Values of Impact Enterprises Beyond Financial Performance
Impact VCs¹, when asked a question about the “exit planning” of their portfolio companies, often responded, jokingly of course, that they “pray, in most religious manner possible”. Exit is always the obsession of all VCs. We start to think about exit from our first meeting with the entrepreneurs and constantly adjust our thinking about it based on current market situations. Exit also represents a paradox to most of us: the more we are worried about not having a good exit from a company, the more we pressurize management to improve their performance, straining the relationship and negatively impacting the outcome.
In reality, nobody knows where and how exits would come from. External factors like market sentiment matter a lot. Exit is especially more challenging in the impact investing space, where the exit track record is sparse, with only microfinance business model has clearly emerged as a winner². Nevertheless, since exit-ability is always going to be a critical factor in making decisions, exit planning is still a mandatory exercise for all Impact VCs.
Let us start with the most obvious exit-ability metrics that all start-ups are aiming for: scale and profitability. In my personal experience, I have not seen a single company providing a 5-year financial projection that does not end up having dominated the market and doing so profitably be the end of year five. Most of the time, when they have a good team and we believe their planning is realistic, then we make the investment. If the projection becomes reality, then we would be in a perfect position to get the best possible value at the time of our exit, be it through public listing or private acquisition by financial or strategic investors. However, the journey of an impact enterprise is more often than not tumultuous rather than following a straight line (let alone a hockey stick kind of trajectory). Therefore the VC and the company should prepare for alternative value propositions that could provide complementary values to potential suitors in the case of financial performance not yet reaching the target for an ideal exit at the end of the investment horizon.
1) Access to low-income and/or rural market segment
While large corporates in general know how to develop products and services for the affluent urban markets, the capabilities required to tap into the low-income segment are very different. Impact enterprises, with years spent understanding this market by developing the right products with the appealing marketing approaches and appropriate distribution channels for them, are attractive acquisition targets. Financial inclusion companies Mapan (acquired by the unicorn Go-Jek), Kudo (acquired by another unicorn Grab), and Express Life Ghana (acquired by Prudential) are examples of how access to low-income markets is very valuable to strategic investors wanting to expand to this segment³.
2) Access to sustainable supply
Socially and environmentally conscious customers are rapidly moving in towards sustainable agricultural products. They need to know exactly where the products come from, who produce them under what conditions, and how the proceeds are distributed to the producers. Many impact enterprises are in the forefront of the sustainability movement and have exclusive access to specific segment of producers. Etsy, who is doing good by empowering the creators of handmade goods, went through an IPO in 2015 despite not yet reaching profitability⁴. Burt’s Bees, a personal care company that brands themselves as “earth-friendly company” was acquired by Clorox as early as 2007. There are many other commodities that either having supply issues in general, like cocoa, or having troubles establishing sustainability credentials, like seafood, that would benefit immensely from having impact enterprises sorting out the ways of improving the integrity of the supply chain. The big corporations are taking notice and seeing value in the successful ones.
3) De-risked technology
Impact enterprises developing innovations with technologies serving the poor could implement a dual approach of (a) trying to get the low-income segment buy and use their products and (b) trying to prove that their technologies are also relevant for large companies. Many start-up companies are struggling with selling to the poor because they don’t have resources to do the necessary groundwork of customer education and financing. They should not not trying to do (a), but they should always do (a) and keep an eye on (b) as the latter one represents the most feasible way of getting an exit.
Each of the main clusters of technological innovations, namely agritech, medtech, edtech, and clean energy tech, have different industry dynamics. Big agriculture companies are already setting up their own investment arms to look at start-ups in farm technologies like IoT sensors, drip irrigation, weather forecast, and soil analysis. In edtech, firms like Pearson has been active in making investments in affordable learning through PALF. With their VC investment vehicles making early-stage investments, there is strong indications that the parent companies are ready to do later stage acquisitions as well.
What does “de-risking” mean? Basically if the company can prove that the product is effective beyond small lab scale, reasonably durable, barriers to adoption is low, and there is economies of scale in product manufacturing, then the company has a value proposition to offer to potential acquirers.
4) Impact credentials
Impact credentials can also attract potential buyers. There are two kinds of motivations underlying the interests: It could be to adapt impact and sustainability principles in the acquiring company, or it could just be to label themselves as “impact” (impact-washing). It is not easy to determine whether an acquisition is motivated mainly by impact credentials or not because, it is like admitting that the acquirer has a bad track record in sustainability matters. There are also other factors other than impact credentials that might come into play as well. However, I would guess that some acquisitions like Bumble Bee’s takeover of Anova Seafood, and Aditya Birla Fashion’s acquisition of Jaypore, could at least be partially motivated by impact credentials.
The fact that tech unicorns like Grab and Tokopedia are issuing impact reports is an indication that there is a global trend to move towards impact and sustainability, either for consumer marketing or to tap potential investors with sustainable mindsets.
None of the above four values are sufficient in itself to make a company attractive to potential acquirers. A certain level of scale and a certain level of profitability would still be needed to ascertain acquirers that they do not need to put excessive amount of additional capital to bring their target companies towards being financially sustainable or fully integrated in the acquirers’ main businesses.
Exit opportunities could come from any directions and at any stage of the company’s journey. Having clarity of value propositions of the company, beyond traditional metrics of financial performance, could be instrumental in preparing the Company and the VC to safely navigate the uncharted and unpredictable territory of the “exit marketplace”.
[1] Those who invest in equity or quasi-equity securities, often from a fund with 10-year duration with 5-year investment period and 5-year exit period in which they have to get their money back to the fund’s limited partners
[2] Check out my previous article about it here
[3] Some large corporates like Unilever or Bank Rakyat Indonesia do have access to low-income segment customers, so this is not a universal point
[4] Share price of Etsy has since been quite volatile. Etsy also offers a cautionary tale about how short-term pressures can kill off a high-minded company mission. A hedge fund investor forced Etsy’s “Values-Aligned Business” team, which ran social and environmental efforts, to close down, and the company is no longer a B Corp, a certification indicating a commitment to high social and environmental standards.
