Learning from failure: there is no easy button
I dream of a day when we have a full ecosystem supporting Impact Companies—those that have social and spiritual gains alongside financial returns—at all stages of growth from startups to billion dollar private equity deals. A lot of really smart (and lucky) people will need to contribute serious amounts of capital and sweat equity for this dream to be realized.
But there’s a worry that sometimes takes root in the pit of my stomach. If our first attempts at impact investing don’t return impressively against their comparable benchmarks, the rocket will never reach orbit. We early adopters of impact investing truly believe that business+purpose is an essential element of solving entrenched social issues. But we’ll never see the movement come into full growth unless serious people apply serious investing and business discipline. Or as my friend likes to say:
“Making money is table stakes for having impact”
That’s why I’m especially troubled by stories like the one I heard last week and why I’m writing this cautionary blog post.
I recently had coffee with a friend who has stepped in to “do a favor” for another friend by cleaning up a business that has neared crisis. As we talked, I uncovered a hornet’s nest of issues that suggest either gross mismanagement, at best, or possibly even fraud. Knowing the investors who backed the deal, I wondered how these smart, successful business guys could find themselves so deep in a mess.
I’ll retell the story, with a few details and names changed to protect the innocent, so that we all can learn from it.
Back story: The main investor (we’ll call him “Sam”) got into a real estate investment deal as a way to fund the mission work of his friend who we’ll call “Joe”. A large majority of the net profits were to go to Joe’s charity. Sam and Joe hired a couple of guys from their church to manage the business. These managers promised to do “business as ministry”. At the outset, it looked like a great triple win—the managers would earn a living while ministering to the employees and customers of the business and the profits would fund Joe’s missionary work.
Today: Fast forward 2.5 years and investors have sunk $2.5 million with very little to show for it. Tenants are walking away. Leases are missing or in disarray. The county is threatening to shut down operations for multiple code violations. Insurance is inadequate. Corporate funds have been comingled. The financials don’t make sense, with missing or incomplete transaction records. I could go on, but let’s just summarize: it’s a MESS.
So what can we take away from Sam and Joe’s story?
1. Impact investing is NOT the same as granting to charity
This impact investing world can be confusing with the intended social good looking so similar to charity that we forget to apply investment disciplines before, during, and after the transfer of cash.
Too many times I’ve seen people excited by their first visions of investing for financial, social, and kingdom impact that they join the first deal they find. Impact investing may be relatively new (the term was coined in 2007 by Rockefeller Foundation), but it is developing fast. Mission Investors Exchange and the Global Impact Investors Network have developed excellent research materials and best practices for those wanting to go deep in their understanding of this burgeoning movement.
For the rest of you who don’t have the time or patience to pour through long research paper, follow along with me at our blog and I’ll bring you short summaries.
2. Ask the hard questions before the investment
Falling in love with the vision of a potential charity or investment opportunity is just the beginning. After that, we need to set aside the vision and conducting due diligence. Pretend the potential for impact doesn’t even exist and vet the potential deal in the same way we would any traditional business. Look at the revenue model, the market opportunity, the go-to-market strategy, the experience of business managers in this industry, etc. It may even be a good idea to hire investment experts to perform due diligence. I suspect that if our friend Sam had performed this level of diligence beforehand, he could have saved himself $3.5m or would have found another investment opportunity.
If private equity or venture capital investing isn’t a personal strength, there are plenty of places to turn for help. Mission Investors Exchange has a database of consultants touting experience in vetting impact investments. It’s certainly not a complete list, but it’s a place to start.
Similarly, it is worth investigating the market to see what other companies are out there. By talking with others in the field, you may even find that there’s an existing impact company working on nearly the same issue as you’d like to tackle. Perhaps there’s an opportunity to join along with those efforts with less risk and headache than a bare startup.
Again, Mission Investors Exchange offers a tool to find potential investment opportunities by sector, geography, and deal type. While these deals tend to be heavily weighted toward social and environmental returns rather than spiritual impact, it’s still a great place to start. For specifically spiritual impact, Impact Investing Foundation is glad to help with research and advice on what else may be happening in a particular cause.
3. Pay attention to legal details
You’ve heard the saying “good fences make good neighbors.” The same is true of legal documents like a good operating agreement or set of bylaws, a strong shareholder’s agreement with buy-out provisions and dilution protections.
Please please please don’t assume that simply because the investors are all like-minded (code for “professing Christians”) they will agree on how the business should function. No one expects an investment or business relationship to go south, but it’s always a possibility. If you plan for disputes and make a clear pathway for settling them, you’re much more likely to emerge from the investment with capital and friendships intact.
For those who doubt the importance of governing documents, see any number of articles published after the Supreme Court decisions of 2015 or this in-depth law review article.
4. Hire experts and pay them accordingly
Passion and personal relationships cannot make up for experience and acumen. Enough said.
Furthermore, volunteers can help get a new venture off the ground, but it’s much more difficult to sustain a business with them. Things like accountability and employee retention get especially tricky to manage when there is little or no compensation paid.
5. Stewardship means oversight
Just as we need to perform thorough due diligence before the investment, we must pay attention to the company going forward. Ask for and read regular reports from the CEO. If your investment is large enough, expect a board seat and attend regular meetings.
This is especially when investing with charitable money from a donor advised fund or private foundation, where one has a responsibility to make sure the funds are used appropriately. Again, if this isn’t a personal strength, hire experts to help.
It may be easy for me to look at Sam and Joe’s story and write a nice set of lessons from it. Hindsight is 20/20. I realize this business of impact investing is difficult. That’s why we started the Impact Investing Foundation—to help simplify the process and make sure Christians are at the table to have a positive influence on the world. Follow along on our blog or give us a call to learn more about investing for triple impact.