given the small size of these companies, training and development will mostly come on the job and you are expected to hit the ground running, which eliminates in a sense many would-be applicants without sufficient prior experience. Also, understand that if you are a transaction-oriented person, who thrives on execution, that in the current state of impact investing, you may have to wait longer than you expected to actually do deals. This can be a combination of either being assigned to a region where the market is not developed yet, or because your firm has not internally resolved expectations between managers and funders/donors, or because there is generally inconsistent applications of investment principles on the fly.

• Let me conclude with an old German saying that describes different stages of maturity in an industry, and its relationship to the benefits of the people living through different stages. It used to be applied to describe differences in the plight of generations of farmers starting with a barren piece of land waiting to be cultivated. Roughly translated, it says that “The first shall reap death. The second shall inherit struggle. The third shall eat bread.” In other words, the first generation will kill themselves setting the playing field trying to shift old, heavy prevailing conditions. The second generation will inherit struggles to even out the kinks, to standardize, to introduce processes and to sow the right seeds in the right ground. The third generation, finally, reaps the benefit of the previous generations’ efforts and scales them.

• Translating this into impact investing today, I believe that we are somewhere between the first and second generation of farmers, trying to find common terminology, methods, approaches, and agreeing who it is we want to help and for what in return. Recognizing the stage where we are at may give us some comfort in dealing with the uncertainty and widely differing approaches to impact investing that we see today. As the pool of potential investments grows and as we find out better who is best suited to support whom, we hopefully will also find a way to best determine who would be most happy working for whom. Until we figure this out, I wish you all the best of luck as you try to make your mark and gain experience in impact investing.