Social Spending, Social Investing, Social Disruption

Yesterday I attended an Impact Investing conference in Chicago. Matt Bishop lead the discussion. It was interesting. I am very curious how others approach impact investing. In my portfolio, I have several companies that I would categorize as “impact” companies. They are, Tallgrass Beef, Dabble, Nextspace, Desktime, Deskpass, Brilliant, and Public Good,  That’s about half the active portfolio.  If you can become a customer of one of them or introduce someone to one of them, you will be making an impact.

I think that impact investing is finding its footing.  There are some points that Matt made that I will make here, but I also want to juxtapose them with some other points to try and add some context.

Here are three key points Matt made:

  1.  If it’s an equity investment, then traditional risk/reward variables hold.  The market is king.  The company be built to survive and sustain in a market based environment.  Examples of this are linked above.  So would companies coming out of Impact Engine.
  2. If it’s a debt investment, then traditional risk/reward variables do not hold. It is acceptable to receive less than market rates on interest for loaning money.  Microloans are an example of this.  Loans to people so they can start a business at rates less than they could get from a bank would also be an example.  Of course, in this day and age they probably couldn’t go to a bank to get a loan.
  3. At the outset, a business has to have “impact intent”.  Meaning tackling a problem that is considered a societal ill.

Number 3 is where it gets messy.  Can I make a profit?  Over a range of people you might find enough things that are considered, “societal ills”, but if you sample enough people and ask the question different ways you probably won’t find a consensus.  It goes back to questions like, “What’s fair?”.  Normative economics are messy.

The Impact movement needs to be entrepreneur lead.  It cannot be lead by a government, or a foundation.  It can’t be lead by a funder.  They are feeders.  The principles that Brad Feld eloquently laid out in Startup Communities apply to the impact community too.  Follow them, they work.

I am a big fan of an entrepreneur creating a sustainable business that solves a problem government spending hasn’t solved.

But, when these problems are solved, government is often disintermediated.  Government loses power.  Government doesn’t like to lose power and uses it’s far reaching and obtrusive power to crush the entrepreneur in a lot of cases.  Currently we are seeing that with Uber and AirBnb.  We most certainly will see that with educational and medical startups.  Most of the impact companies I have seen to date are not a direct assault on government power-but that’s going to change as impact investing develops over time.  Government isn’t your buddy or pal. It’s often your competitor.

I believe impact investing disruption starts from the bottom up.  It cannot come from the top down because the bureaucracy will do everything in its power to hold power.  Bureaucracy will pick winners and losers.  Network beats hierarchy, and utilizing the network to innovate returns individual choice and power to people over bureaucracy.  Often we think of this in terms of corporate bureaucracy and innovative startups, but the same principle holds for government bureaucracy and innovative startups.

Conversely, often times to disrupt something the initial target market is the top of the market.  A company targets those with the best ability to pay.  Technology then starts to commoditize and filter down so that more and more people can afford it.   Cell phones are a good example.  Education might also be a good example.  The wealthy have less risk in choosing innovative companies since their safety net is much larger than a poor persons.  They can pay for things like ACT/SAT test prep.  They can opt out of public schools and send their kids to private school.  But, now there are online ways, like Benchprep, to reach more people with really good test prep.

Remember when Facebook founder Mark Zuckerberg gave $100 million dollars to Newark, NJ schools.  None of the money went to the students.  It went to pay off pensions, and to pay consultants.  In other words, it fed the bureaucracy.  Zuckerberg would have been better off giving scholarships to poor kids, or setting up a VC fund that invested in impact companies.  Virtually all private money that goes into an effort to reform a public bureaucracy is wasted, no matter what bureaucracy.  Federal and state governments have spent billions on public education.  Individuals and foundations have poured billions into it too.  It’s almost a total fail.  Bill Gates will have lifted more people in the world up by creating Microsoft than he will with the Gates Foundation.

If we want to impact invest and solve what we perceive as problems, I have some suggestions on how to approach it.

  1.  Focus.  These issues are too big and broad for one startup.  Solve one tiny piece of the problem, and do it with one eye on top line revenue.  Revenue might not happen right away, but it has to be a part of executing the business sooner rather than later.
  2. Build a profit motive in the business to make it sustainable.  Otherwise, it’s just a charity.  Capitalism raises people up and creates more opportunities.  Making a profit means you are creating value.
  3. Invest with a guiding principle of putting power in the hands of the individual.  Don’t make their decisions for them.  Their property belongs to them.  Networks beat hierarchy and there are plenty of cool ways to use technology to build networks today.
  4. Don’t ask permission.  Scale fast.  Enable natural human behavior.  Uber is too big to regulate.  AirBnb is too big to regulate.

There are lots of opportunities to disrupt government bureaucracy.  Education, Farming, Transportation, Energy, Communication and Medicine are just a few of the places that can be 100% turned upside down.  The government bureaucrat is not some angel that divine intervention installed and will rule with the hand of King Solomon.  63% of our federal budget goes to entitlement spending and it is unsustainable.  That budget also feeds government bureaucracy and the jobs that come with it.  Entrepreneurs building impact companies will upend it and government spending should drop as a result.

The other really cool thing that building a startup does for the people that use it.  You give them hope.  You raise their standard of living.  Bureaucracies sap hope.  It’s why President Reagan was so right when he said the worst words one could hear were, “We are from the government and we are here to help.”