NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Before any enterprise model has been demonstrated, before there is customer traction or any talk of “post-revenue, pre-profit” ventures worthy of investment and certainly before any impact is evident, there are countless early stage entrepreneurs who first believe innovation is worth the effort to create new solutions to existing market problems. Investors, on the other hand, are inherently looking to manage risks of all types. This difference in perspective between entrepreneur and investor is at the heart of a persistent gap in seed stage funding for social entrepreneurs.

A closer look reveals that there is great investment opportunity in this space between investors and entrepreneurs—and the currently fragmented ecosystem of seed stage impact investing is ripe for innovation by new and existing intermediary organizations working to build this investor infrastructure. Two separate reports by the Global Impact Investing Network and the angel network, Toniic, both address these challenges and opportunities in depth. It is no wonder that investors are exploring how to create better support for early stage ventures: a healthy, productive seed stage ecosystem is critical to the inspiration and success of social entrepreneurs, and it is this very ecosystem that holds the pipeline of deals—truly the future—of investor opportunity within the growing field of impact investing.

I have long been in conversations with entrepreneurs and impact investors trying to match capital to ventures to execute their respective strategies. As a founding board member of Pacific Community Ventures, a past advisor to sustainable private equity investment funds, convener of the ImpactAssets 50 and now senior strategic advisor to three family offices — each of which is executing significant, multi-million dollar impact investment strategies — I have had many discussions on the complicated capital waltz between impact investor and social entrepreneur.

Systemic challenges that hinder the flow of capital into seed stage investments include:

Risk and Return: When investing for financial return with social and environmental impacts, investors are taking on both financial risk and impact risk – which together can be difficult to assess, manage and overcome. In some ways, the long-term outcomes and risk-return profile of seed stage impact investing are still somewhat of an experiment at a cultural and market level, with each funded venture providing a new data point.

Investment Size and the Realities of Allocation: Aside from those operating purely as angel investors, seed stage investing will usually represent only a small portion of a total portfolio due to its high risk and the need for early stage investors to have the capacity to truly “add value” at this stage of enterprise development. Taken together, there is a fairly small pool of investors capable of making meaningful contributions to seed stage investments to round out a diversified impact portfolio.

Expense to Source, Analyze, Monitor Deals: Regardless of size, investments must be sourced, subjected to thorough due diligence, negotiated on various terms and continuously monitored after the initial investment. All this represents costs that often do not scale in relation to the size of the investment, making seed stage investments expensive relative to the capital being put to work.

Lack of Information: A tremendous amount of time may be spent hunting, gathering and cultivating seed stage deals due to often opaque (or non-existent!) internal business systems and the need to gather diverse information. Limited visibility into what deals are being made within impact investing has left both investors and entrepreneurs without effective benchmarks or a range of outcomes by which to orient themselves in negotiations regarding new investment opportunities.

Though natural in a seed stage environment, these challenges reveal unexplored areas for innovation in the ecosystem in which ventures develop and thrive. Powerful solutions in sourcing, vetting, monitoring, mapping, reporting, networking, entrepreneur capacity-building, investor training, and many other areas will spur entrepreneurial activity and the flow of seed stage capital. There are five main areas I see as ripe for innovation:

• Simplifying the sourcing of high-quality ventures
• Reducing transaction costs and requirements
• Opening up early stage investment opportunities to a wider pool of potential investors
• Creating an improved enabling environment to support smaller investments
• Developing new models for sourcing investment opportunities

To explore these areas, ImpactAssets recently launched a Seed Ventures Platform for clients of the Giving Fund (a donor-advised fund committed to impact investing with over $100 million under management) to catalyze additional pools of capital for seed stage investing. Other established organizations, such as ANDE and Accion, are also developing new ways to support the seed investing ecosystem—yet more actors are needed to fill the gap. Developing innovative solutions throughout the impact investing ecosystem will only continue to strengthen deal flow for impact investors and social entrepreneurs alike, providing new ways for the “right” deals to find the “right” capital – and that, after all, is what it is all about.

For further discussion of challenges and opportunities in seed stage investing, please see one of our latest essays, ImpactAssets’ Issue Brief #11.

Jed Emerson has played founder roles with some of the nation’s leading venture philanthropy, community venture capital and social enterprises. He is senior advisor to four family offices executing 100% impact/sustainable investing strategies of family assets, and also acts as Chief Impact Strategist for ImpactAssets, a nonprofit financial services firm.