Originally published June 7, 2014.
The marrying of the words impact and investment is still a slightly unexpected match in the financial world. What used to be a taboo is slowly becoming accepted by investors and financial institutions. That said, it’s not all rainbows and sunshine just yet.
Just because we’re talking about impact investment, don’t think of it as a donation. It’s not.
It’s still a classic investment and the investor still expects to make a gain, except here it’s on two levels: financial and social. In a sense, impact investors can perhaps be even more strict than classic investors, as social business is still deemed a higher “risk” area and the field is relatively new.
The key is finding the balance between making profit and having a social impact. This balance isn’t always easy to achieve- usually you’ll find yourself leaning more towards one than the other.
A big no-no here is going in with only a social mindset. Of course the goal is to have a social impact, but with an investor, you need to be a self-sustaining and profitable business and to do this, you need think from a business perspective. In many cases, impact investors have the same expectations as a “normal” investor. Impact doesn’t mean less profit; it means there’s a balance between both elements. What the right balance is, depends on your investor. Therefore expectation management is critical when you’re first getting to know each other. Ask yourself, do you want an "impact first" or "finance first" investor?
The relationship between an investor and entrepreneur is like a marriage, you’re bound together in the good and bad times. That said, choose carefully.
Before the first date
Do a background check. A good investor can be an invaluable mentor and provide you advice and an essential network. How much knowledge does an investor have in your field or industry? How much can they help you? Will they give you the right advice? Do they share the same values? This is critical when talking about impact investing, there needs to be a strong emotional connection between the investor and your social mission.
The dating stage
Once in talks with an investor, be prepared to get naked. Investors will do a 360 degree review of your business and will want to talk to all stakeholders. Be prepared, have answers and don’t try to hide anything. This will only cause problems down the road. Be realistic about you want to achieve and don't underestimate the importance of expectation management. Be careful what promises you make. If you over promise and don’t deliver, investors will get frustrated. Also important here is that you account enough time for this process, due diligence can be lengthy and make sure you’ve planned accordingly and started the process early enough.
The serious relationship
Sometimes you and your investor will disagree. The art of an entrepreneur is to stand your ground. Remember, you know your company, your target audience, your mission- stick to your guns and don’t be afraid to take a risk, sometimes that’s where there’s the biggest pay off. That said, stay rational even in the tough moments. Don’t fall in love with an idea. Listen to others and don’t stand your ground just to save face. Your investor can provide invaluable advice, don’t ignore it.
Other important questions:
Should you go with a fund or a private investor?
Funds: Funds raise money beforehand and then have a pot of money with which to invest.
Pro: Usually funds don't spend all their money at once. Meaning if you burn all your cash and still aren’t breaking even, they can follow up with a second investment to help carry you over. (Obviously this isn’t an ideal situation, usually they’ll expect to see proof of concept before they’re ready to invest again. It’s hard to get money without showing that the concept works- meaning you're making actual sales and even better, that your making repeated sales, which indicates customer satisfaction.)
Con: Because a fund is essentially a big piggy bank full of different people’s money, they have pressure from the outside to get that money back. What does it mean? It’s means they’re generally stricter because they have investors pushing them and need to deliver. If you’re interested in going this route, the Social Venture Fund or Bonventure might be good places to look.
Private: Private investors might be a little more relaxed in terms of their return on investment (ROI) but often won’t have additional money kicking around for a follow-up round. So if you need money quickly, they might not be able to help you.
Pro: Often they’re more flexible and if they’re strongly emotionally connected to your social mission, they might put less emphasis on profit.
Con: They can’t bail you out should you run into unexpected financial troubles. A solution here might be to raise more money than you think you’ll need initially, so that you don’t get into the red zone after your initial cash burn and before you start making money.
What about an exit?
Generally speaking, the goal of most investors is to have an exit. With social entrepreneurship this can get a little complicated, as it’s not always clear where the industry is. In many cases, the first round investor will expect to get out by selling their shares to another strategic investor or through a manager buyback. (i.e. the social businesses management will buy out the investor.) In other cases you might want to structure the deal as a loan rather than equity.
Where does impact measurement fit into all this?
In many cases, social impact is beyond quantitative measurement. This can be hard to show your investor, but you have to try. Don’t exclude numbers (investors love that stuff!) but do include the qualitative picture. Make this as accessible, emotional and short as possible. Tell the story in pictures and quotes and leave the novels to J.K. Rowling.
Key steps to getting investment ready:
- You’ll need a business plan. Even better, you’ve done a pilot and can show something “real” and not just a concept.
- Develop your business model. Investors will look closely to see if your business model can cover all the costs.
- Conduct market analysis. If you can find proof of concept in a different market, this can serve as a major confidence booster for potential investors.
- Create a financial planning sheet for the next 5 years. Almost everyone knows that this is based on assumptions and that things hardly ever turn out as planned, but you still need to get an idea of where you EXPECT to stand.
- Define what kind of capital you want.
- Decide what kind of investor you want. What’s most important- knowledge, contacts, emotional fit, capital?
- Create your pitch. Presentation is key. Highlight the key points- the easier it is to understand, the better your chances of getting an investment.
- Find the right fit. Here it’s all about the chemistry.