Truly Patient Capital – How We Can Create Systemic Change – Part 1

Over the last few posts we have been sharing our thoughts on the industry in general.  We started ID last year because there was a need in the market for seed investment capital for impact-oriented startups. We thought the solution was simple. Let’s do what they did in Silicon Valley! Then came reality.

Silicon Valley has throngs of experienced industry executives with deep pockets fresh off their latest IPO. They not only throw money at countless start-ups but share years of experience and can open up Rolodex as thick as the Palo Alto Yellow Pages. Impact investing has good intentions and money.

No problem, we thought, we can create a business and pair our industry experience and contacts with would-be Angel Investors capital. Problem solved! Well, maybe not. Invested Development began with just that mission and is still doing that today. But one year later, we have realized that despite a lot of progress, we can’t possibly change the game with our current model alone.

Although a few Impact Angel Investors and non-profit investors have emerged to provide seed funding for socially motivated start-ups, we need to attract many, many more. Impact investing is getting hyped and the money will continue to trickle in. As an industry, Impact Investing has grown by 22% per year since 2001. Conservative estimates suggest the market will reach $500 billion over the next 10 years[1].  These are impressive numbers, not to be downplayed, but let’s put it in perspective. We are still talking about 1% of total assets under management.  And even then, most of that money is institutional Socially Responsible Investments with a do-no-harm, social screening[2] mantra; not a do-good promotion of companies that put their social missions first[3].  Systemic change will require that we do more of the latter.
One Solution – Pareto Holdings
Pareto Holdings is a concept that we have been throwing around here for the past six months. In a nutshell, it is a socially oriented holding company that swaps Preferred Stock shares in nescient (but profitable) social ventures for its own Common Shares. The thought is that a large holding company’s Common Shares will be increasingly more liquid than a single investors Preferred Shares in an early stage company. Overtime, the steady stream of dividend disbursements (and profit sharing) will create an attractive, steady, and reliable return for institutional investors and progressive government funds (a.k.a. the Dutch Lottery system). The end result is steep reduction in liquidity risk for Impact Angel Investors and added velocity to their investment cycle.

I won’t pretend that we have run the necessary models, dug into the necessary details or even interrogated the underpinning assumptions sufficiently. But we have put a good bit of thought into why it’s needed and who will benefit from it.

How It Will Work
The general concept is that Impact Angels face liquidity risk well beyond their projected returns (odd how you can project returns without a clear liquidity event… but we’ll save that for a different post). Additionally, even theoretical exits in this industry are plus-minus.  Scaling an enterprise is much easier when you can attract a buyer, but attracting a buyer often means jeopardizing your social mission. Pareto solves both issues by creating an exit scenario that is more predictable (largely focused on the company having profits) and socially palatable (missions will stay intact because Pareto investors are motivated by that part as well)

Let’s outline a few more details on how it will work:

Preferred Stock: For Pareto Holdings to generate cash, it will rely on cash dividends (or profit sharing) from Preferred Stock shares in young, but profitable, social ventures. Shares will likely be negotiated as straight, perpetual preferred stocks with guaranteed or floating dividends (however, this will take considerably more research and projections).
Share Exchange: Angel investors often receive Preferred Stock shares for their seed investments. These shares lack voting rights but guarantee dividends once the company becomes profitable. However, most Angel investors are not interested in the dividend income. They are more focused on exiting the investment, regaining liquidity, and re-investing that capital into new start-ups.  Pareto will assist them by exchanging highly liquid Common Shares in Pareto Holdings for their less liquid (but dividend yielding) Preferred Stock in qualified social ventures.
Dividend Cash Flow: By creating a pool of dividend yielding shares, Pareto Holdings will create a diversified, consistent and profitable model for long-term social investments.  The benefits gained from negotiated dividend terms, priority (dividend and liquidation) and perpetuity will offset the rare upside risk of not holding common shares or convertible debt instruments.
Traded Shares: Overtime, Pareto Holdings will create a large enough pool to yield secure and sound returns for socially oriented investors seeking liquid investments with a proven commitment to impact investing.
The why and how are probably enough to digest in a single post. I’ll follow up in our next post with more on Pareto and how each stakeholder will benefit.

[1]  Monitor Institute – “Investing for Social & Environmental Impact”, 2009
[3] For more on the difference between do-no-harm and do-good, read our previous two posts Investing in Development and Impact Maximization