At a time of rapid change and uncertainty, the importance of diversity becomes even more apparent. Ask any ecologist – diversity is critical to allow ecosystems to adapt to change, and thus a crucial element of sustainability. Of course, the same goes for human endeavors. The more rapid the changes or challenging the problems, the more important it is to have diverse perspectives, experience, and tools to generate a creative solution.
As we work to address significant challenges with social entrepreneurship and impact investing, diversity becomes that much more important. We need people of varied experiences to develop the most creative solutions, especially people who have experienced the very issues we are trying to address. We need philanthropists who have broad perspectives on these challenges to engage, as well as investors with financial savvy. And bringing these different views together around an issue can result in the most creative responses.
The same goes for the tools we are using. Not only do we need diverse perspectives, but multiple investment approaches that match opportunities’ growth trajectories. Traditionally, early stage venture investing has used an equity investment structure. Before revenue scales or companies reach profitability, traditional debt financing is not an option. Investing in return for an ownership stake in the company is the reasonable, standard approach. This continues to make sense when there are clear exit opportunities for the investors to receive a return through company sale or initial public offering.
In the impact entrepreneurship space, however, this single approach can be too limiting. We tend to work on the margin, addressing challenges with innovative business models in untested markets or new sectors. In some cases, there may not be a track record of traditional exit opportunities or the model’s growth trajectory may not be the hockey stick that attracts acquirers. For an investor with only the equity investment tool in her toolbox, such a deal is “uninvestable.”
Fortunately, alternative approaches are diversifying the toolbox. “Structured exits” that provide liquidity to investors through an ongoing, predetermined percentage share of revenue are increasing in use among and beyond IC members. This approach relies more on a company’s near- to mid-term revenue-generating potential to provide the investor’s return. Such an approach was used recently in IC NC members’ investment in Spotlight Solar, a company with significant revenue that is pioneering a new product category while promoting the adoption of clean energy., and poised for growth with financing. The creative structure provides investors with monthly payments based on a percentage of growth revenue over a baseline, ensuring the company can fund its own growth while generating liquidity for investors. The structure is expected to generate an up to 24% IRR in 50 months, with a minimum of 12% if growth does not reach targets. Warrant coverage provides additional upside.
Do you have a creative investment approach to add to our members toolbox? Let us know! We are capturing these examples to inform our workshops and resources.