Good Capital

Sean, a professional financial advisor, on Good Capital, a social investment firm.  Will there be a capital market for "slow" money that will abstain from profit maximization, if need be, in order to produce a higher social return? Will people who are willing to devote their life energy, at low wages, to creating socially significant businesses find their match in investors who are willing to forgo the utmost return on investment? I know, we are supposed to say that high returns and high social returns are possible, and sometimes no doubt that is the case, but between a pure philanthropic "give away" and a "pure investment play" there is a wide spectrum. How about businesses that do huge good, while just breaking even, or operating at a small ongoing loss? Would they make a good investment for a foundation or a good-hearted social investor? Will pools of socially conscious capital come together so that social entrepreneurs will approach funders with not only a business plan showing dollar returns, but also a "theory of social change" addressing social good? And will investors then settle for a "blended" return? Also, how will intermediaries be organized and paid? Will funds like this be offered by merchant bankers to wealthy qualified investors only? Packaged as funds provided by brokers on commission? Traded inside wrap accounts? Hedge funds? How will this market work to match investors and investee organizations? Will it be regulated? (How does one verify the claims made in a prospectus that the social venture will do social good? What are the conventions about "hype" and acceptable sales practices? Who will settle issues like fraud? "Your fund made me money, but show me the social good! You knew, or should have known, those organic tomatos were harvested by migrant labor at $3 an hour. That is not good capital, it is bad, bad, bad! You defrauded me." Who will settle such cases, on what basis?)

Comments

[tom]

Some time ago I listened to an informal pitch, more just a description, of something perhaps bordering on a maybe relevant example. A sort of hybridized venture capital for small VCs, who put some $ into some sort of debenture instrument, held in US banks. The money was then funnelled to a US/Latino developer who was building homes and offices on a sort of modified USian planned community model in Latin America. The homes were sold to locals - not a retirement mecca for US expats - and locals were buying at prices that were said to provide a healthy return to the VCs. The return was not fast; the VCs lost the use of their money for several years. But the idea was, it was helping create something worthwhile - well built real estate - in a place that needed it, and that has a burgeoning middle class to afford it. And in the end, the money cames back with a healthy, but not extravagant, addition to itself.

The venture depended on the good faith of the developer, the investors, and the financial firm putting them together. The firm was about socially responsible investments.

In a sense, the VCs were buying in on the idea that there was less risk because the enterprise was guided by people with more on their minds than ROI.

The other point provoked by your questions: You seem to assume that capital flowing toward unprofitable small biz would not transform their outlook. Is that assumption warranted? Who is to say that worthwhile small businesses which are just breaking even could not be made more profitable via the creativity and contacts of a smart bunch of backers with virtuous inclinations?

[Phil]

I was thinking more of a business that is marginally profitable because it fills a need that does not generate much cash, like pharmaceuticals for diseases like malaria that afflict the poor who cannot afford to pay much for them. Venture capital is indeed often "engaged," providing advice and contacts as well as cash.

[Gerry]

I like the terminology of Cool Capital that represents the equivalent of mature ecosystem where there is much internal cycling and the resources actually stay longer in the system, and more fully utilize resources to do actual work and build healthy communities. After all the purpose of economies should be to effectively allocate resources, not to accumulate wealth and power in the hands of the few.

[Phil]

Interesting link, Gerry, thank you.

[Joy Anderson]

Great set of questions. We struggle with many of them daily at Good Capital. I've spent the past two decades working with nonprofits, including direct service organizations working with the most vulnerable. The challenge was always to find the right mix of capital that would get the job done: a mix of government contracts, individual philanthropy, foundation grants, earned revenue, secured debt.

Social sector organizations swim in complex economic systems. The goal is to find the appropriate capital to sustain the mission. We are focused on one gap in this ecosystem: risk capital for scaling social enterprises. We are raising capital from investors who recognize that there is a cost of doing good and that therefore market rate returns are not appropriate or to be expected.

What we are finding is that many experienced philanthropists are able to add social investing to their portfolio because they know about how capital moves in organizations today and they understand the problem we are solving is important one for the organizations they care about. They can think about the gaps and what would become possible with risk capital that expected real but appropriate returns. This is one of many opportunities where investors can meet the capital needs of organizations committed to social good. For some people the fund feels like a new kind of investing. For others it feels like a new kind of giving. For still others, it's nothing new but the institutionalization of something they've doing on as needed basis for individual mission focused organizations they support.

Whatever the starting place we are helping the movement of more capital to good places where it is truly needed for serious missions.

[Phil]

Joy, thank you very much for the in depth analysis and for the pioneering work you are doing. Yes, for some it feels like investing for an appropriate sub-market return, to others like a new form of giving. Do you see a market emerging in which the investment/gifts can be packaged and provided to the public through conventional financial intermediaries? I have not yet seen such investments emerge in the mainstream world of financial services, but I would be interested in any "early indicators" that things are moving in that direction. Pooled good capital funds with diversification? Imagine that provided to foundations and generous people?

[Kevin Jones]

Phil, as another Goodcap principal let me chime in, I do find a lot of financial intermediaries moving this way for one simple reason:their clients hearts and dollars are moving this way. And since most high value financial intermediaries are compensated by the amount of dolllars under management, I am seeing intermediaries increaingly willing to engage with what we are doing at Goodcapnet. Kevin Jones

[Joy Anderson]

Social investing has been packaged for conventional financial for a long time through the low income housing market and now microfinance. Both of these areas, in general, make a case that investments can hit market rate returns. The conversations we are having are a bit different. We are working to articulate a separate class of assets where the return expectations are adjusted to allow for social return. This is hard conversation to have with existing financial intermediaries. Its hard to talk to most foundations about their principal, and quite hard to talk to their money managers except with a pure market rate play.

Therefore, we are focusing for this fund only on high net worth individuals who are willing to carve out a separate class. Or, and this is where things get really interesting, they want to use the principal of donor advised funds that have already been set aside as philanthropy but usually have a traditional investment portfolio for the principal. The conventional managers of DAF's should take note, folks want to do more with that money. It is in those arenas where we are starting to see opportunities for a portfolio of products and have even started those conversations.

DAF's have been coming of age for a while now, and, right now, they look like a fertile ground for this kind of creative opportunity.

[Jeremy Gregg]

This sort of effort depends on shareholders. I think that more and more foundations, for example, are becoming aware of the importance of investing in organizations that are not counter -- if not complementary -- to their core values. Look at the media swirl around the Gates Foundation's investments, for example.

If provided no incentive to pursue the "triple bottom line," it is not reasonable to expect companies to do so otherwise.

Jeremy Gregg, Editor
The Raiser's Razor

[Phil]

Jeremy, on incentives I agree. But selling a stock - how much incentive does that give management of a fortune 100 company to change anything? For every seller there is a buyer - so what if you sell? Tobacco stocks are doing very well. What has their being "screened" by Calvert done? I don't question the goal, but I keep asking people whether the means will have much effect. I have not heard a convincing case. The PR effect of massive sales by a certain foundation might have some effect. Anything that affects consumer perceptions affects the brand, which affects the stock's value. But surely there are more important ways a foundation can influence direction of a company or an industry or a regulatory and political climate than by buying and selling shares of the fortune 100. So far what strikes me is the brand thinking - I am liberal so I drive a Volvo and do not own tobacco stocks. All about me, really, and the perception of me. Phillip Morris could care less.

[Phil]

Joy and Kevin, thank you for amplifying the points. It seems like common sense (as opposed to marketing jive) to say that there are a class of assets that will have positive but sub-market returns but do a huge amount of sustainable social good. To capitalize these assets, to get them up and running, so they go on doing good forever, seems like a very attractive proposition when the alternative is a pure gift. What one is "giving" is the difference between the expected market return one the chosen social asset and the expected market return for, say, an index. A social investor just has to ask, "What am I getting in the way of social results for the difference? And is this the most efficient, lowest risk way, of achieving that result?" Take an example: A group has a political or social viewpoint. They set up a publishing house to publish articles, magazines and books by authors who are key to their movement. The point of view resonates with a fraction of the public. The publishing house barely breaks even, or losses money. But the books, articles, and growing cadre of 'published experts' grows the audience. Sales rise, profits rise. Now that is a double or triple bottom line investment pitch. "Slow money" or "cool capital" going into the deal, produces a self-sustaining business which over time may prove a pretty good or very good financial investment, just not right away. Why might not the investment committee at Pew find this interesting, since they are concerned about the quality of publications, news, and culture? In effect, "the grant" is the present value of the difference in return for Plan A and Plan B, where one is the publishing house above, and the other is a balanced portfolio of conventional assets and where Plan B is adjusted for "subtractions" for conventional grants producing an equivalent social result. If social results were indeed quantifiable in some hard and fast way, the math would be feasible. Of course, the issue, the core issue, is that social returns are largely in the eye of the beholder. A lot depends on what the small publishing house is spewing out, whether for a religious organization, a conservative cause, the Klan, or what. "Social change" - we all want that, but not the same change or the same direction of change. Still, grants too are oriented to social values that are particular to a group, and grants too achieve results that are hard to quantify. So, maybe it comes down to who makes the investment decision in a foundation and who makes the grant decision, and how these professions are walled off. I can see why you find your market in wealthy individuals, or maybe foundations without staff, or DAFS, where the decisions about investment and the decisions about grants are all made by one person who is looking at the situation holistically, seeing the money in a given fund as "already gone for social good - so how can I get the biggest impact on what I care about - give it or invest it?"

Thank you for guiding us through this thought process. It is very helpful.

[Phil]

Joy and Kevin - one more query. How are the deals you do packaged and priced and do intermediaries get compensated and how are the deals regulated? Who can buy, who can make a market, who proffer their own business as a possible social investment? Given how regulated financial services are, this must be a minefield. Yet it could be a profitable market niche for firms, advisors, and maybe merchant bankers.

[Timothy Freundlich]

Phil - good questions! As another principal at Goodcap, let me chime in.

As a Limited Partnership, GoodCap's Social Enterprise Expansion Fund acts as a private equity pool under Reg D filing. 99 investors max, no more than 35 of which can be unaccredited (and in practice it is affirmatively and primarily positioned for accredited high net worth and foundations only). In terms of the merchant banking activities on the ground in these deals that we may undertake, they are technically ancillary to our core investment activity and are generally uncompensated syndications around our investment to bring others to the table, whether they be equity, debt or grant funders. I do think that there may grow up a niche play in this space, but do note that the transaction sizes and unique characteristics of these does make it quite challenging as a brokered business of some sort. There is some anecdotal activity though, and it should increase over time. It is not, however, our model...which is as an private fund manager.

[Phil]

Timothy, thank you. That is just the information I sought.