Whereas in prior crises foundations and funds may have rallied to support specific causes or to help affected communities, many private market investors have expanded their field of action to include impact investing in private early-stage innovative companies. Impact investing expanding the field of action. This time around, however, there is more at stake as investors feel the pressure to seek more tangible and meaningful impacts from their investments to realize our just and peaceful coexistence on this earth, and not just shift portfolios towards slightly less dystopian futures.
Early-stage investing is on a continuum of expected returns. For clarity, this article focuses on private impact companies ranging from seed to Series A and B rounds to steady growth companies that may be seeking an exit or transition to a new structure. Yet all seek benefits beyond mere financial returns and have defined a vision to address environmental or social aims. Goals can follow the Sustainable Development Goals (SDGs) framework or can be defined to create an impact in a specific community or around certain underdeveloped industry sectors.
Within an investment continuum of expected returns, social impact investing runs the gamut from below-market returns and exponential growth depending on the specific complex problem and the social, technical, and cultural change required to achieve the intended goal.
Emerging perspectives in impact investing
Interest in impact investing within the family office arena is emerging from two different perspectives On the one hand, younger private wealth owners within families are increasingly interested in impact investing but face barriers and challenges from developing investment strategies to obtaining buy-in from family members and wealth managers.
On the other, founders and early-stage participants in successful tech IPOs and acquisitions arrive to impact investing with solid operational experience for how to scale but may be unfamiliar with how to embed their values in their investments.
As a result, there is the paradox of choice for new impact investment opportunities. For all of those who have been involved in the impact investing community, 2020 posed unique challenges as each day reveal a paradox of choice. Among the many announcements for new impact startups, new impact investment funds, new grand challenges, and prizes designed to address SDGs, new impact accelerators, and new alternative investment vehicles; it became dizzying for new entrants and established experts alike to choose among the options.
But what do you measure at the start? While the industry has worked to develop rigorous ESG and SDG measurement criteria that help to evaluate a company’s ability to execute business strategy and create value over the long term, these KPIs are not predictive in the earliest months and years of a venture.
ESG metrics track a company’s footprint and progress against corporate social responsibility and governance goals. But what if a company is pre-revenue or even pre-carbon footprint?
At the same time, there has been a flood of founders emerging from diverse backgrounds and geographies, suddenly able to get meetings with investors from around the world. Zoom board rooms are compressing time and space, COVID19 may have positively disrupted our staid rituals and practices for how we regionally disburse capital to the most promising founders which have remained trapped in the top startup ecosystems of the Bay Area, Beijing, New York, and London.
Yet as more diverse voices enter these rooms, which are now Zooms, they are asking different questions of capital. These new founders are questioning the core premise of venture capital expectations for growth, high failure rates, and risk.
More money is chasing more deals. More impact capital is chasing more impact deals. But more impact founders are hyper-aware that money is not just money. A strong values-aligned relationship with funders makes all of the difference when it’s time to pivot or make difficult decisions not previously envisaged.
How might the newer technology-minded investors and next generation of family office members participate meaningfully in the impact investing arena?
Five principles for establishing values aligned relationships.
The following outlines an additive process to traditional deal-finding and due diligence to create value-aligned investment agreements with private company managers. First comes the recognition that no one can predict outcomes with certainty. Logic models and so-called theories of change are brittle tools that break when confronted with exponential technology growth, rapidly declining cost curves, and sudden shifts in cultural and social behavior. Funders and founders alike recognize that they are managing uncertainty, together. The answers to address impact challenges may only emerge as the company interacts with the people and systems they intend to change.
Next comes the acceptance that misalignment can be destructive. Many company founders have experienced huge rifts in the boardroom when a company has to make tough decisions in the face of changing market conditions or chaotic situations as we all witnessed throughout 2020. Company owners are thinking more critically about who they invite into their board rooms and values alignment is one of the often-overlooked methods to force how visions align. Fundamentally incompatible stances on key decisions can rapidly lead to a downward spiral.
1. Values Alignment Can Establish a Learning Loop
The process of value-aligned investment is built into a learning loop vs. the linear path. A standard total portfolio approach typically involves a values diagnostic exercise for the family, a translation into an Investment Policy Statement, a rebalancing of the portfolio, and then the arduous task of ongoing management to ensure alignment to the values.
When investing in private companies and especially impact ventures, however, it’s not always clear what trajectories or growth pathways the company will take. But it is an excellent opportunity to explore values in richer dimensions, and put those values to the test when key decisions need to be made.
2. Visual Stimulus for Values Diagnostic
When choosing values, looking beyond the standard categories used by the impact investment community to explore universally held values can help to engage founders of ventures in meaningful discussions. There are visual stimulus options in the form of “values decks” – or tap into Professor Shalom Schwartz’s Theory of Basic Human Values, one of the most commonly used and tested transcultural theories in the field of behavioral research.
3. Values Reflection, Diagnostic, and Alignment
What is novel about this approach is that it can be organized as a facilitated discussion with consultants and advisors developing a deal flow pipeline, and critically between the investor, and the founder, to role-play how both will lean on their values as standards to guide actions and decisions.
While this may seem obvious, many in the impact investing community conflate values with ESG or SDG metrics. Metrics are what you use to measure outcomes and impacts. Values guide actions, especially when facing difficult trade-offs and ethical dilemmas.
This work is more interactive and encourages conversations about potential consequences and trajectories the venture may take, and to build scenarios for how to respond. For a founder seeking a values-aligned investor, this approach helps build relationships and differentiates from other offers from funds or investors who speak only narrowly of market opportunity and financial return.
Many impact-oriented family office members are seeking to be active investors, to influence intended impact if not outright control. Ensuring values alignment can create conditions for companies to better weather treacherous waters and to best benefit from an investor’s active involvement towards growth and stability.
4. Ensure Inclusion Through Co-Design
When an impact company is focused on a core system change in a sector or community, it makes sense to expand the field of inquiry to include beneficiaries in the exercise, or to ensure the company has regular processes for design with, not just for, their beneficiaries. Co-design is a practice from social innovation and service design to not just include intended beneficiaries in the process of change but given them agency within creative stakeholder engagement.
This approach moves from looking at social impact as a driver towards solving social issues, and shifts to prototyping new and sustainable ways of living in collaboration with communities and organizations. These ‘prototypes’ can potentially be scaled-up or replicated and adapted to other communities, as they become models for new behaviors in a sustainable society. Co-design focuses not on the “user” but on the community as the enabler of change.
5. Values Exploration is Additive to Diligence
If there is a desire to enhance purpose or preserve legacy with direct impact investments, then adding the lens of the values can strengthen the diligence process. Values exploration and alignment as a set of questions and discussions through the process can reveal congruences or red flags.
In any “getting to yes” negotiation, you are learning about what is motivating people in the short and long term, what their interests are, and what they care about. On the contrary, avoiding these values questions and focusing only on financial mechanisms or data room diligence may result in obscuring the intangible concerns that increase the risk to a deal.
Values questions can help you discover if there is compatibility, and reassure founders and company owners that core elements of the culture and purpose will be preserved. I’ve worked with several founders and investors to put key values and purpose statements in the initial letter of intent and legal agreements.
To be sure, many lawyer’s first instincts are to redline these statements as legally non-binding. But the very statements can form a moral commitment that endures beyond the legal documentation. In some cases, investors have won out in competitive term sheet negotiations because of the insistence of vision and values alignment.
To Make Sense in the Face of Complexity, Align Values
Few expect that our primary challenges of climate change and social cohesion will be easily addressed through simplistic silver bullet solutions. Much of the work of building back from this past year will involve a reframing of what is that we collectively value, and rebalancing whole portfolios to reflect these priorities. For the portion of portfolios dedicated to investing in private companies, engaging in a dialog about shared values can create cohesion and shared trust to navigate future decisions and best support these companies to address the social and environmental aims we all require to live on this earth, together.