I was going to do a longer post on this topic, but a fellow Berkeley Haas alum wrote an article for Fast Company recently that hit just about every point I wanted to and a couple I didn't think of. Her start up is a toy company, but the most of the alternatives she lists are just as relevant for social ventures. I'll come back later to write more specifically about grant opportunities for for-profits as well as ways to intentionally layer different types of funding. And, um, Go Bears.
I don’t have a lot of time today so I thought I would do something today not connected with my previous posts and share a few thoughts on conferences and specifically panels. Impact investing is a conference-heavy profession, and as a result I have been in a bunch of rooms where one man is asking three other men a few questions each. Sometimes I am one of those men, and sometimes I am one of the people looking at my phone in the 4th row. Very occasionally I am the man asking the questions. The experience from all three perspectives stinks. Everyone I have ever asked about this shares my opinion. It is so difficult to find someone that doesn’t share this opinion that it borders on fact. Fact: panels are stupid. No on likes them, and yet for 90% of conferences they are the default organizing element. Keynote/panel/panel/lunch/panel/panel/keynote/dinner/drunkenness.
I think there are some fairly basic reasons most of us are there in the first place. They are:
OK, but I know this isn’t realistic, at least in the short term. Setting up panels is easy and low risk for organizers. People’s expectations are so low, you rarely hear someone say “Boy, that was a bad panel.” It requires almost no preparation. So, let’s talk about #6, the only things panels are good for. The point of panels is to be seen. We use panels to signify who is important in our corners of the world, who is worth talking to. It’s not about what those people actually say (which is usually very little). Often if I am trying to understand a new space, I find a panel listing for a conference I didn’t even attend and call the three panelists because I assume those are the three best people to talk to to understand what is going on in that space. And those three people are almost always look like me.
The standard argument for why 3 white guys on a panel suck is that different people bring different perspectives. I guess I hate panels enough to say that 3 people with 3 genuinely different points of view assembled into a panel will still suck, but it can’t hurt. More importantly, panels are how we signal to the audience “These are the people worth talking to”, and more often than not we are signaling “the most important people in this space are all white dudes” That stinks. Its almost never true, and even if it is temporarily true in some tiny niche topic, it’s worth forcing some new voices in before they have anything interesting to say. After all, no one ever says anything interesting anyway.
So, for what it’s worth, no more all white dude panels for me. Not as a participant, not as an audience member. And for any conference I actually help organize, no panels. They stink.
I know, I know. I don’t like how that sounds either. Give me a minute. I don't mean these guys
For the past ten years I have worked with impact focused companies and fund managers at every stage - from those just starting to those raising money for expansion to those looking for an exit that preserves the impact they have worked so hard to create. At every step, almost every one of these people, most of whom had deep domain expertise, had no idea what they were doing. They were chronically under-advised.
This shouldn’t be that surprising. Impact investing and social entrepreneurship are still relatively new domains. So, at best, I meet people who have been successful entrepreneurs or fund managers in other fields looking to move their talents into the impact space. More often, I meet people who know their sector well but have never raised money for anything. In both cases, there are networks and knowledge that these people don’t have, many of which are common to impact transactions that would be better held and re-used by an advisory firm than re-learned from scratch every time someone wants to get something funded. The key questions include:
So that’s what companies and funds need from their investment bank. I think there is enough activity in the market to justify a few different firms providing this kind of service. But there are rational reasons it hasn’t happened yet
One last thing, I do think these need to be new entities. I don't think traditional investment banks can do this work. There isn't nearly enough money in it for one. For another, I don't think they mesh culturally with either investors in this space or entrepreneurs. I do think, though, that this type of firm could selectively poach talent out of investment banks.
So my hour is up, that’s the idea for today. Impact investment-focused banks could greatly accelerate the introduction of a whole host of impact focused companies and products. The next step is to identify some projects that are closer to investability that could use the services I listed above and figure out specifically what they need. If you know someone with $10m to capitalize a new bank, leave a comment.
We are about to know more about our physical environment than anyone thought possible. There are revolutions happening in micro-satellites, drones, low cost sensors and software platforms to manage all that data. Add to that mix tens of millions of potential citizen scientists holding tens of millions of phones and you have an avalanche of data that is about to come our way. This should be of great interest to environmental groups and environmentally-focused impact investors. That’s the good news. The bad news is, by and large, we don’t actually know what most of this data is good for
“Big Data” - the ability to capture, manage and analyze ever larger data sets for better decision making – is a trend effecting almost every sector, including conservation. Advances in imaging, sensors, data aggregation and analysis make it possible to collect higher quality data more often at lower cost and analyze it in such a way to better manage resources, verify improvements or degradations in ecosystems and give individual actors the ability to make better, data driven decisions.
Private, venture-backed companies are developing many of these technologies. SkyBox (now owned by Google) and PlanetLabs are have developed and launched micro satellites that promise higher resolution earth imaging data at a higher cadence than has previously been available. Climate Corp (recently purchased by Monsanto), FarmLink and Farmers’ Business Network are platforms that help American farmers manage data and make better decisions, while aWhere and SourceTrace are building data collection and management system for smallholder farmers in developing countries. Liquid Robotics and Saildrone are building unmanned ocean going vehicles, while Honeycomb, Ecodrone and many others are developing unmanned aerial vehicles that promise to drive the cost of remote sensing down significantly while improving the cadence and quality of data.
Why Should Environmentalists Care?
This big data revolution is going to effect many aspects of conservation:
So this is (mostly) good news and part of the good news is that the technology and the ensuing mountain of data will move forward with or without the environmental community or impact investors lifting a finger. Companies raising investment in the space right now benefit from simultaneous ag tech and big data bubbles (on top of the existing venture bubble) so they’re not hurting for funds at the moment. I expect that, given the California drought, water data companies are seeing a similar rush to funding. A few things to keep in mind though:
What Can We do?
Well, the four of you who read this blog work for or with foundations, wealthy environmentalists and/or large environmental groups. So I’m talking to you guys specifically. I think a lot rests on the environmental community’s ability to digest these new data flows as they arrive. That means understanding what’s coming down the technology pike, having tools developed to analyze data that produce actionable recommendations and finally to have new credit/certification/financing models ready to take advantage of the new data. To get all this done, we should:
So in Part 1 I described what had happened to P2P lenders (who I am calling online lending platforms from here on given that many of them now raise money from institutions, not individuals) . Part 2 covered why we should care that these platforms, despite impressive growth, aren’t yet reaching new audiences or lending in any radically new way, especially given that, from an impact investor’s perspective, there is a far greater need for debt than venture capital.
Before I offer a few different options, I’d like to point out a few key traits of the new lending platforms:
The first P in P2P is essentially gone - Most lending capital is being sourced from hedge funds and other institutions. If you are lending on one of these as an individual, you are basically picking through the scraps that the institutions didn’t want.
Now that the model is ironed out and the infrastructure is in place, there is a huge lead conversion element to their business model - They have the machinery to underwrite, process, fund and service loans. Now they need to generate leads in large quantities and then convert some percentage of them into loans. Their success will hinge on a) how good their leads are and b) how good they are at getting a lead all the way through their process to actually take out a loan. This conversion rate is a result of a mix of lead quality, their own process quality and how competitive their loan is with other options
Their conversion rates are really, really low - Most of these platforms are way under 1%. That means there are several hundred people, each of which the platform has spent money to find, who start the application process for every one loan they end up making. Most people abandon the process before the ever get to underwriting. The platforms are spending a lot of time and money trying to figure out how to get that conversion rate up.
Their underwriting is algorithm-based, rather than rule based - Traditional bank underwriting is rule based. If you fail one criterion, credit score for example, there is no other place you can make it up. You’re rejected. The lending platforms, by and large, are algorithm based, which means they have more flexibility in setting underwriting standards. Low credit score? Maybe there is some recent income history you could show to make it up, or maybe you can pay a slightly higher interest rate. Whether or not they are yet using it, they have the capacity to deal with non-traditional credits than banks because they have this inherent flexibility. It also makes them easier to collaborate with, as long as you understand how they are building their own credit algorithms.
OK, so with all that said, I think it is time for impact investors to come back to these lending platforms. The regulation is more or less understood now. The business models are set. The lending infrastructure has been built. And there is a huge need for responsible loan products across a whole host of sectors, from broad based local economic development to support for specific industries to specialized retail loan products. There are at least three ways to attack the opportunity:
Build a New Platform - There is now a workable model for how you build a lending platform. With enough time and capital, you could build an impact-specific platform from scratch. There are many venture funded, non-impact focused companies that are following this path. However, I wouldn’t underestimate the time and money required to build one. The regulatory side of things, while well understood, is still not simple and varies from state to state. If you want to go this route, it helps if you have $10-50+ million in equity to burn and a couple of years to get to scale. And it’s not worth doing unless you think you can run a few billion dollars through that platform, which is a tall order for an impact-only lender. There are a couple of groups going down this path (Community Sourced Capital and Kiva Zip) on the impact side, but I get the impression they are taking a short cut around regulation by only doing interest free loans.
Buy an Existing Platform - With all of the VC funding going into building new platforms, it is only a matter of time before some of the also-rans are for sale. Of course, you have to wait for the right opportunity, but potentially it is a way to own the infrastructure without paying the full cost of developing it or waiting several years to build your own.
Rent Someone Else’s - Many of these platforms are more than happy to underwrite process and service other pools of loans as long as they are structured to fit within their existing processes (so, for example, you can have different underwriting standards, but the methodology by which you approach underwriting has to be similar) It’s a nice bit of extra revenue for use of there infrastructure without a lot of marginal cost. It’s even better of there is some expectation that the conversion rate is higher than 1% (which it should be given that many impact lending programs come with additional grant funded educational programming and/or a subsidized interest rate)
The trick with renting (and with the other two approaches for that matter) is that you need to guarantee a certain amount of volume for it to be worth doing. This means you need a large enough pool of qualified borrowers on one side and enough lending capital committed on the other to guarantee a certain minimal scale. I don’t know exactly how much, but it’s probably in the neighborhood of $10 million. This may sound like a lot but its well within the scope of many larger non-profits in terms of their outreach, and well within the scope of foundations or high net worth individuals to fund, especially if you consider that you could earn a reasonable rate of return on that capital. Here’s a graph of how it might work:
Once you did this with one type of loan/borrower, that infrastructure can be used again and again across a whole host of other programs, which gets you this
Once you did this with one type of loan/borrower, that infrastructure can be used again and again across a whole host of other programs. In theory, it feels like a win-win-win. The funder, a foundation, government or high net worth in this case, can deploy a large amount of capital relatively quickly with tight control over the mission scope and the interest rate with a relatively low amount of operational exposure. Non-profits get to extend new services to their clients without having to build the whole back end. The lending platforms get a guaranteed piece of revenue that requires little extra effort on their part.
The key question, in my mind, is, are there funders and non-profit partners that would be ready to use this tool if it existed? If there are, I think it may solve one of the big current road blocks in impact investing: how you preserve the mission lens that non-profit partners bring without being dependent on them to scale up and manage the actual nuts and bolts of lending programs.
OK, so my hour is up and I think I am going to move on from P2P next time. I’m not sure how well I am articulating the vision in this post, but I think the approach has real merit. The question now is whether it solves a real problem for anyone in the short term. If any of the four of you who read this blog have any ideas, call me. Or post a comment.
I am about a month into the blogging experiment. My main purpose is to get some thoughts organized around a few developments in impact investing for myself, and doing it in a (barely) public forum makes me slightly more accountable. My hope was to write three times a week for no more than an hour, and to set a relatively low bar in terms of prose quality. While I haven’t been able to write quite that often, and the prose has been as dismal as predicted, it has been a useful exercise for me and hopefully somewhat informative to the four of you who are reading. So, I’m going to keep going.
One of the downsides of semi-stream of consciousness blogging is that I will sometimes write things out of order. Last time I did an overview of the so-far-missed opportunity for impact investing through P2P and direct lending portals. What I didn’t do was say why any of us should care. Maybe it’s obvious to all four of you (hell, two of you know more about this than me), but allow me to give a few reasons:
By and large, banks aren’t lending - Of course, this is a blanket statement, but in general banks have retreated from small business lending, and with good reason. In the wake of the Basel II and the 2008 financial crisis, banks are increasingly careful how they allocate their risk capital and for many there are more profitable places to spend risk capital than small business lending. As a result, many small and medium businesses are starved for capital that would otherwise allow them to grow and add jobs. (Side note: Many CDFIs do great work in this space, but my general impression is that the problem/opportunity is much much larger than the capital they have to deploy. Find ways to support you local CDFIs!)
When they are lending, they are sticking to what and who they know - When banks are lending, they are keeping their underwriting standards high and rigid (again, for good reason - the less risky the loans are, the less risk capital they have to hold against the loans). They are sticking to individual businesses and sectors with which they have significant history, which means new businesses and emerging sectors go wanting. Businesses that don’t conform to these high underwriting standards are out of luck. I recently had an employee of a committed social lender tell me, “We’re in this business explicitly to make a business, and the loans we make are good loans. But as a bank, our underwriting standards are so high, if someone can get a loan from us, they have offers from 2 or 3 other banks as well. So what’s our real impact?”
Individuals have access to access to some credit but it’s really expensive - Even unbanked and underbanked individuals and families often have access to credit through credit cards or payday lenders, but this money is so expensive, its uncommon that their financial situation is improved by access to this type of credit.
For personal credit, the use of funds matters - I was talking to someone who understands the unbanked and underbanked markets better than I, and he told me that there is almost no evidence that providing people access to lower cost credit has any measurable positive impact in the medium to long term. Give someone with 25% credit card debt access to a 12% loan, and usually they’ll just be carrying a correspondingly larger debt load when you check back in a year. On the other hand, loans that are used to make an investment, starting a business for example, or to weather a one time trauma, like emergency medical expenses, or a fixing a broken down car you use to get to work, can have a lasting positive impact on the borrower. One unfortunate (and totally predictable) element of the Indian commercial microfinance scandal of a few years back is that impact investors told ourselves lovely anecdotes about loans being used for the latter purposes (investments and one time shocks) when most loans were being used for the former (consumption smoothing at best, unsustainable spending at worst.)
Non-profits and social ventures are developing innovative lending programs, but lending has a lot of moving parts and, therefore, scaling can be difficult (and sometimes dangerous) - Confronted by a lack of reasonably structured commercial sources of capital, both non-profit social service agencies and for-profit social ventures have ventured into the lending world to fill some of these gaps. Programs run the gamut from medical debt to auto repair to small business loans in traditionally underserved demographic groups. Many have identified group of borrowers and corresponding loan products that pencil out, both in terms of returns to investors. A few, like Progresso Financiero, have found ways to go to significant scale. But for most, scale is elusive. Why is this? Well, to answer the question, I have tried to write out the simplest diagram I can of how a person who needs a loan can get one:
I am probably missing a few steps, but the point is, it's a lot, and there is very little margin for error. Talk to any foundation program officer about the fantastic $20,000 revolving loan facility at a local non-profit that expanded to a $1 million and promptly collapsed under the weight of the operational demands of running a "professional" lending practice, and they'll give you a knowing grimace. I personally know of two very innovative non-profits in my home state of Oregon, both of whom were working with large pools of potential borrowers for loans that appear to have strong financial and impact characteristics. One raised a sizable ($10m+) fund based on the performance of a small test portfolio, but it eventually collapsed due to structural and administrative reasons despite the fact that the loans themselves were still performing. The other non-profit raised $5m of lending capital to invest into small businesses in a remote community, but eventually returned it unused because they couldn't find a reasonable plan to be able to process, underwrite, and service loans at that scale.
So you have banks that are fairly limited to who they will lend to, individuals who have access to a lot of credit that isn't good for them, and non-profits and social ventures that are innovating to solve these problems but have a hard time executing at scale. Now, remember from last time, P2P platforms (which from here on I'll call online lending platforms since most of their capital is coming from institutions now) are showing up on the scene. They have spent the last 9 years building the infrastructure and regulatory buy in to underwrite, process and service loans at massive scale. They are fundamentally different from banks in terms of their motivations and limitations. But so far, there hasn't been a big positive social impact in the way we were hoping back in Part 1. Today, if you are the sort of person who could get a loan already, online lending platforms offer you a much more convenient process to get a loan on somewhat similar terms to what you could get from a bank. It seems reasonable in the future that certain small business segments that should have had access to credit all along will be better served by some of these platforms than by banks. But if you are someone on the fringes of traditional finance, or an impact investor who has watched your traditional partners struggle to scale to serve all those people on the fringes, the massive efficiency gains promised by online lending have not yet been realized, either in terms of access to funds or the interest rate at which they are available.
But I think there is a lot to be hopeful for. That will be next.
Patrick Maloney lives in Portland, OR where he helps nice people working on cool stuff. He tries to limit his blogging to things about which he knows something.