September 13, 2016 - Deal Structures, Funding/Financing

Impact Investing: VCs Recognize Social Enterprises Can Outperform Traditional Start-Ups

The notion that a company should care about more than just making money started with corporate social responsibility over 50 years ago, but the trend has rapidly increased in recent years and has produced a multi-billion dollar impact investing market. Today, we have new corporate forms structured around an entity’s social mission, such as the public benefit corporation and the social purpose corporation, and companies consider their social and environmental impact now more than ever. It comes as no surprise that a solar company or children’s food company would care about their impact, but it’s no longer just nonprofits and sustainability companies that care–it’s everyone, and especially investors.

VC firms and their impact.

Just recently the venture capital firm, Foundry Group, became a certified B Corporation. A “B Corporation” is a for-profit company certified by the nonprofit organization B Lab to meet rigorous standards of social and environmental performance, accountability and transparency. This continues the trend of venture capital firms, such as RSF Social Finance, TriLinc Global, City Light Capital and other VC firms becoming B Corps. Foundry is not a social impact investment firm, such as DBL Partners, so this news shows that even non-impact-focused VC firms, ones that still have their eyes on the dollar sign, are now giving attention to more than just profits. Strong financial performance and social impact are not inversely related, and investors are increasingly recognizing this as they manage their capital.

You don’t have to be a Benefit Corporation to be B Corp Certified.

Many companies still choose traditional entity forms, such as the LLC or “C” corporation, in lieu of the new corporate forms. However, companies don’t have to make an “either-or” decision. Companies can be B Corps and retain their corporate structure, mission and business model. VC firms that are B Corps epitomize this best-of-both-worlds strategy. These VC firms are still limited partnerships focused on making investments in early-stage companies with the expectation of growth and profit but are running their firms, and following policies, in a manner that is conscious of their impact as an organization.

It should be noted that some VC firms are focused on impact but are not qualifying their investments as “impact investments” or becoming B Corps, such as Obvious Ventures. These VCs simply have a business thesis that solutions to the most pressing social and environmental problems of the day will yield the greatest returns. Furthermore, some fund managers are engaged in this space by contributing a portion of their carry to impact investing and/or having an affiliated impact fund. Even mainstream capital, such as Goldman Sachs and BlackRock, have impact investment initiatives and funds.

How else can VC firms have impact: debt and equity.

Beyond solidifying their own social and environmental standards, investors can ensure the accountability, and mission preservation, of the companies in which they invest through their investment instruments, such as convertible notes, SAFEs and stock purchase agreements. These instruments can include affirmative and/or negative covenants delineating that the borrower can only use investment proceeds in a mission-aligned manner or, conversely, that the borrower may not use the proceeds for activities that conflict with the mission. Furthermore, investors can have the traditional covenants in their agreements drafted towards mission preservation. Mission violation can be included as an event of default, or deviation from the mission can trigger pre-payment, higher interest rates or redemption rights, or investor returns can be increased or automatic conversion in the future round of financing can be removed if mission deviation exceeds a certain threshold. Investors can get creative with conversion formulas, cumulative dividends, waterfall provisions, earn-back rewards and other traditional terms of their investment contracts to ensure mission preservation and that their investment will have an impact.