My last two posts featured Hector Bonilla, the co-founder of Proteak, a Mexican renewable tropical forestry company. (Read part one here and part two here). The goal of the interview was to capture insights from the company's experience with a successful IPO in 2010. However, recognizing that IPOs are still a rare delicacy in the impact investing sector, I decided to interview a Wall Street veteran turned impact investing expert, Mike Van Patten, to see what he thought the sector writ large should expect going forward in terms of exits.
Van Patten is the founder and chairman of Mission Markets Inc., a specialized financial services firm that provides investment banking and advisory and operates an online private exchange for the social and environmental capital markets. Mission Markets seeks to "create a marketplace that improves the flow of capital for sustainable investments that generate measurable social and environmental impacts thereby improving humanity and life on earth."
Essentially, Mission Markets is creating a secure online platform whereby sustainability minded investors and businesses can directly interact.
Given that New Ventures works to support environmentally-focused SGBs in emerging economies with their growth strategies and capital raising efforts, I'm naturally very interested in platforms like Mission Markets and how they can help the companies we work with gain access to greater amounts of capital, and ultimately create more successful exits.
NextBillion.net: In the impact investing sector, we need more examples of successful exits to make the case that environmentally and socially focused SGBs can create solid economic returns. How can we generate more exits in the sector, and how is Mission Markets playing a role in this effort?
Van Patten: The current lack of exits in the sector is largely a function of the immaturity of the market. You have to look at the evolution of the sector like the evolution of any asset class. If we're in a 20-year evolutionary framework, we're still very much in the early stages, at year three or four. We'll see more exits as more companies become more mature.
In order to move the sector along, Mission Markets is creating the capital markets infrastructure that will allow more stakeholders to get involved. This will help speed up the evolution of the asset class. The logic goes like this: as we create the capital markets infrastructure, the flow of capital will accelerate (mostly as a direct result of the greater amount of information available), and then the speed at which companies evolve will speed up as a result of this increase in investment and information around transactions.
NextBillion: When exits do occur, they are often through owner buyouts or the sale of preferred shares. It is rare that an investment in an SGB will result in an IPO, given that local stock markets are often underdeveloped or non-existent in emerging markets. What are the tradeoffs of these different exit strategies, and in your opinion, recognizing that each situation is very different, what can we expect to see going forward with regards to exits in the impact sector?
Van Patten: I have seen some exits occurring in this space, but they have been fairly infrequent. Most of them have been in the microfinance sector. These investments are usually backed by traditional private equity that came later in the company's evolution. But I still don't think we're going to see any microfinance IPOs for awhile.
What I've seen for SGBs are less traditional exits. There have been more management buyouts and acquisition buyouts. How this affects the company's valuation is that the investor ends up getting much lower multiples. When a company has a much lower exit, it's obviously not as profitable for an investor.
In the next few years I think we will continue to see this pattern play out. We will continue to have relatively modest returns as a result of these less traditional exits, but the good thing is we should see more exits, since not that many impact companies have even had an exit yet. What we need is for more companies to mature.
I think you will definitely continue to see debt exits continuing, but I don't see getting money back as a real exit. Debt investors are just getting paid back their original principal. Investors need to see a return on capital and a return on their investment (equity).
NextBillion: How does the idea of patient capital play into exit strategies for mainstream investors? Are you seeing that mainstream investors are becoming more tolerant of the idea of patient capital?
Van Patten: If you look at what's happening around the world in our current global economic climate, whether you are a "mainstream" or "impact" investor, you have essentially become a patient investor.
What I'm saying is that all investors have been forced to become patient investors. For traditional capital markets, the average baseline return has gone down. As a result, return expectations are much more modest than they were even five years ago. If you're competing with traditional capital markets, impact returns are a lot more competitive than they used to be. And to the extent that impact investing is associated with patient capital, which might be associated with lower risk, this can be a good thing for the overall impact sector.
Also, investors in this economic climate are looking for stability. Private equity is looking at down markets. There's a new paradigm of investing, which is getting returns that keep up with inflation over a long period of time. The major stock indexes are negative, which means that individual stock holdings are down even farther. This year as it was in 2008 and 2009 the joke will be that the new up is down 3-5 percent. There's been a reversion to the mean and many impact investments are now above market rate.
Investors are also favoring real/tangible assets, like raw land. Impact companies have a lot to offer in the way of tangible goods and services, so this is a good thing for the sector writ large.
I don't think the idea of patient capital is as much of an issue. What's still a potential issue is the IRR of these companies. There's simply not a long enough track record to prove high rates of returns. This is different in the microfinance sector, but for SMEs, it's not. We need more successful company examples to draw from.
NextBillion: How does the Mission Market platform help generate overall sector liquidity? Which sectors are most ripe for this option?
Van Patten: Mission Markets is hoping to provide and establish transactional transparency, standardization, and price discovery and pricing information for the impact sector. We are a full services financial firm. We are trying to provide aggregated information to investors so that there is one centralized destination for anyone involved in the impact and sustainability sectors on the capital markets side.
Without basic infrastructure, we can't increase the flow of information necessary to increase the flow of capital. Without this flow, there is limited liquidity. Liquidity is a form of supply and demand. When more capital is flowing, liquidity will increase. Whether it's two-three years or ten, it's all a function of increased transparency and access to information.
One of the sectors that is most ripe in emerging economies for generating sector greater liquidity are mobile devices, which can help business owners, especially small business owners, access price information. Mobile devices are very inexpensive communication tools. With this increased information flow, you're seeing the lowering of the cost of services and more efficient services being delivered. We take this for granted in developed nations.
Social networking is another sector. What you saw in the States and in Europe five years ago is now replicating itself in the developing world. Online companies, telecommunications companies, and the like are acquiring companies that are creating these networks. For instance, social networking is allowing farmers and other business owners to get information on crops, water usage, etc. This is fundamentally changing the way they do business.
NextBillion: What are the investors you speak to most worried about when it comes to investing in "impact" companies with regards to exits?
Van Patten: Investors are most worried about what any investor is concerned about in early, seed-stage ventures: which companies will make it? Impact investing is no different than any other investment category. The only thing that's different is that investors are more tolerant and accepting that companies may need more time to provide a return. That's getting back to that whole Patient Capital discussion.
Investors are worried about whether companies will evolve to the stage where they are commercially viable. Most won't. They are asking themselves which companies of the ones they've invested in will eventually become the leaders. As well all know, companies require more than passion and innovation to succeed.
NextBillion: Given the difficulties of debt-related investments in many emerging markets, do you think we will see more equity investments in the coming years?
Van Patten: Debt-related investments are a direct function of a company's ability to service the debt. Most double or triple bottom line companies are not at a stage where they can do this yet.
Equity will still serve as the primary driver of capital into companies over the short-term unless you have a company that has a PRI (program-related investment) and other investors coming in with equity, known as "blended capital." But this is occurring mostly in the U.S. because you have more sophisticated issuers.
Going forward, more social and environmental SGBs need to mature in order for more traditional exits to occur. Mission Markets is playing a critical role in moving this process along and other organizations like New Ventures will continue to help companies with their growth strategies and gaining access to capital. But the impact investing community writ large also needs to remember to practice what we preach: patience.
To learn more about Mission Markets, please visit: www.missionmarkets.com. Mission Markets also owns and operates Mission Markets Earth Exchange, the first online platform facilitating transactions for multiple environmental credits and conservation finance mechanisms. For more information, visit: http://mmearth.com.
For more information about New Ventures, WRI's center for Environmental Entrepreneurship, please visit: www.new-ventures.org.
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