Venture Philanthropy and Social Investment are popular and fashionable fields at the moment, two potential innovations in the social sectors which are hyped to revolutionise the way in which finance is directed towards tackling social and environmental issues. They aim to bring the most successful innovations of high finance to bear on social issues. They are, within a 21st Century context that is singularly failing to meet challenges within society and the world, but is utterly obsessed by the private sector, perhaps seen as two of our last bastions of hope. Because if they fail to deliver on their promises, it doesn’t seem that many in the mainstream social sectors have much else up there sleeves?
There are quite a few funders in the UK social sectors who purport to operate like venture philanthropists, and increasing number of social investors, their ranks swelled by exiles from the no longer quite as respected world of high finance. I do hope they prove successful – capital, it is true is very poorly allocated in the social sectors. And some of their rhetoric and innovations are certainly encouraging. But I’m sceptical, if only because we have to be quite sceptical about everything to do with financial markets and investment in the days since the financial crisis.
My experience of the few players in the social sector to say they operate like this is that they have a very long way to go in developing their models and could do with taking a significant step back to reflect on current successes. Such immaturity of model is perhaps to be expected in a new market and my softer side is tempted to be gentle and say that we need to wait for new approaches to emerge. However, the hype around social investment especially remains at fever pitch, so we needn’t be too gentle. And what is more challenging is that these new types of funders face some structural challenges at the moment which will perhaps ever hold them back forever. What seems to hold them back, isn’t often just an immaturity of methodology, which could be iterated around quite quickly, but a flaw in their very makeup. That although venture philanthropists and social investors purport to bring the best of the private sectors to the social sectors, they end up bringing over a bastardised form of a model that wouldn’t survive a moment in the sectors from which it came.
I’d hope that some deeper analysis of the problem could push forward our thinking about what existing and new funders need to do to develop their models – there are some very exciting new funding developments on the horizon: Power to Change, the Access Foundation, both with over £100m at their disposal. It would be a shame to see it wasted. Though we exist in a sector where it seems easier to get £100m than £100,000, £100m is quite a lot of money… Many have argued that UnLtd’s £100m endowment is not employed nearly as well as it could be, so let’s not see that happen again.
As the basis of an argument, my premise is that social sector funders do not operate as effectively as they could – so social investors and venture philanthropists are not wrong in wanting to look for expertise elsewhere. My other premise is that the best venture capitalists, in well functioning markets with rich talent, are good at their stated aims to make a return for investors. You might be the VC that missed Facebook, but there are enough people around who will pick it up and grow it into what it could be, and you’ll either get lucky with something else or go out of business (do funders ever go out of business – a topic for another time?!). My third premise is that, whatever your view on the value of technological innovation, it is impossible to deny that it has been a space of rich and rapid innovation that has transformed the way in which we think about the world. If the social sectors were as active, it would be an interesting time to be alive.
So I would argue that when it comes to the efficient deployment of capital we have much to learn from Venture Capitalists and I, like many others, think it would be great if the social sectors were to take on the qualities of good VC firms. However, though I may be entirely wrong, there are some notable differences between the venture philanthropists and social investors you get in the sector today and the world of real venture capitalists. And critically there are some notable differences between private and nonprofit sectors, which mean that ways of working don’t always translate:
- Venture Capitalists are professionals, venture philanthropists and social investors are relative amateurs. In the VC world, investing in new ventures is the full-time job of the person who makes the investment decisions, and they work at it. Or at least it has been their full-time job, they have grown up in the space, they have lived it and breathed it. It might even be a good chunk of their wealth. This is not some sideline, nor some career change, a part-time secondment or something where success or failure, you still get paid at the end. Although venture philanthropists and social investors often have well qualified staff teams, most social investors and venture philanthropists operate where the decision making power still sits with people who do their philanthropic activities as a sideline, on boards of trustees, or part-time as social investment advisors. Investment committees are typically populated by ‘private sector expertise’. Too often you are appealing far too much to heart and too little to head when it comes to your pitch to a venture philanthropist/social investor. And too often they don’t really understand the market dynamics that you face, which are almost entirely different to those in the private sector. The same could, I think, be said for nearly all large funders, but it is especially disheartening to see from those that see themselves as bringing ‘investment expertise’ to the sector.
- Investing in high growth social enterprises takes a very different mindset to traditional investing. Related to the above point about many of the sector decision makers coming in from outside, investment decisions are often clouded by a lack of knowledge about what it takes to grow a social sector enterprise. Revenue, impact models are very different, social issues themselves bring whole new levels of complexity, and even the motivations you are dealing with require specialist expertise (you can’t just ‘fire’ volunteers for example…). Heads are too often left at the door and the laziness of thinking that sees corporate volunteers running amok in social sector enterprises proliferates. When I get a chance to tell £50m+ companies about their financial capital requirements, as private sector investors do in their day jobs, I’ll start taking advice on the financing requirements of a £1-5m entity. The different market dynamics that social sector organisations face in terms of revenue streams are huge and current social sector investors understand too little about them.
- There are obvious exits for traditional investors, not so for social sector investors. Buying and selling in the private sector is common place, IPO, mergers, acquisitions are part of the endgame but not so in the social sectors. Investors are therefore trying, often, to put a square peg in a round hole in terms of how they might eventually reap financial returns. Analysis of the endgame is still important, but under current market dynamics, it’s very unlikely to look anything like that in the private sectors – which will especially mean a complete rethink of expected financial returns.
- Finally, I may be wrong but strikes me that more funders should have been builders, as least for smaller/riskier investments. Someone can likely prove me wrong, but the best VC firms (it seems to me – like Andressen Horowitz) are those where the principals founded huge and successful companies. Show me a social investor who both has decision making power and used to be a successful social entrepreneur and so can have an intelligent conversation with potential investees rather than spouting the usual platitudes about a scalable strategy. I was quietly pleased when a new social sector CEO, who used to be a big funder said to me “it’s really hard dealing with running an organisation isn’t it”. Yes, it is, and there is no reason why they should have had any inkling of that beforehand given the way in which funders operate.
Unfortunately, there are some natural challenges posed by the social sectors that prevent investors having been closer to the action previously and the market therefore correcting some of the above itself:
- It’s hard to get rich and get the money you might need to become the ‘investor’. Many Venture Capitalists, as mentioned, were successful entrepreneurs before they became investors, in the social sectors you’re unlikely to sell out, make it big and then move into the world of investment.
- There is, no doubt, a skills gap in terms of financial expertise in the social sectors currently. I spent 7 months at an investment bank during my gap year, but my knowledge of financial products is pretty limited and I’d be happy to admit that at least some financial sector expertise is needed in the sector as it grows.
However three thoughts:
- It shouldn’t be impossible to overcome the talent issue. Lots of VC firms only have a small core of founders’ money, backed by other investors. So they need not be massively rich to have a lot of money to invest. Crucially they are held accountable though – bad investments will lose them money. At a social investment intermediary?
- It should be possible to bring financial expertise into the sector at the service of social investment. More senior staff in social investment intermediaries need to be from the social sectors, so they can shine a real light on the real financing needs of organisations. At the moment, finance, ever powerful, is perhaps just taking control and wreaking havoc.
- Successful entrepreneurs could still apply for jobs with large funders. However, the question then is will they have any decision making power. I get the feeling that in a good VC firm the Principal is making the decision – and is also doing the venture hunting. Whereas often for X Large Funder, you go through a million committees before you get to the Principal and the decision is still made by an investment committee with even more people that don’t know what they’re talking about.
Unless it can overcome these issues, many of them talent related, the sector is currently setting itself up to fail. I was struck speaking to a very successful social entrepreneur who has a big funder on their board and the funder said at a meeting “we can probably get you money for that’. The social entrepreneur thought “no you can’t, because you’ll go back to the office and I’ll have to fight through all your underlings and then your board and the idea will die a horrible death”. CEOs/Principals/Investors need to have executive authority, be held accountable and be close to the action. Or you get a bunch of mortgages originated by cowboy lenders who then eventually bring down the whole financial system…
WHAT WOULD BE THE IMPACT OF BETTER VENTURE PHILANTHROPY AND SOCIAL INVESTMENT FIRMS?
- We might actually achieve something and have a shot at tackling the challenges we purport to want to solve.
- Perhaps fewer enterprises would get funded, but those that do might have a chance to grow. It has been extensively written about but I was still surprised recently to read some of the annual reports of even the largest funders and see that their funding remains concentrated in the £20,000-£100,000 range. Almost nobody provides the growth capital that enterprises really need to grow, the well researched funding gap of £250,000 – £1,000,000. There are always rumours that such funding is ‘just around the corner’ but in the meantime the pioneers are still taking the arrows, whilst waiting for the gold. Perhaps it’d be as well to tone down the hype in the meantime.
- Founders and teams would live longer. A hugely dysfunctional funding market causes extremes of stress and uncertainty on nonprofit organisations. I have written more about this talent issues elsewhere.
- We’d know ‘how far’ a sector/venture could get. Nonprofit enterprises might actually get the chance to ‘solve’ some of the issues that they set out to tackle and reach scale, rather than just tinkering around the edge. Silicon Valley VCs have a question they like to ask of their potential investees “Why is now the right time for your idea”. The thinking being that they want an idea to reach scale, quickly, and there needs to be a confluence of factors to make that happen. We’re still waiting for such thinking on scale in the social sectors and will be waiting a long time.
I want to look into the whites of the eyes of an investor and them tell me my business is crap, not one of their team tell me that I couldn’t fill in their box ticking exercise. Long story short, I think I could name you 5-10 people that if they were allowed to make investment decisions and sit on the boards of their investees could transform the way funding is provided. They just know how to fix stuff for real, rather than advise you to attend another useless training session. I have great hope for social investment in many ways, but not in the way it is currently deployed, which just seems to be moving money around from pot to pot for much the same purpose. Let’s help our funders get better.
Question: Are there truly excellent funders out there who operate like excellent investors do?