Do-Gooder Finance

Tuesday, February 19, 2008

These days, doing good is good business, right? Tell that to the venture capitalists. When they hear about a for-profit company driven by a social mission, their refrain is still the same: “You need to focus more on profits. How are we going to get our 30 percent returns?” Banks often sing the same tune; few are willing to back ventures with unconventional business models, at least not without exorbitant interest rates or risky personal guarantees. Tim Freundlich, a director at the Calvert Foundation, which invests in companies that do community development or poverty alleviation work, first noticed the problem in 2000, when venture firms were all too happy to invest in high-tech start-ups with no profits but do-gooder companies still had to bootstrap growth. “There was an abject lack of expansion capital,” says Freundlich. “Companies reinvested their profits and grew really slowly. Or they relied heavily on family, friends, and credit cards. When you do that, your chances of failure are higher.”

What, then, should socially minded entrepreneurs do if they’re trying to create planet-saving, world-changing, and yes, moneymaking enterprises? There’s a burgeoning market of investors and lenders that actually seek out companies that pursue social goals. Over the past five years, at least 15 social venture funds have launched, with the goal of investing in companies that are interested in more than profits. In 2006, Freundlich co-founded Good Capital, which has raised $4 million of a planned $30 million fund. Banks are getting into the game as well. New Resource Bank, a community bank in San Francisco, lends to companies with sustainable practices; the bank opened in 2006 with about $25 million in capital and now has assets of more than $130 million. By Nitasha Tiku

These days, doing good is good business, right? Tell that to the venture capitalists. When they hear about a for-profit company driven by a social mission, their refrain is still the same: “You need to focus more on profits. How are we going to get our 30 percent returns?” Banks often sing the same tune; few are willing to back ventures with unconventional business models, at least not without exorbitant interest rates or risky personal guarantees. Tim Freundlich, a director at the Calvert Foundation, which invests in companies that do community development or poverty alleviation work, first noticed the problem in 2000, when venture firms were all too happy to invest in high-tech start-ups with no profits but do-gooder companies still had to bootstrap growth. “There was an abject lack of expansion capital,” says Freundlich. “Companies reinvested their profits and grew really slowly. Or they relied heavily on family, friends, and credit cards. When you do that, your chances of failure are higher.”

What, then, should socially minded entrepreneurs do if they’re trying to create planet-saving, world-changing, and yes, moneymaking enterprises? There’s a burgeoning market of investors and lenders that actually seek out companies that pursue social goals. Over the past five years, at least 15 social venture funds have launched, with the goal of investing in companies that are interested in more than profits. In 2006, Freundlich co-founded Good Capital, which has raised $4 million of a planned $30 million fund. Banks are getting into the game as well. New Resource Bank, a community bank in San Francisco, lends to companies with sustainable practices; the bank opened in 2006 with about $25 million in capital and now has assets of more than $130 million.

Socially minded investors tout their funds as “patient capital.” They’re not looking to flip companies as quickly as traditional venture firms are, and they’re willing to wait if selling threatens to dilute a company’s social mission. David Berge, managing member of Underdog Ventures, a social venture firm in Island Pond, Vermont, says the firm aims to sell its stake in the companies in its first fund within seven to eight years, with a possible two-year extension. Typical VCs favor a five- to seven-year exit.

But make no mistake: Social investors have to deliver to their partners. Berge expects each of the six companies in his first fund to yield returns of about 15 percent a year–market rate for expansion capital. Good Capital, which plans to close its first deals early this year, will expect double-digit returns from its for-profit investments, though it also lends to nonprofits, which will bring down total returns. And New Resource charges interest rates based on risk, just like a regular bank.

There are, however, some major differences between this new crop of funders and their more traditional brethren. For one, social VCs are willing to consider unusual models. Though traditional VCs are excited about most things green, they’re still pursuing the usual high-tech, high-return investments. That’s great for solar-energy and biodiesel start-ups, but an entrepreneur who imports fair-trade goods or has a nonprofit arm–and thus has lower margins initially–may be out of luck. A great way to end a meeting with a traditional investor or banker is to say, “Oh, by the way, I give away 10 percent of my profits to charity.”

Priya Haji learned that when she sought a line of credit for World of Good, which imports fair-trade products like wood-and-bone spoons from Tanzania and lacquered bowls from Vietnam. Haji puts 10 percent of the company’s profits into a nonprofit arm, which helps the families and communities of her suppliers get access to things like clean water and computer labs. The model won Haji first place in the Global Social Venture Competition, run by several business schools, in 2005. It also helped her raise more than $300,000 in prize and seed money. But Haji also wanted a line of credit, because it’s common practice for fair-trade companies to pay half the cost of each purchase in advance. She tried traditional banks, but they weren’t interested because she didn’t have a three-year track record. “For them, it didn’t make sense,” Haji says. “There’s a consumer-driven demand for this kind of ethical consumption, but the debt markets don’t understand that.”

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Source: Inc Magazine (link opens in a new window)