I have weird friends. I'm not sure what you talk to your friends about, but over the past three days, mine have celebrating, denigrating and debating Mark Zuckerberg and Priscilla Chan’s announcement that they will be spending 99% of their Facebook wealth on the Zuckerberg Chan Initiative (ZCI) to advance a broad set of social goals during their lifetimes. The response in my circle came in three waves – Day 1 was euphoria, Day 2 was the depressingly predictable backlash and Day 3 was a creeping realization
With respect, friends, those first two statements are wrong. Like, fundamentally factually incorrect. And the third one is a truth bomb. I’ll explain why in a minute, but some advice for Mark and Priscilla:
First bit of advice: Fire the person who told you that public letter to your daughter was a good idea. Fire them now. Yeah, sure, right now you are riding a wave of mostly good publicity (aside from the creeping backlash) but it’s pretty shortsighted. You got your name in the news cycle for 48 hours, but the general public will forget about this in a couple of days, and did you need to be in the news this week? From a PR-centric view, by taking a public victory lap before you’ve really started on a lifetime undertaking, one in which you will fail early and often, you are trading a good story that you can’t capitalize on now for a depressingly predictable hit piece in two years that will have a real impact on your still nascent organization. In the smaller community of practice that will actually remember this announcement, you got a bunch of people who run various non-profit and for-profit enterprises excited that the Chan Zuckerberg Initiative cash spigot is about to rain money from the sky on their projects. Only it isn’t because you don’t yet have an organization that can deploy or manage grants and investments at scale, and you won’t for a while. You’ve made future-you’s life more difficult in exchange for a PR bump that present you doesn’t need.
Second bit of advice: If you aren’t already in the process of building a world-class team of people to deploy that money . . . well, you shouldn’t be press releasing anything. It will take time to find the right people. It will take time to get your legs under you. It will take time to build the knowledge and networks and infrastructure to be good at this. And even then, deploying almost $50 billion dollars is going to be hard as hell. 100% of your success as philanthropists will be dependent on the quality of people you bring in and the quality of organization you build, and I haven't heard anything about that from you yet.
I have a third bit of advice related to that second one but I’ll save that until the end.
Back to the euphoria, the backlash and the realization.
#1: Oh my God, they’re donating 99% of their wealth to charity!! How amazingly generous!
No, they’re not. After setting aside a half a billion dollars for living expenses, they’re allocating the rest of their wealth to making the world more how they want it. Most of their admittedly vague goals seem like good ideas to me, but there is nothing inherently generous about it. The Koch brothers spend hundreds of millions of dollars in what I assume they genuinely believe makes the world a better place – reducing the drain of wasteful government on hardworking, job creating corporations that make the products people want to buy – but I don’t see anyone in my social circle referring to this as “generosity.”
This isn’t a knock on Zuckerberg, or the Koch brothers for that matter. Modern philanthropy, with its focus on metrics and outcomes and accountability to founders, isn’t really about generosity. It is about setting a strategy of how you would like to see the world changed, and then engaging with organizations through grants and investments to enact that change. A lot of the time that vision includes education for children or better crop yields for poor farmers or eradicating illnesses, but it can also involve busting teachers’ unions or building nuclear power plants or fighting what you think is unnecessary government regulation. When someone says, “I’m going to make the world a better place!” the rational response is to say, “What do you mean by that?” The next rational response is to actually watch what they are doing and see if it matches what they are saying. Zuckerberg and Chan somewhat understandably don’t have a defined worldview or much of a track record (which is funny, given that they have already spent a billion dollars.) I don’t fault them for this, but until they do, I’m skeptical. You should be too.
#2 Oh my God, they’re transferring the funds to an LLC instead of a foundation! This whole thing is just a tax dodge! What a couple of jerks!
No, it isn’t. There were some stories in major outlets that either implied or explicitly stated that the LLC vehicle was being created to avoid paying taxes. This is simply not true. Mark Zuckerberg already has an army of attorneys “managing” his “tax liability,” and there’s no need to create yet another legal entity for that purpose, let alone engaging in some nefarious public relations double bluff for that purpose.
The reason they chose to an LLC instead of a foundation has nothing to do with taxes. If anything, there’s a chance they’ll pay more in taxes because of this decision, not less. The reason they chose the LLC structure is that there are a bunch of restrictions on what you can and can’t do with foundation funds, and they would rather pay some extra taxes than be told what to do with their money. As someone who has worked in and around foundations for a long time, I have mixed feelings on this. I think people underestimate what you can do within a foundation structure, but overall, I think it’s completely defensible. Anybody who has spent time working on program related investments or expenditure responsibility transactions or “educational materials” for lawmakers understands how a creative, ambitious person could chafe within a foundation's restrictions, and I respect the desire to do all one can to make the world a better place.
I used to work at Omidyar Network, the first organization I’m aware of to use this LLC structure. If I am at all less skeptical than usual about ZCI, it’s because I went to work every day at ON with good hearted smart people who were genuinely interested in using every tool at their disposal to help people. I can say with great confidence that Pam and Pierre Omidyar had no motive in creating the LLC structure other than maximizing the amount of good (albeit “good” as they define it) they can do in the world. I’m proud to have worked there, but if we’re being honest Omidyar Network is still figuring out what to do with all this freedom. As an organization has had its ups and downs. In its 11 years of existence, it has already gone through several generations of staff, strategies and tactics. There was a time, hopefully past, when it had a hard time figuring out what kind of people it should hire and how to retain them. Understanding the right way to use investments, the right way to use grants and how and when to combine them for impact is still a work in progress. I don’t think there is any shame in saying that ON is still just learning how to explain to other stakeholders in the community what it is, what it wants and how it works with others. It’s relatively easy to cast off a flawed foundation model, but without a clear template to follow, ON and now ZCI are basically ensuring that their first few years of existence will involve a lot of fits and starts and organizational convulsions. If you pick this path, you’ll fail more than you succeed in the beginning, and you’ll change directions multiple times. Pam and Pierre Omidyar, despite their wealth, had the advantage of being relatively private figures compared to Zuckerberg and Chan, so ZCI has the disadvantage of having to do this on a more public stage. Which leads us to the third reaction:
#3: Holy shit that is a lot of power for one family to wield.
It’s not like there hasn’t been any debate over Bill and Melinda Gates philanthropy, but the Gates (Gateses?) chose to work primarily within the traditional limitations of philanthropy. People I talk to are generally curious, nervous and/or deeply suspicious about what ZCI will do having cast off these limitations. (It’s interesting to me that I have friends who are far more enraged by the vagueness of this charitable commitment than they would have been by an announcement that Zuckerberg will buy jets and islands and leave the rest to his children, but that’s a post for another day.)
From an ethical perspective, I’m not sure whether Zuckerberg and Chan actually owe us more of an explanation than they have given. My opinion for now is that we as a society have an economic system and tax regime in which this money (and power) has legally accrued to them, and until we pass a different set of rules, they can spend it however they want. However, I also respect every one else’s right to be really fucking suspicious of what this totally unconstrained, unprecedented new organization is going to do with all this money and power.
OK, so where does that leave us? We have a new organization with no infrastructure or clear model for success that is going to fail more than it succeeds in the early years. It has a tremendous amount of money and power concentrated in the hands of one family with no constraints or even a template for how they might wield that power. I would guess that most people who follow this news are solidly behind Zuckerberg and Chan (How couldn’t they be, they’re for communities and children. Who’s anti-communities and children?) but there is already a vocal minority of folks, especially in the circles that ZCI will be working in, who are deeply distrustful of ZCI’s agenda. You can count on that that group growing in the first few years as this new organization experiments, stumbles and pivots on a very public stage. And ZCI will be a less effective organization because of this loss of public trust. Listen to me. I worked at google.org.
So here is my third bit of advice for Zuckerberg and Chan (well, whichever of them is a regular reader of America’s greatest profanity-friendly impact investing blog) is this: Make ZCI a benefit corporation. I support your casting off of the constraints of a foundation, but you need to articulate what rules you are playing by to give people reason to trust you. Codify how you plan to work with others and welcome some debate on the topic. You’ve already talked at lengths about the societal benefits of radical transparency, and I would be genuinely intrigued by how you could enact that within a philanthropic organization. How much power and decision making can you push out of ZCI into the communities you aim to serve? This would be incredibly difficult and it would take years of revision to get right, but it’s worth doing, and it would serve the next generation of philanthropists, many of whom will pick this structure and will need guideposts on how to work.
OK, let’s end on a positive note. I hope ZCI becomes an amazing organization of awesome people. If anyone needs help with something, you know where to find me.
A few months back (yes, I know, I’ve been busy), Sean Parker wrote an Op Ed in the Wall Street Journal called, “Philanthropy for Hackers” Like a lot of things I read these days about philanthropy, it struck me as hot nonsense. I went back to it yesterday, and as is often the case with things I hate that I read a second time, there were parts of it that had some redeeming value: a call to stop viewing philanthropy as a tax-planning tool with some altruistic side-benefits; encouraging a tolerance for experimentation and failure, and underscoring the need to focus on policy, something which many techno-libertarian hacker types are loathe to do. However, the thing that still made me mental about this op-ed the second time around was this: Parker places the hero philanthropist at the center of the story of social change and scientific innovation. Our hero philanthropist must look for “hackable opportunities” in areas he* understands well enough to “spot problems that are solvable.” He must resist the urge to “institutionalize” lest he lose his ability to continuously change directions as he identifies (or perhaps actually creates?) and funds the innovations that will solve the world’s most pressing problems. None of this would be worth getting worked up over if it wasn’t the latest manifestation of a disease that seems to affect 95% of young male philanthropists: what I will call “Good news, dummies, I’m here” syndrome. And GNDIH syndrome basically wipes out any value any of these young men create in their first five years of giving
GNDIH syndrome has a few distinct elements:
Before I go through these one by one, allow me to emphatically agree with Mr. Parker on one point. Most philanthropic institutions are everything he says and more: risk averse, bureaucratic, and overly focused on self-preservation. But everyone knows this, and a few smart people are already trying to do something about it. Criticizing old-line philanthropy is like criticizing the post office, or Amtrak or academic tenure or that album Metallica made with Lou Reed. Most of us already agree with what you are saying, so saying it out loud isn’t a courageous act, and simply saying it is not actually a step toward correcting it. So go do something about it. Only, that isn’t as easy as it looks.
OK, on to the three symptoms of GNDIH syndrome:
Making big proclamations and/or commitments before actually doing anything
Listen, recently minted billionaire, I know you are the smartest person you have ever met, and I also know you are coming off a run where you did something amazing that made you all this money. However, I also know this. You are terrible at philanthropy. It’s nothing personal. In a few years you may be great at it, but right now you have no experience, no networks, no organization or infrastructure behind you and no experience managing philanthropic relationships to impact. You have a thought or two on the kind of things you want to support, but I guarantee your first few grants are going to go worse than you think. I know you are terrible philanthropy because every young genius (or old genius) in Silicon Valley has fallen on his philanthropic face out of the gates. I know because I have worked for most of them. It is not that surprising that Mark Zuckerberg’s foray into Newark was a failure, instead it is surprising that he did it (an no one around him stopped him) without looking to the experience of every smart, wealthy successful man that came before him. Also unsurprising is what he has done since the failure in Newark: made grants closer to home in the Bay Area and stayed out of the press until he has some experience of substance to talk about.
Mixing up contempt for existing philanthropic institutions with a contempt for organization-building and philanthropy as a discipline
Look, like I said, most foundations are terrible. (No, no, not your foundation. Your foundation is great. Please hire me. You guys are great) But that doesn’t mean philanthropy is easy and doing it well at scale requires an organization to support it. A brilliant young man with a checkbook can’t do the work, especially if he has other interests, and yet, time and time again they speed past the hard work of building an organization to do the work necessary to be successful: the opportunity identification, diligence, management and evaluation necessary to support real change. Just because most foundations are crap, that’s no excuse to not build the infrastructure you need to be successful. Just don’t make it crap.
Placing the philanthropist at the center of the narrative of social change
OK, this is the absolute most important point. I named the post after it.. You are not the hero of this story. Mr Parker says you are. Your PR person says you are. Everyone asking you for money says you are, but you aren’t. I understand why you are confused. For the past 10 or 5 (please god, don’t say 2) years, you have been an entrepreneur. You were at the center of every decision. You understood that market better than anyone. You were the hero!! Well, Mr. Parker writes this article saying, “Hey, come over here and be the hero of this story by being a philanthropist!” Well, Mr. Parker is a goofball. Imagine a venture capitalist arriving in Silicon Valley saying, “Good news dummies! I’m here! I have big ideas for how to revolutionize tech and I’m looking to fund companies that fit those ideas!” Goofball, right? Because a VC’s job is to follow everything entrepreneurs are doing, make smart bets on the best ones, support those companies and protect their investments. No one would trust an investor who is trying to execute on his own vision of technological progress, and yet folks like Mr. Parker seem to encourage philanthropists to do just that. Philanthropists are an essential part of the ecosystem, but they are no more the center of the narrative of social change than VCs are the center of the narrative of technological progress.
The venture world has a distinct advantage over philanthropy in weeding out GNDIH thinking. In VC, good opportunities are oversubscribed, so if you’re not creating value as an investor, none of the deals you want in on will take you. But in philanthropy, no one will tell you when you’re acting like an asshole. You open your checkbook and start blathering on about all the things you know about how to help impoverished women farmers and 9 times out of ten, they’ll just smile and nod and hope your money isn’t more trouble than it’s worth.
This fundamental misunderstanding by successful entrepreneurs of the supporting rather than primary role of philanthropist is THE thing that hamstrings most young men when they get here. There is plenty to reinvent about philanthropy, but being a better funder is a totally separate discipline from actually innovating solutions to specific problems. Your success or failure will be entirely dependent on whether you can build an organization that identifies great organizations, funds them in a way that expands and amplifies their impact, connects and supports them, evaluates what works and what doesn’t and then folds that into the work going forward.
OK, so what SHOULD you do?
No seriously, shut up. Future you wants you to shut up even more than present me does.
Don’t make big commitments early. Start with small experiments that help you build knowledge, networks and internal capacity. Focus on learning, not only about issues and organizations, but also about the kind of philanthropy that is going to keep you engaged for the next few decades. Poor Mark Zuckerberg found out too late that he has absolutely no interest in the minutiae of municipal politics or labor negotiations.
Build a world-class organization
Philanthropy IS chronically under innovated, but far more at the funding level than at street level. There are very few great funding organizations. Build one, whether it’s a foundation or an investment fund. Track what works and what doesn’t not just in terms of outputs and outcomes, but also in terms of the kinds of issues and groups that are best suited to the organization you are building (and vice versa)
Spend 50% of your time on philanthropy, or spend 0.5% of your time on it. Please don’t spend 5% of your time on it.
Throw yourself into it, or delegate it to someone you know and trust. No one wants a boss who shows up once a month.
Invest in organizations, not ideas
This venture capital truism that you invest in teams not ideas is just as true in philanthropies. Your job as a philanthropist is not to have new ideas. It is to identify, support and expand great organizations. And that is hard enough.
Be as externally consistent as possible (internally too if possible)
New philanthropists are notorious for radically shifting strategy (and staff) every 12-24 months. Some of this is unavoidable for a relatively young person/organization learning on the fly, but an organization continuously relaunching is a pain in the ass to deal with (and, ahem, to work for). It minimizes any internal capacity you are building, it diminishes your value to other organizations and the best organizations, which do have other options for funding, will eventually avoid you.
Speak up when you have experience to share
Even then, don’t make the story about you.
Seems pretty simple, right? Except almost no one gets this right. Almost everyone, through a combination of hubris and naiveté, wastes the first five years of their philanthropy in disturbingly similar ways. I expect I’ll go into more detail in the future about specific cases, but for now my hour is up and I promised myself I would post this today, given my long hiatus from writing.
If you happen to be a newly minted titan of philanthropy, feel free to email me. I am fun to talk to, as long as you promise to not use the phrase “This needs to be managed more like a business."
* Yes, "He." Find me a woman acting this way and I'll happily go back and edit my pronouns.
You may have seen the news that KickStarter is becoming a benefit corporation. I said most of what I wanted to say on the topic a few months ago, but congratulations to Kickstarter’s management for making a decision that is somehow both courageous and remarkably obvious. Courageous because I am sure many smart people around them told them they couldn’t or shouldn’t do it. Obvious because the decision is consistent with everything I have ever heard them say about the kind of company they are building. It will be interesting to compare Kickstarter to Etsy over the coming years: two companies with seemingly genuine commitments to various constituencies that have chosen different paths. One bit of trite advice for entrepreneurs: nothing gives you better leverage to defend the social mission of your business than majority ownership and positive cash flow.
That’s all I wanted to say today. Apologies again for not blogging more lately. I have flushed a few posts lately because they were heavy on complaint and light on solution. That’s not how I endeavor to roll.
Hi everybody. Hope you had a great summer, mine was fantastic. As a result of being on hiatus for so long, I have a backlog of topics that I’ll be running through in the next few weeks. Some may not be quite as of the moment as you have come to expect from such an august publication. Remember when Deval Patrick joined Bain Capital to work on impact investments? Or when Google held that conference on Effective Altruism? Or when the Rikers SIB didn’t pay out? Do you remember thinking, “I wonder what the world’s only blog offering profanity-laden advice about impact investing to the subset of foundations and high net worth individuals who are not put off by the aforementioned profanity thinks about this news of the day?” Well, better late than never.
I’ll definitely be covering pay-for-success, effective altruism, RCTs and DCTs in the next few weeks. Email me if you have other ideas. Now, let’s get to work.
Sorry guys, I tried to make this funny without a lot of success. So, I’ll try to be succinct. And there is a funny (to me) picture at the end.
Almost every impact entrepreneur I know has experienced significant depression or anxiety over some stretch of their journey. I have a few simple recommendations for anyone going through this. Funders of impact entrepreneurs have a enlightened self-interest to offer long term mental health resources to the people in whom they invest.
I got a nice response for the previous post on The Long Startup. A number of people got in touch to share their own experiences and add a few things to the list. Some people talked about raising money. Some people talked about recruiting. Some people talked about working with government. But every single one of them talked about depression, anxiety and the effect this work has had on their mental health. And most of them thought they were the only person going through it.
I don’t know why this was so surprising to me. People are finally talking about depression in mainstream entrepreneurship. I can’t be the only person who reads Brad Feld’s blog specifically for the posts on depression. You should go read them. As an admirer of Brad Feld’s, I would offer that impact entrepreneurship is like regular entrepreneurship only it takes much longer, there are fewer examples you can refer to and in most cases you don’t get to dream about being rich at the end. Another thing I have been reading about lately is Imposter Syndrome, which is when a high achieving person lives with constant anxiety that they will be found out as undeserving of their achievements. Anecdotally, Imposter Syndrome seems to effect women, highly educated people and creative people disproportionately. Guess what group of people is disproportionately educated, creative women? Yep, impact entrepreneurship. For what it’s worth, almost every man I know has experienced it too. I literally jumped for joy when someone gave me a term to describe how I had felt my entire life.
Thanks to the Brad Felds and Sheryl Sandbergs of the world, there are now plenty of places you can go to read about the mental health challenges of being an entrepreneur or being a person trying to balance career goals with other life goals. I won’t restate them here. I would point out that impact entrepreneurs face these same challenges with a few added wrinkles:
I have struggled with depression and anxiety for as long as I can remember. I self-medicated until I was almost 30, and it had a pretty toxic effect on my work and my relationships with other people. Since then, I have managed by being mindful of my own mental health, being aware of my natural cycles and the situations that either fill up or draw down my emotional reservoir, but it’s definitely a work in progress. There is a longer story that explains why I am blogging to you from an office above a beer store across the street from my kids’ school, but we don’t know each other well enough for that yet. I am not a professional (Note: If you are in trouble, go see a professional. Please.) but I have my own tips and strategies that I share with anyone who asks. As importantly, since I have become more comfortable talking about my own challenges, people have been more inclined to share theirs with me, and any time someone shares something useful with me, I file it away in my “Hey, I should tell other people” file. Here are a few:
Reject counterfactual thinking - At their darkest moments, the top two laments of impact entrepreneurs are:
When I used to work in large organizations and have my own attacks of Imposter Syndrome - when I was sure that I would be found out and fired at any minute - the best thing I could do was compare myself directly to my peers, about half of whom were mouth-breathing jackasses. (Just kidding person reading this blog I used to work with!) That would calm me right down. The problem with being an entrepreneur is that you don’t have peers to compare yourself to, and you will always be lacking in comparison to your idealized self.
Find a Peer Group - One of the most helpful things for a person going through a rough patch is just to know that their situation is not unique. Unfortunately, a lot of impact entrepreneurs are isolated from anyone who shares their experience. Find at least three people who are in the same boat as you, preferably in a completely different area. Talk to them at least once month. You will likely find that being helpful to these other people is its own reward.
Find a Mentor - Find someone who has done something similar to what you are trying. Find someone you can speak honestly to about how you are doing. Talk to them at least once quarter. By the way, your investor is not your mentor. You need to reserve the right to shine them on occasionally.
Talk to a Professional - Like I said, I am not a professional. If you are having real trouble, don’t read my dopey blog. Go talk to someone who knows what they are talking about.
Don’t Sacrifice Too Much - A mentor of mine, someone who has founded two different successful social impact companies, said something pretty profound to me a few weeks ago. “Now that I know how it turned out, I'm glad I did it, but I am also glad I didn't sacrifice anything important to get here.” We’re talking about social changes that happen on a decadal scale, and a lot of the things we try don’t work out. Pay attention to your family and your friends. Have a good time. Take care of your health. After all, you’re going to be doing this job for a long time, and who knows how it will work out. Be happy while you’re doing it.
One big idea for funders: Fund mental health services for your portfolio
When I was at the Lemelson Foundation, we funded a great organization called Lex Mundi Pro Bono Foundation. LMPBF provides pro bono connections for impact entrepreneurs to attorneys around the world with specialized legal expertise. A entrepreneur can call LMPBF, describe the issue they are facing, and they are connected with someone who will help them. We figured, correctly I think, that having access to good advice on patents and contracts greatly enhanced the odds of success for the social impact inventors that Lemelson supports. It was kind of a no brainer.
Well, I think foundations and investors who support impact entrepreneurs have a similar opportunity in front of them. You are encouraging young people to embark on a career path that promises great personal (and sometimes material) rewards but that also promises a decade or more of the kind of mental health issues mentioned above. One could argue that these funders have a moral responsibility to provide long term mental health resources to their entrepreneurs, but I think there is an even clearer argument that a relatively small amount of money spent on things like peer leadership, mentorship and access to mental health professionals protects their investment. It seems like another no brainer to me.
Anyway, those are my thoughts on mental health, in honor of May being Mental Health Awareness Month. Be nice to yourself. Be of service to other people. Call me if you need something.
And laugh as much as you can.
Hi everybody. Today ran long so I will put my main point up top in case you don’t want to read a halfhearted partial book review before I get to it.
For a number of reasons, impact enterprises usually take much longer than traditional start-ups to mature. It is inadequate to transpose startup methodologies like lean innovation - which prioritizes agility over stability - into impact entrepreneurship without recognizing this fundamental difference. Impact entrepreneurship needs a complementary methodology that can teach entrepreneurs how build an organization that can survive, thrive and innovate for the decade or more it will take to have meaningful impact
I was going to spend today picking apart The Lean Startup, which is one of those books everyone quotes at you and almost no one has actually read. Silicon Valley has a tendency to adopt one of these books every few years - books which confirm whatever the prevailing wisdom of the time is, reframing it as just contrarian enough to flatter the reader (or, um, would-be-reader). The would-be-reader gets the high-level points from a magazine article or CNBC interview, then heads out into the world, biases confirmed, demanding of all his subordinates, portfolio companies, students, etc, “You have to read it right now, it is completely relevant for what you are working on and it completely changed how I think about this.” Then they state what had previously been opinions as newly-minted capital-F Facts. After all, they are in this book that everyone is quoting. Before The Lean Startup, it was The 4 Hour Workweek, before that The Innovator’s Dilemma, before that Crossing the Chasm. I once had a boss who made us all buy our own copies of Jack Welch’s Straight From the Gut, but in retrospect that may have been an isolated incident as that guy was pretty much a sociopath.
Quick aside: If someone actually read a book, got something out of it and wants you to read it? Nine times out of ten, they will hand you a copy of the book, and most of the time the book they are handing you will be dinged and dented and, you know, read. I give someone my copy of Startup Communities every few months, then I go buy another one. If someone tells you to read a book without giving you that book, and that person isn’t a librarian? Take the recommendation with a grain of salt.
Anyway, back to The Lean Startup. I, like the rest of you, had never read it, but people have been using it to annoy me for three or four years as its influence extended from VC funded tech entrepreneurship into other parts of the world, including social innovation. “Minimum Viable Product!” “Pivot, pivot, pivot!” “Fail fast!” “Continuous innovation!” “Ploughing time doesn't stop at night!” The buzz around lean startup methodology seemed to encapsulate the short-termism of the current bubble - a guide for redlining a team to quickly build something of value that can be sold to someone else before the ground falls out from under it, reflective of a peculiar time when a wide eyed college senior tells you the job they want after graduation is “Startup CEO” Oh, really wide eyed college senior? What does the company do? “Oh, I don’t know yet. I’m just really excited about entrepreneurship.”
My idea for today’s blog was that I would read The Lean Startup and then explain why it was wrong. I read it this past weekend and . . . it’s actually an OK book. For anyone starting a company or developing a new product, it is worth reading and engaging with. The core message - that products should be built in partnership with users rather than labored over in secret then unveiled fully formed - is hard to argue with, and some of the tools are helpful. And of course you want to develop things as cheaply as possible. The contempt with which the author, Eric Ries, talks about customers (in short, you should A/B test everything in small batches because customers usually don’t know or can’t tell you what they want) is exhilarating for anyone who has been across the table from a client who keeps telling you they want something that you know for a fact they won’t actually be able to use. Even the idea of the “pivot,” which for me encapsulates the worrying short attention span our era, makes sense in the contexts in which Ries puts the idea forward. It’s not perfect - there’s a lot of stuff in there I don’t think is particularly useful or applicable as broadly as he seems to think - but my idea to spend this post pointing and laughing fell flat.
Wow, so you just spent almost 700 words telling us what this blog post isn’t about?
Um, yes. I haven’t blogged in almost a month. I thought it would make you less disappointed in me if I made it clear I read a book for you during that time off. Also, I came with a clever title related to what I am writing about, but it’s not clever if you don’t get the Lean Startup reference.
So what are you going to be mad about today, Pat?
Well, I do think the ideas in the book are worth engaging with. I am not going to summarize them because most of you already know them despite never having read the book, and the rest of you can read them here. However, I take issue with the book’s “holy text” status, by which I mean that its mostly good ideas are now being presented as universal truths for all entrepreneurs. It is the dominant methodology at almost every incubator and accelerator I know of, including those that purport to care about social or environmental impact. “Lean innovation” is everywhere. My alma mater just sent me an email stating that they are even going to make lean innovation a core part of their non-profit management courses. And this unquestioning adoption of lean principles in other sectors, I think, is a mistake.
Why? Because, at the risk of oversimplifying, lean innovation is a sprint methodology, one which values speed and agility over stability. This makes sense for a tech firm going after a ready market and which is facing multiple competitors, hence the sprint to market. For the team of four ramen eating engineers that has 9-12 months to hit it big or die, this makes sense but it ignores a fundamental fact of most innovative impact-focused business:
They take a really, really, really long time before you know they’re going to succeed. Like a decade. Or a lifetime.
Look, I don’t want to tell anyone to work with less urgency or tell a new impact entrepreneur to lower their expectations, but I’ve been doing this work for long enough now that I have a reasonable number of data points when I talk about impact-focused businesses. The “Are we going to make a real go of this?” that takes 3-9 months for a tech start up can take 5 to 10 years for an impact entrepreneur, and at least once during that period the answer is most decidedly “No.” And it stays “No” for months. Or years. Categorically telling every company that they should burn energy and relationships agilely revamping their product and strategy during this long period looking for a quick fix is at best counterproductive and at worst teaches people they should quickly pull the plug on projects that could never have been expected to work in a few months.
For impact focused businesses, persistence is at least as important as agility. We need a complimentary set of tools for these businesses that teach them how to stay alive and relevant long enough to get to the point that they can be agile and high growth and all that good stuff. We also need to teach them how to preserve value and continue making progress during the long fallow periods that every one of them will experience. I don’t claim to have all the answers, but I will give it a good first stab. And I am humble calling it The Long Startup methodology. Get it? The Long Startup? Get it? Well, it was funny to me. OK, question one:
Why do most impact-focused enterprises take so long to mature?
As I’ve stated previously, I am not the word police. Social entrepreneur, impact business et al mean different things to different people, and I am a big tent kind of guy. I use the terms interchangeably and here I use them to describe a person or organization that is developing a product or service that will have some demonstrable social or environmental impact, and is doing so in a market or context which purely profit-motivated businesses are rationally ignoring for now. I think this is a fundamentally different context from lean innovation, which is more relevant when you have a bunch of competitors that you need to beat to market and continuously out-innovate.
The rational reasons other companies aren’t interested in what the impact focused company is doing can include:
All of these issues take time to address and, as importantly, are often partially or completely outside of the company’s control. More than once I have waited alongside a hungry group of entrepreneurs for more than a year while they wait for the right set of licenses to start operating in a developing country. If you want to do anything innovative in ecosystem services in the US, I guarantee you will have at least one 18-month delay while you wait for a lawsuit to be resolved. Oh, and does your project involve an innovative partnership with a state or federal agency? Prepare for multiple 6 month periods where you are simply waiting for the next thing to happen.
Impact companies also have their own set of common characteristics that stretch out the reasonable time frame for innovation, including:
Both of these bullets probably deserve their own post at some point, but it’s really important for people entering this space to internalize that first one - that they are almost certainly going to fund their entities through a patchwork of different mechanisms. I can count on two hands the number of ventures I know who did the friends & family to seed funding to venture capital linear march that so much of our start up curriculum assumes. And most of the time, these other funding sources are better (or more available) resources than VC, so the delay is worth putting up with, but you have to be ready to deal with that delay.
The Long Startup
So, this is a first stab at some principles I have gleaned from watching many other people’s long startups. My dream outcome for this blog would be for a few other actual practitioners to pick this apart, improve it and make it something actually, you know, useful.
Rule #1: Don’t die - while you are working on your innovation and you are working on making the world ready for your innovation, don’t forget that you have to still exist when those two things intersect some time in the future
Rule #2: Stay active - What you are doing during those fallow periods to build your organization and to conserve your forward momentum, is still important
Rule #3: Be resilient - Not just emotionally resilient (that is important) but also structurally resilient. How can your people, your finances, your processes survive and thrive over a 5-10 year period that involves multiple accelerations and decelerations?
Rule #4: Be prepared to accelerate quickly when opportunities present themselves - when it’s time to step on the gas, have your people, your partners and your finances ready to accelerate
Rule #5: Be prepared to decelerate just as quickly - And ideally be able to decelerate without damaging your relationship with customers, with employees, with funders and with strategic partners.
Rule #6: Make allies - It’s going to be 10 years, and you are going to need as many friends as you can get. To the extent that I have any issues with lean innovation and the “move fast and break things” ethos we are teaching startups, I guess this is it. Shipping borderline bad products and constantly staying one step ahead of collapse can work for 3, 6 or even 12 months. But eventually, you get a reputation as undependable, and you lose people. Customers, regulators, funders - they all have to be able to trust you.
Underlying these big picture rules, I can think of a few specific recommendations, grouped by functional area. I am heavy on finance as that is where most of my experience is, and I am sure any practitioner could think of more.
So, there you go, a few thoughts by me on the nascent field of Long Innovation, which I think is a complement to, not a refutation of, Lean Innovation. I can think of at least ten people I’d like to run this by, and I’ll probably have a follow up post once I do. In the meantime, feel free to email me or use the comment section to offer thoughts, criticisms or anecdotes.
I am going to talk about corporate philanthropy today. I am going to skip over whether corporations can and should be doing philanthropy in the first place, which is a legitimate question. If you read this blog, you probably already have your own opinion, and besides today’s entry is going to be too long anyway so thank your lucky stars I didn’t tack that on too. In case you don’t have time to read the whole thing, my main point is:
There are great new opportunities for corporations to leverage their assets for social and environmental impact, and their own employees are increasingly demanding this of them. However, corporate philanthropy is usually unable to meet this challenge because it retains structures and practices from past eras. Companies that want to meet the challenge and take advantage of the opportunity need to integrate as much as possible their philanthropic objectives into their business.
OK? If you have time, keep reading. I used some profanity this time, so you have that to look forward to.
What do I know?
My work has intersected with corporate philanthropy twice. First was as an employee with a day job in risk management at a large British bank. I had recently left the non-profit world, and I felt pretty rotten about how meaningless my work was. To make myself feel better I led a mentoring program for at-risk youth, and we won some kind of Chairman’s award for corporate do-gooding. They gave me a plaque that I still have somewhere, and they put me on the San Francisco committee that directed tiny grants to local groups. I never got to talk to the Chairman, but a few years later the Chairman’s special assistant flew in from London to talk to my partner and I when we were working (on our own initiative) on the first risk-optimized socially responsible equity fund. He told us how happy they were that we had taken on this project on as it gave them a talking point when the bank was questioned by reporters and shareholders about unsavory governments they were required to work with to stay in business in Africa. A few months later our project, which was making a tiny bit of money for the bank, was shut down by our local managers who could care less how this effected our colleagues in London. Local management’s (correct) assertion was that my partner and I could be better utilized making gobs of money working on other projects (well, let’s be honest, it was mostly my partner). He stayed, I left. He owns three houses now. I have one house and a blog. How many houses does one person need? Non, je ne regrette rien.
The second time I worked in corporate philanthropy, it was on a much bigger stage, and it was a complete goddamn tire fire, so much so that the New York Times felt compelled to cover it. I was told that one of these reporters was going to write a whole book about it, but after interviewing most of the principals, it was such a mess of score settling and recriminations that there was no coherent narrative. Well, I have no scores to settle. Almost everyone I met there was nice and smart and wanted to do good work that helped people. I still have borderline-irrational affection for that company, and their current philanthropic efforts now have a lot to recommend about them. In many ways, the failures when I was there had nothing to do with the failures of corporate philanthropy broadly, but there were a couple of things that I will try to share below, both in terms of things they did wrong and as importantly things they now do right.
Since then, I have worked with people in corporate philanthropy/CSR as a co-investor, collaborator and sounding board. I fancy myself a student of corporate philanthropy. I mention all of this merely to show that I have some real life experience to bring to bear answering the question:
Why is most corporate philanthropy so bad?
I meet with a lot of entrepreneurs who run impact-y companies and business-y non-profits. (My advice is usually free, and I try hard to make it worth more than they pay for it. Feel free to drop me a line if you want to talk.) It’s an exciting time to be working with start-ups, for profit and non-profit, because so many people with business backgrounds and business mindsets want to solve big problems and are taking non-traditional approaches to do so. Good social entrepreneurs always have a short list of companies who would be ideal partners for them, and usually money is not the top of the list of things they need from a corporation Access to expertise, channel or employees, or signing them up as an early customer - all of these things rate higher on the wish list and, as importantly, good entrepreneurs usually have a solid pitch as to why this is in the corporation’s long term best interest.
Through my business school (Go Bears), I meet a lot of MBAs with an interest in social entrepreneurship. By virtue of their debt loads and Bay Area real estate realities, most of them end up at larger companies rather than non-profits or start-ups, but they are just as interested in social innovation and often pick their jobs based on some expectation that they will be able to find worthwhile opportunities within their new company. I try to connect them, when relevant, with the entrepreneurs I meet, but unless I know someone in exactly the right business unit, the answer is usually, “I don’t know how I could help them. I think my company has a foundation? Maybe I can connect you with them?” So off we go to the corporate foundation, the central mechanism by which this company “does good”.
Why Does a Corporation Do Philanthropy Anyway?
I think I already outed myself as part-libertarian on this blog, so my thoughts on this shouldn’t be shocking. For perfectly logical structural reasons, corporations do not do anything over the long haul that is not in their own self interest. The difference between enlightened companies and Koch Industries is how willing they are to think hard about defining stakeholder groups, how their decisions and resource allocations serve those stakeholders in the long term, and how positive relations with those stakeholders benefit the firm in the long term. Historically, corporate philanthropy was primarily a fairly straightforward, uncreative exercise in community and government relations. You have a factory in that town? Make sure you give something to the local charities. When it comes time for the city council to vote on the tax break for your factory expansion, it will help that you are known as a good citizen, right?
Cause marketing came next. You know, the super bowl commercial with the breast cancer survivors on it and the beer company trumpeting its support for some well regarded breast cancer charity, p.s. please drink some more beer? I am curious how well this works ( I personally couldn’t drink any more beer without threatening my already tenuous parenting record.) The few deals I have seen up close involve less actual money to the charity than you would think and more “Your logo will be on all of these ads and billboards. We’re raising awareness.” but I am willing to admit that some real money moves here. I am also not sure how well this works as marketing, but I assume smart people are crunching the numbers at the breast cancer fighting beer company.
More recently there has been a great deal of talk about the role of corporate philanthropy in attracting and retaining talented employees. Study after study suggests that workers, especially millennials, want to work at companies that are achieving some broader goal beyond just profit. Campuses are filled with students starting social ventures, the White House has an office of social innovation and a bunch of scum sucking investment banks are licking their lips at the prospect of selling impact investing products. Using philanthropy to recruit and retain talent makes sense in theory, but to be honest, I have seen very little of it in practice. In my experience, people are excited about what they work on directly and/or the core product or service of the company, and almost no corporate philanthropies are integrated into the core operations of the company (Once again, tip of the pen to Mark Benioff and Salesforce, once you are done hearing me complain go listen to this podcast around the 23 minute mark)
I think that this - attracting and retaining talent - is the most important, self interested reason to do corporate philanthropy, and most of the CEO surveys I have seen confirm that top management agrees with this assessment. What is interesting to me about this is that almost no corporate philanthropy is actually structured to maximize employee involvement or give employees visibility into the process, despite the fact that more and more corporations say that this is why they are doing philanthropy in the first place. Well, how are they structured? Good question.
The Types of Corporate Foundations
95% of the time the corporate foundation turns out to be one of three animals: the Citizen (this is about 60% of the time), the Brander (30%) or the Specialist (the other 5%). The final 5% are great, but in the interest of time I’ll talk about Salesforce Foundation some other day.
So, each of the structures above have their own individual failings. The Citizen rarely provides enough support to any individual group to meaningfully help. The Brander’s opportunism is easy for all but the least sophisticated to see though, and it’s unclear how much all their promotion actually helps the cause. The Specialist . . . ugh, the Specialist . . . the big corporate philanthropy I worked for was a Specialist. Cut off from the rest of the company, staffed by smart well-meaning, ex-Department of Energy and World Bank employees, working on impossibly big problems that had been identified in corporate retreats by well meaning executives. One of my last retreat-y meetings there, I watched a senior staffer add “Cure Polio” to a whiteboard list of objectives for the upcoming year as an afterthought. Ugh . . . .
Anyway, for all their differences, the three models above have their most key failings in common. And these failings, dear reader, are why they are so goddamn disappointing to the rest of us
Add all of this together and you have organizations that are appendages to corporations rather than integral to their operations. That may have been fine thirty years ago, but if they are serious about integrating philanthropy into the culture of the company in a way that resonates with employees, it’s not going to cut it.
OK, smarty pants, what should they do?
Well, start with the realization that it’s really, really hard. Way harder than having a standard corporate foundation, which means it’s not for everyone. And, you need a commitment from the CEO on down or it’s not going to work. OK, ready?
OK, corporate america? If you need help, call me.
These days my path to wisdom seems to involve the following steps:
This is going to be one of those.
Customers are more valuable than investors. You are more valuable to an early stage venture as a customer than you are as an investor.
I was out for drinks last week with a friend of mine who works for a large environmental conservation nonprofit. We have talked for over a year off and on about his organization starting a program to invest in some of the huge explosion of agricultural data companies (drones, sensors, data platforms) whose products could be turned toward measuring and managing environmental outcomes. It’s an interesting proposition if I do say so myself, and something still may come of it. But as we talked about each of these companies, especially in what is today a very frothy venture investment market, it quickly became apparent that there is an easier way to support and influence these companies: buy and use their products. At this stage of their development, any one of them are willing to spend a lot of time with a customer who is willing to pay for their beta product and give them feedback. The fact that much of this feedback will be tailored to help them build products that better meet the need of a conservation buyer is gravy. And, unlike an investment program which would require hiring new staff and building out new capabilities, this organization already has staff who understand the technologies and can make informed purchase and deployment decisions.
So that is the high flying start-up ecosystem, but what about everyone else? I wrote a few months back about how venture capital is not useful for 99% of social ventures and regular businesses. This is a major stumbling block for most social investors (including governments and corporations) when they realize that most or all of the companies they want to support have no ability or intention to create an exit for equity investors. But if you talk to these companies, most of them will tell you they don’t really need investment, they need good customers (and by good I mean long term relationships that create good margin without inordinate hassle) If they really do need investment, the right set of customers make getting a bank loan relatively easy.
I know this is probably obvious to most, and maybe it’s a result of the little corner of the universe I inhabit. I talk to corporations, foundations and NGOs all the time about setting up strategic investment programs, but we rarely talk about setting up strategic purchasing programs. This seems like one area where government is ahead of the rest of us, although they usually insist on calling it “procurement” which sounds vaguely like proctological procedure . I am very proud to say that my home city of Portland, Oregon, is about to launch an Early Adopter Program (powered by Switchboard) that encourages city departments to contract with local start-ups. It is notable that they decided to do this instead of launching another seed-investment program. Their (correct) view of the local scene was that these start-ups need their first large customer much more than they need another seed fund.
So, NGOs, corporations, foundations and governments should consider strategic purchasing as a complement to (or instead of) strategic investing for some simple reasons:
Finally, and I am going to get high falootin’ here:
Each party is giving and receiving something of value, and, managed correctly, you have a chance to avoid some of the power dynamics that plague philanthropy and impact investing where one party has all of the resources and power, and the other flatters the powerful to get access to those resources.
OK, so that’s the big institution perspective. What’s in it for the little guy? Plenty.
I think most people get this intuitively. Part of the explanation for many on crowdfunding platforms moving toward pre-purchase arrangements has to be artists and entrepreneurs saying, “Look, I don’t want or need a donation, I just want to know that you guys will buy this thing if I make it.”
Obviously, there are some complications to consider. Working with small companies requires some extra engagement and there’s risk that things will show up late or not as initially imagined. From the company perspective, large clients with an explicit social or environmental mission may take some extra work to make happy, but these seem like surmountable issues and I am glad that cities like Portland and start ups like Switchboard are taking the lead. I don’t think any of the points above diminish the importance of impact investing, but I do hope that some of the PR glow we currently enjoy could slide over to the world of procurement Step one: come up with a better word than procurement.
There has been a lot of talk lately about impact investing “maturing”, even becoming “its own asset class” People talk about pension funds moving into impact investments, creating pools of tens of billions of impact investing dollars to fund new projects. At the same time mutual fund managers are staffing up to create impact investment products for their retail clients. Implicit or explicit in these discussions is the thought that an individual or institution can make a market-rate of return while also creating positive impact with their investments, that they can “Do well while doing good.”
The idea that you can provide market rate returns while also creating real impact is a myth, and it is a myth with real negative consequences.
I have written this post a couple of times and flushed it. I shared one version with a friend of mine who told me I sounded like the word police. If you ever want to really hurt my feelings, call me the word police. Anyone who has spent time in philanthropy or social justice knows that we waste a lot of time defining, redefining, parsing, defending and then reinventing terminology, often at the expense of actually, you know, doing stuff. So, it’s on me today not only to say why I think people are misunderstanding or misappropriating the term “impact investor” but also to explain why it matters.
Last week I wrote a couple of set-up pieces trying to define what I mean by impact investments (investments that demonstrate additionality) and market rate investors (investors who generate a rate of return across a portfolio of investments equal to an equivalent non-impact portfolio). To summarize the key point from each post:
Now, to combine those ideas:
I am going to repeat this last point because it is important and is often lost on smart people. You can invest in a bunch of projects which each, on its own, has the potential to provide a market rate of return, but if there are additional “uncompensated risks”, you are almost certain to underperform the market on a portfolio basis. So, there is such a thing as an individual market rate impact investment, but as you build a portfolio of them, the portfolio will underperform. As such, the market rate impact investor is a myth.
OK, now I'll describe three archetypical investors, each of whom professes to be doing well by doing good, and show you what goes wrong because they claimed to not have to make a trade off between returns and impact. I even made this handy graph to show you I have an MBA!
Archetype 1: The Symbolist
The symbolist wants to build a portfolio of investments in companies that are, broadly speaking, doing good things but have given their investment people strict instructions to “stay commercial”. (This is often a sofa bed solution to having one board member who is very interested in impact investing and another who is adamantly opposed to doing anything that could compromise returns.) The various fiduciaries understand this directive and, rather than investing in a portfolio of impact investments with additionality, they (rationally, given their mandate and professional ethics) invest in well-understood products that plenty of other institutions invest in as well: some thematic public equity funds, some muni and corporate bonds that fund solar installations, the fourth fund of a respected clean tech VC, maybe a timber manager they’ve used forever who happens to have a sustainability strategy.
What they build is a portfolio of fully commercial investments in some neat sectors with ZERO additionality. Because they have stayed in the part of the capital markets where capital is functionally infinite, their decision to enter “impact investing” has in no way effected the amount of capital available to businesses or the terms on which it is available. They have made a symbolic gesture. 95% of the new pension and retail “impact investments” fall into the Symbolist camp.
The easy compromise of the symbolist approach provides a way that the Board or family considering impact investing can stop arguing. But it is a compromise in which nothing meaningful is accomplished. No meaningful impact happens, something that pro-impact investing board member usually realizes 3 or 4 years into the new strategy, so they’re not happy. The board member who didn’t want to do something in the first place, they're not happy either. The real damage is that, in some sub-set of cases, had the Symbolic compromise not been offered, the board would have made the hard decision to actually consider investments with real additionality and accept whatever additional risk, diminished returns or higher investment management burden (more on this in a future post) that strategy required. So, my argument is, the Symbolic compromise deprives us of investment capital that could have been used to make real, additional impact.
Archetype 2: Rapunzel
Rapunzels are those who are serious about creating real impact and equally serious about meeting or beating the market. They set a high bar on each, they allocate some money, they assemble their team, they meet with everyone they possibly can over a 6 month period and declare . . . that nothing meets their standard. For two or three years after that, they are a fixture on whatever the relevant conference scene is, declaring their dismay that no one can scale their tower to claim the prize of their investment. The market is failing them!
Say what you want about Rapunzels, unlike the Symbolists they often dedicate real resources to searching for and evaluating investments. Unfortunately this means they waste a lot of other people’s time (mostly people trying to get funds or enterprises funded) trying to find investments that, if you buy my definitions above, don’t exist. They also, and this might just be the Rapunzels I have met, seem to always find a way to spin the fact that they weren’t able to build the magical unicorn portfolio that they invented in their heads as a failure of ingenuity of the people actually doing, you know, real work. For most of us, Rapunzels are a minor annoyance. For people raising money and building investment products, Rapunzels are major time and resource sinks and even more major . . . well . . . bummers.
Archetype 3: The Closet Case
The Closet Case declared at the outset that they were going to achieve impact and a market rate return on their portfolio, just like Rapunzel. But when they started looking at investment opportunities and saw that the impact deals had some extra hair, they (unlike Rapunzel) decided to invest in a few of them. They made some "market-rate" loans to impact enterprises that were having trouble getting financed elsewhere. They invested in a couple of first-time venture capital managers with an interesting thesis around serving unbanked and underbanked people. They found a couple of ecosystem services opportunities that, once a couple of state and federal agencies line up, could provide a nice return. None of the investments are explicitly concessionary, but they each have an extra wrinkle or two. The great news is, if they pick carefully most of these investments should be fine AND there is real additional impact! The bad news is that, over time, those uncompensated risks will effect portfolio return negatively (and the more investments they make and the longer they carry on, the more certain this is). And, they told everyone going into this that they were not going to compromise on returns. They are now a closeted impact investor.
The problem with being in the closet is that:
Seriously, you are beautiful just as you are. If they don’t like you, go get new friends.
But Pat, I thought nirvana was when impact companies could access the “regular” capital markets to fund their activity?
It is! The fact that a commercial wind project can now raise billions of dollars from investors who could care less that it is clean energy is a great thing. And all of the early investors (and rate payers) and developers of wind projects who spent decades standardizing and de-risking those projects should take a bow. But, having a separate pool of money in the capital markets that is now investing in commercial wind projects at the same terms as everyone else and calling itself “impact” helps no one (except maybe the investment bank that is taking some extra fees from their wealth management clients who want an “impact product”) It doesn’t make more projects happen. It doesn’t make them better or faster or cheaper or help them on any other meaningful metric!
I guess my main point, in case you TLDR’d yourself through most of this, is that, if all of these faux impact investors would think long and hard about what they wanted to do and how much risk they can legitimately take AND they were not being offered the “Have your cake and eat it too” solution of market rate impact investing, one of two things would happen:
Because some people actually doing something is better than lots of people just pretending to do something. More on that next time.
(p.s. I updated this a day after posting to fix an egregious number of typos. Apologies to those who read the first draft, I can't spell when I'm mad)
Welcome back to the second of two definitional sections of that will lay the groundwork on my upcoming post on the corrosive myth of market rate impact investing. Thursday I took on additionality. Today I want to talk a little about “market rate investors.”
This is a term that should sound silly to most of you. After all, in most of the world we call these people, you know, “investors.” But in our little corner of the world where people are granting money or lending at a discount or seeding new ventures with only the haziest notion of when the money is coming back, it is important to define “market rate investor”, by which I mean each of the institutions and individuals who are looking to meet or exceed the “market rate of return” across a portfolio of investments. This is tougher to define than you might think, as every portfolio has a different mix of assets that reflect different mandates, plus the projecting expected “market rate return” for a particular asset is a mix of art and science. I am not going to rehash any of that here as a) you probably know this and b) there are places you can go read about that which don't have silly pictures at the top.
Instead I want to focus on a few key elements of the investment world that are not always appreciated by outsiders (it is sometimes not even fully realized by people on the inside):
If it’s not clear already, I am telling this one from the perspective of someone trying to raise money for a new impact investment that offers a market rate of return. (The picture above is Cheap Trick, who wrote “I Want You to Want Me,” one of the ten best rock songs ever. Get it? Get it? I remind you that this blog is free)
OK, here we go.
You probably already know this, so I’ll make it quick. Almost all professional investors, be they individual fund managers, pension/endowment managers or consultants, are managing someone else’s money. They are fiduciaries (as opposed to principals.) Here is a fun drinking game: google the term “fiduciary”, click on any link and then take a drink every time you see the words “prudent” or “prudence”. Fun, huh? Ok, now go sober up. I’ll wait here.
So, we have a couple centuries of professional ethics telling finance professionals that their fundamental duty to clients and investors is to be careful. There is a ton of interesting debate about what it means to be a fiduciary, but for now let’s just leave it at this: finance professionals are generally amoral, anti-social libertarians with a confidence in their own opinions that has been scientifically proven to have no basis in fact. You want their professional ethics to generally be telling them to knock it off rather than egging them on.
There is also a simpler math to this risk aversion as well. There are a few corners of finance - early stage VC, certain hedge fund strategies, some kinds of prop trading - where you will see investors taking big risks with other people’s money, but this is always in pursuit of equally outsized returns. In most asset classes and most investments though, you don’t have the possibility of massive upside, so the way you make your money is by not making mistakes - by avoiding the investments that actually lose money. For all of the talk about risk adjusted returns, in my 20 years in and around finance, we spend way more time talking about controlling risks than we do talking about maximizing returns.
Think about it this way. Lets say you have a bunch of potential investments. 70% of them will succeed and each of those will have a return somewhere between 10% and 12%. The other 30% will fail, resulting in a 100% loss. As you are researching and making your picks, will you focus your effort on making sure pick the successes that return 12%, rather than 10%? Or will you focus on making sure you stay away from anything that has a chance of failing? What if I went further and said, “The 10% return investments are easy to identify, but the 12% investments and the ones that fail are indistinguishable at the time of investment?” In that case, the clear optimal strategy is to load up on the sure thing.
So, on one side we have a whole profession of fiduciaries who are bound by ethics and self interest to avoid any additional risk that doesn’t produce commensurate upside. - a rational aversion to novelty, if you will. On the other side you have new impact investments who think they have made it over the hump because they have read about all these new “market rate impact investors” and they have an investment that theoretically provides a “market rate risk adjusted rate of return” (whatever the hell that actually is) Only, there's a fundamental problem: their investment is novel as hell. It usually has a) an unproven market, b) an unproven strategy, c) a first time manage and/or d) a new structure. This means it likely has a higher chance of failure than another comparable investment, but the same potential return.
So to interest a prudent "market rate impact investor", it's not enough to offer a good return. You also need to be "de-risked" in a number of ways, most of which involve executing your strategy for five years and coming back after all the risks have been buffed away. But at that point, if you have actually been successful, any investor would be interested in looking at your fund. So what use was that impact investor in the first place?
Stay tuned . . .
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.