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

In almost any context, the word “pioneer” conjures up exciting images of individuals, or teams or companies, who blaze a trail and create new opportunities for the rest of us. Pioneers venture into uncharted territory, take on a great deal of risk, grapple with uncertainty and craft new rules as they forge ahead. The odds are great that they fail rather than succeed, but still, they persist knowing that if they do prevail, the rewards are sweet.

Despite these positive connotations, and the benefits that await, very few impact investors are deploying “pioneering capital” – small investments into very early-stage ventures. Pioneering capital is the first in, helps the entrepreneur get her idea off the ground and paves the way for other investors to come in and scale the venture. According to the Global Impact Investing Network, less than 3 percent of impact funds were deployed into early-stage ventures in 2017. We can and must do better.

Five years ago, we at Upaya Social Ventures wrote about this gap in pioneering capital and the lessons we’d learned as pioneers ourselves. Since then, we’ve had our fair share of missteps and stumbles, but we’ve internalized those lessons and are proud to share several here for the benefit of others. In more recent years our successes far outnumber our failures and we find ourselves converging on a playbook that works.

Our portfolio speaks for itself: out of 14 investments, we’ve had two exits, one write-off and two “stalls” (ventures that are undergoing major re-structuring). The remaining nine continue to chug merrily along. These nine are scaling, attracting follow-on investment (15X the amount that Upaya originally invested) and, all in, our portfolio has created nearly 8,000 dignified jobs for the poor.

Malabika (right) and a co-worker prepare “tree free” paper-like material at the El Rhino factory (an Upaya investee) in Assam, India. Photo by Laurel Curran

We believe Upaya is thriving in its pioneering niche, and we’ve enjoyed collaborating with the few other peers in this space. However, there’s plenty of room at this party as the need is far greater than what the current pioneering capital investors can satisfy.

Perhaps what is holding others back is the perception of rapidly evolving business models and the significant effort of evaluating investments in this early stage. Investors may feel they can’t afford to dedicate scarce diligence bandwidth to entrepreneurs slogging through the pioneer phase. In the first one to three years, entrepreneurs are still experimenting, learning how to strike the right product-market fit, understanding their customers’ needs, and settling on the best methods to generate revenue.

There is also a higher risk of business failure at this early stage. Granted, there are occasions when entrepreneurs discover their ideas are simply not viable, but more often the case is that they simply run out of funds and resources before they can prove the concept. For entrepreneurs working to alleviate poverty, in highly marginalized communities, the rate of failure is even higher as they contend with poor infrastructure, political and social instability, and opaque and unpredictable markets. There is the practical challenge of even assigning a value to the enterprise at this stage: What is the investor’s stake really worth? Can the investment be structured in a way to compensate for the risk the investor is assuming?

We wouldn’t deny these challenges exist, but we’ve been surprised by our own journey. We’ve had several epiphanies that challenged many of the notions we ourselves held earlier.

One such notion involved the nature of our capacity-building support. For years, we had seen entrepreneurs struggle with financial management, pitching to investors and articulating a solid business case. Because of this vulnerability, and because the entrepreneurs were single-handedly juggling hundreds of moving pieces as they launched their companies, Upaya took a 1:1 mentorship approach. We focused our coaching on one entrepreneur, a few months at a time, before moving on to incubating the next one. It was often resource-intensive, but we were reluctant to take shortcuts and our results have proven the “return on impact” for support resources invested early on.

In 2017, we experimented with a different approach – by organizing our lessons and tools into discrete modules that could be administered in a classroom setting over a few days. We also launched an accelerator program that would support eight entrepreneurs over a six-month period. Interestingly, we found the 8:1 approach was just as effective as the 1:1 approach. One could argue it was even more effective.

The accelerator platform allowed us to not only administer training but also fully leverage our network connections. We invited subject matter experts, other entrepreneurs and, of course, investors to interact closely with our entrepreneurs. At the end of the program, the entrepreneurs remarked that the network connections were just as valuable as the training they received. We are now refining our accelerator program for 2018 and assessing the upper boundary of how many entrepreneurs can benefit in the same way, without compromising the quality of programming and overall outcomes.

So, for organizations like Upaya that wish to prime the pump of early-stage entrepreneurs and greatly improve these entrepreneurs’ chances of success, how can they best extend support? In short, we recommend a light but targeted approach to capacity-building, combined with some creative deal-making. More specifically, this means:

• Delivering discrete, “bite-sized” training modules to improve investment readiness: We have seen time and again it is not a lack of business savviness or technical know-how that bars entrepreneurs from securing investment; rather it is simply that they do not speak the same language as investors. Short, targeted training modules – covering concepts like unit model, and the ideal debt/equity mix – are sufficient to increase the entrepreneur’s fluency, and encourage her to think more like an investor. Targeted modules, fortunately, can also be delivered via web services, from anywhere in the world, bringing down costs significantly, and allowing for much greater scale and replication.
• Supporting entrepreneurs in breaking down their challenges into smaller solvable problems and identifying the right resources: Oftentimes, entrepreneurs working on social impact don’t get much breathing room and feel the weight of the world on their shoulders. Hitting the next growth trajectory can sound like a daunting task until they realize that what’s first needed is making incremental improvements to their sales process, CRM and/or financial management system, etc. For an entrepreneur working in the weeds, these steps may not be evident, but from an investor’s vantage point, they’re easier to spot and package into recommendations.
• Exposing entrepreneurs to a wide network (and not just funders): Early-stage entrepreneurs need the proverbial village to help them build critical momentum with their ventures. The most talented entrepreneurs – and the ones most likely to succeed – are hungry for more connections, will invest time to meet peers, experienced members of the business community, and will offer their help in exchange for someone else’s. Thoughtful entrepreneurs are not just fixated on meeting funders; they understand and appreciate that listening to and learning from a wide variety of different stakeholders will contribute to their success.
• Breaking down the investment commitment into smaller tranches: This may seem like a no-brainer, but we’ve seen a number of investors who commit a small amount of capital (say up to $50,000) deploy the funding in one lump sum to the entrepreneur. They may feel that it is too much effort to structure an investment this small and to sub-divide the amount. We argue that it is not, and given rapidly evolving business models and teams at the early stage, any effort expended can protect the remaining capital if the investment were to go sideways. In our experience, it usually takes one working session with the entrepreneur to construct a mutually agreeable milestone plan.
• Incorporating a sliding scale valuation into the term sheet: Many investors rightly feel that valuation at an early stage is mostly art with little science. After all, there is limited to no financial history, including any revenues, and just a proof of concept on the product, and it can be tough to settle on numbers like cash flow projections or multiples to justify a particular enterprise value. However, experienced impact investors can tell that there is an opportunity for return given the team, the market and the product. Therefore, we have started to include an upper and lower bound for values in our term sheets. For example, we will tell an entrepreneur that her venture will be valued at a minimum of $750,000 and a maximum of $1 million and that the exact value will be determined by a 4X or 5X multiplier on gross revenues for the forward 12 months following the investment. This incentivizes the entrepreneur to achieve a higher gross revenue but also gives the investor a fallback lower value if the enterprise doesn’t grow as anticipated.
• Planning for different exit strategies up front: For most impact investors, exits are still an elusive phenomenon; for early-stage investors, the path to a successful exit is even longer. We at Upaya certainly have not stumbled on the magic formula, but with our entrepreneurs, we discuss mechanisms for how they can slowly assume full ownership in 5-7 years’ time. What are the tactics they can follow to slowly buy out their investors, and in a way that does not rock the boat? We are also building relationships with other investors, those that come in at a slightly later stage, and put stock in our selection process. They understand that if they help us gradually exit, this will allow us to deploy the returned capital into more pipeline-building. Every investor along the continuum then benefits.

When Upaya started down this journey, we had a notion that working with early-stage ventures meant intensive hand-holding, patient advisory services administered over many months and tailored support of the needs of individual entrepreneurs. In reality, it’s a lighter lift: short and targeted trainings, network access and creative investment structuring can make all the difference in the world. We encourage more investors and accelerators to wade into this ultimately impactful and fulfilling early-stage territory, and look forward to working with many of them going forward!

Above: A worker at Tamul Plates (an Upaya investee) works the pressing machine to produce tableware out of indigenous palm tree leaves.

Sachi Shenoy is co-founder and chief impact officer of Upaya Social Ventures.

Nathan Byrd is a board member of Upaya Social Ventures.

Photos by Laurel Curran