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Archive for the ‘Along the Way’ Category

Wondering how to structure your social enterprise? Wonder what an L3C is and should you be for profit, nonprofit, a hybrid and if so which should own which? Spend a day noodling over such issues with a national tour organized by Criterion Ventures. I worked with Joy Anderson and Jackie Vanderbrug while at Good Capital and they’re definitely “right people”.

Structure Lab is an easy-to-engage, day-long process that helps social ventures take advantage of innovations in capital formation, revenue streams, corporate forms, and independent regulation to promote and protect values and mission.

With support from the David and Lucile Packard Foundation, Criterion designed Structure Lab to explore the range of legal structures available for your venture, whether it’s still on the drawing board or poised for growth. Come create the optimal legal structure for your social venture to thrive.

Check it out!

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As a board member I’m always interested in what best practices are. We’ve had some discussions on one board that has two issues in my mind: one, how much we should keep in reserves to balance prudent management with not seeming too flush for more funding; two, being thoughtful about balancing perceived high overhead expenses with good investment in capacity.

I was in a funder meeting yesterday and the speaker made a reference to less than 30% of nonprofits meeting a standard of 6 months expenses in operating reserve. She referenced the Nonprofit Finance Fund as the source of that standard but what I actually see is the stat that 31% did not have 3 months of expenses. So I take it that a nonprofit should have at least 3 months in reserves, and that someone from Grantmakers For Effective Organizations has it in her head that 6 months is a good idea.

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A Shareholder-eye view

I went to my first corporate shareholder’s meeting today – for Microsoft in Bellevue. I never went while I was an employee, we used to joke that it was at 8 am specifically to dissuade programmers from attending. I checked with someone afterwards and the content of the meeting is public, in fact you can watch it in webcast from the shareholder information section of the website at www.microsoft.com/msft. It was, in many ways, smaller than I expected. Sections were short, simple and to the point. The entire meeting, including shareholder resolution presentations, a short discussion of the business from Steve Ballmer, plus Q&A, was only an hour. Attendance was maybe 400 people? I ran into someone I knew from working there afterwards and he said in the past meetings have been much larger.

Most of the attendees were older folks, I’ll hazard a guess that the average age was at least 65. In fact on my way out one gentleman was seated in a chair and being checked over by emergency personnel. The attendees seemed primarily like direct shareholders from their questions in the Q&A. Before and after there was a product fair with stations demoing flagship products of Bing, Windows 7, the phone, Zune HD, and maybe one other. I snagged a Bing pen and watched the Microsoft person help two foggy-voiced gentlemen who wanted to search for “1970 chevy engine rebuild”. He showed them how to play around with quotes or not quotes to better their results, and was patient when one seemed to need to be 2 inches from the screen to read it.

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Reading the Equal Exchange Blog I learned they have a member who is getting a masters in cooperative (and credit union) management. It’s an online program through St Mary’s University of Halifax, Nova Scotia. According to their Spring 2009 newsletter “It is the only Master’s degree in co-operative management offered in English by an internationally accredited business school.” I’ll speculate Mondragon University may offer a degree but in Spanish.

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I’m not generally a breaking-news blogger, but This Just In courtesy of David Smathers Moore, founder of the Teamworks Cooperative Network in San Francisco. Mondragon and the United Steelworkers union have signed an agreement to work together and develop hybrid union-cooperative process. Initially the unions will seek to implement Mondragon-style share ownership options when collective bargaining (as opposed to agreeing to ESOP structures), and Mondragon cooperatives will integrate the union collective bargaining structure into their governance structure. Baby steps, but very interesting ones!

Read it from the USW here!

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I have an SRI fund manager that I really love, and nearly a decade of experience with them and good performance. I spoke recently to a consultant about them and he was having trouble getting excited. He admitted there was nothing he would really ding them for but that they didn’t float to the top of his column. As I later pondered his general concerns with a friend she came up with the phrase “repeatable process”. That really sounded like a good capture of his concerns for me, and a logical thing he might be looking for. Certainly as an investor looking at companies I want to see repeatable process – in a startup there needs to be at least a few, because growing a company is all about designing and re-designing repeatable processes.

In selecting a fund manager it makes sense to do the same thing – look for repeatable process, but I found myself thinking that SRI shops that’s probably less likely. Sustainable and Responsible Investing (following the lead of Calvert following the lead of Good Funds in renaming Socially Responsible Investing) is about investing in companies and transactions that bring people back into processes. It makes sense to me that the investment funds and managers themselves would be the same way. I could make an argument that it brings more risk into the equation, but I will instead argue that it brings more thinking into the equation as well.

I use an investment advisor and one of their roles is to check up regularly on investment funds and follow up on personnel changes at fund management companies to respond if that change seems likely to impact future performance. It seems to me the advisor layer is perfect for mitigating any additional risk brought on by my funds using people instead of processes, allowing me (and the companies those managers analyze) to benefit from their creative and engaged thinking.

Standard investment advisor practice seems to instead be to focus on repeatable process – creating an unnecessary barrier to understanding, respecting and fully utilizing the value of SRI funds. Perhaps it minimizes the advisors workload but it reduces their value as well.

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The general idea seems to be capital that is willing to wait longer to get a return. That implies to me that eventually, there will be a return, and perhaps further, that said return will be a respectable one. I’m thinking at least market rate for equities over that period of time, and so I would be choosing to do the patient capital thing because I get the satisfaction of pursuing a specific social good or I’m diversifying away from public equity.

I think sometimes “patient capital” represents a reaction against the classic venture portfolio model. That portfolio model is to invest in a series of potentially-high-return companies such that if one hits big it can cover the loss of all the others. In that model, the portfolio companies are pressured to grow very quickly. I’ve come to believe that the high-risk, high-return investment style may be a self-fulfilling prophecy – that growing big quickly IS riskier than growing slowly – there’s little time to orient added employees, develop a thoughtful employee culture, refine internal systems, or establish track records with suppliers, all of which increases the risk that the company will fail.

Is rapid growth really necessary except for rapid returns? Not every market is so competitive that it’s critical to leap to the fore. Network Effects (which create significant advantages for a single market leader) can be huge in new technology, but I’m not convinced they play a big factor in the specialty food industry. When Woody Tasch talks about the Slow Money movement, he’s talking about the idea that investors can instead invest in lower-risk, longer-to-return investments, and still come out as well because while you’re making less money per investment you’re also losing less money overall because fewer of your companies go under.

A challenge with these modest growth plans is that I don’t see how one can construct a self-replenishing investment fund with a time horizon of less than like 20 years. Capital will become captured in the permanent working capital of growing, healthy businesses who need to eventually switch to a “harvest” mode and begin paying out returns to release the original capital. Some community development type funds have had success in generating value (Renewal Partners and Pacific Community Ventures come to mind) but they also still have their initial funds tied up and have raised more money to invest in new ventures. How patient will that capital have to be to turn over? It’s as yet unanswered. To some extent, this is also the role of a bank – longer time horizons, unglamorous returns. But a bank can only step in once the business models are proven – the initial experimental capital has to come from somewhere else.

This gets to the capital in the middle – not philanthropy, not market-rate investing, but essentially grant capital to develop more socially desirable business models. The “investors” need to be conscious of the risk they’re taking so they are consciously spending these dollars this way – not every experiment will lead to an investable proposition, in fact most will probably not. So we’re back to the high-risk/ high-reward strategy, but as patient capitalists, without driving companies to try and be high-reward. We could try to build into the model “equity kickers” that allow the fund to capture the rare “pop” that will then pay for the R&D on all the ideas, but from I’m not convinced it could be self-replenishing: in which case it has to be treated more like grant dollars. We don’t have tax-advantaged models for doing this easily – L3Cs and PRIs will only go so far. Still I think investors with social goals need to explicitly make these grant-investments – you can’t get change without taking risks. Entrepreneurs and investors trying to do something never done before need to look to non-profit models for giving a social return – “donor” engagement, detailed reporting, social metrics.

One problem I see now is investors and entrepreneurs confusing the two types of social capital (experimental and patient): thinking there’s a good business plan to do something new and ignoring the risk involved with the unproven. Investors think they’re investing and entrepreneurs are overconfident about their initial model. Then the company is essentially recapitalized in round 2 or 3 once they manage to demonstrate a successful business model and its true worth can be assessed, if they make it that far.

Another problem is the failure to consistently pursue like-minded capital. A patient portfolio succeeds when investments are low-risk, and an aggressive portfolio succeeds because its investments are potentially high-return. Mixing those two styles of investors in one investment will not likely work for both – one group will be unhappy, and the entrepreneur will inevitably be unhappy too.

Net, we need more experimental capital, we need the social metrics to give that experimental capital at least a social return, and we need social entrepreneurs to focus on developing truly investable business propositions at minimal cost so we can keep social capital funds replenished.

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I attended a webinar last week on Rural Entreprenurial Development Systems or “EDS”s.
It showcases a report funded by the Kellog Foundation and describes a three-year project to work with six sites on creating “Entrepreneurial Development Systems”. The report summaries those experiences and draws lessons on structure and strategy. The webinar introduced the concepts and had presentations from two of the EDS participants.

For this study an EDS should aim to create three key situations:

  • a pipeline of entrepreneurs
  • a system of support
  • a culture of entrepreneurship

These precepts rang familiar to me from a report my friend Mina Yoo did in 2006 with folks from the University of Washington Business and Economic Development Center: Regional Economic Development for the North Central Washington Region. That was my first exposure to the idea that entrepreneurship is a bit of a mindset that can be supported by a local culture – things like emphasizing calculated risk-taking and acceptance of failure. How? In the kinds of stories reported in the local papers, or examples discussed in education and training programs. They also suggested identifying success stories and recognizing them at a community level; and building a culture that embraces newcomers and takes advantage of what knowledge and outside resources they can bring. The UW group posited culture as a foundation that the rest of entrepreneurial support builds on.

In the FIELD webinar we heard from John Parker who leads a project supported by the North Caroline Rural Development Center. They have defined a set of 5 Pillars of Support needed to build a supportive community for entrepreneurship. Their five pillars resonated with my experience in urban entrepreneurial development as well. They are:

  • Education – teaching folks to make informed business decisions
  • Technical Assistance – business services and information. I’ll categorize education as more towards the theory side and TA as more towards the practice side of business.
  • Access to Capital – from a systems perspective an EDS should work to identify gaps, as well as educate entrepreneurs
  • Access to Networks – help folks identify service providers, collaborators, mentors
  • Leadership & Policy Development – again at a systems level, look at tax and regulatory policies and how they can support entrepreneurship.

The work being done in North Carolina is at a state level, working to connect many disparate systems and services. One comment that interested me: John reported that entrepreneurs are often shy about asking these resources for what they need. He said they emphasize to these owners that such services are provided with their tax dollars, so they certainly have a right to use them!

The other presenter on the webinar was Mary Matthews from the Greenstone Group. They are focused on a region of Minnesota and have a targeted approach. From their website: “The purpose of the Greenstone Group is to increase the number and skill levels of entrepreneurs and thus build business wealth and employment through the growth of successful locally owned companies.” Some of their activities focus on building the pipeline. Further, they have a clear focus on moving businesses through the pipeline. The businesses they work with need to have been in business for several years already. For Greenstone, their areas of focus are:

  • Entrepreneurial development via coaching and training
  • A professional service provider network to help Entrepreneurs access the right services at the right time
  • Campus connection to community colleges, again building that pipeline
  • Civic engagement to foster a supportive environment

Greenstone seeks to create “entrepreneurial transformation” and see change in their targeted businesses as Operators start acting more like Managers, Managers learn to be CEOs, and perhaps beyond the program CEOs will develop themselves beyond – into investors and managers of multiple companies. It’s a leadership program focused on developing the skills of the entrepreneurs rather than the broad bucket of creating opportunities for supportive transactions that address needs like financial planning or marketing help.

The webinar was presented by FIELD, the microenterprise-focused sub-section of a larger Economic Opportunities Program that “focuses on advancing strategies that connect the poor and underemployed to the mainstream economy”. The programs are part of The Aspen Institute, a national organization in DC. I’m somewhat familiar with FIELD because they run the Microtest program that Washington CASH has participated in for several years. Microtest uses a summer-long intern and does a deep evaluation of the program and over the last several years has consistently shown that Washington CASH reaches a lower-income population than any other microenterprise org in the country, and yet shows solid income improvement for more than 75% of clients after a year.

All in all, some great system-level thinking on how to support entrepreneurship!

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Capitalism 9

9-9-09 has come and gone. A friend’s birthday and a couple Hollywood movies with 9 in the title were the biggest events I noticed, perhaps it had the disadvantage of being a Wednesday. The 9 on my mind recently is Ice-Nine: a fictional form of water invented by Kurt Vonnegut for the book Cats Cradle. Ice-Nine is a lab engineered crystalline form of water that is “frozen” at Earth ambient temperatures. When it comes in contact with any other water, those molecules quickly align onto the Ice-Nine structure, also now becoming frozen. As you might imagine, Ice-Nine was a fairly deadly substance and by the end of the book the world pretty much ends, frozen.

That’s a bit melodramatic, but the concept that Ice-Nine has this structure that it communicates to any additional water molecules it comes in contact with is brought to mind for me as I study banking and think about it as a core part of how our economy works. Bankers have a lot of rules – perhaps a little bit like the FAA – each rule added after some deal or series of deals crashed and burned. My banking instructor has a great saying that you should not “take ownership risk for loan-ership rates”. It’s in banking that the concept of a risk-return curve truly makes sense to me – you have a loan pool, you build a loan portfolio to a specific return profile, you can afford to lose a specific number of dollars and still make your numbers, period. There is no unpredictable equity upside that makes the whole thing a bit of a gamble. Lenders do an insane amount of verification, as anyone with a business loan probably already knows, because it’s all about managing that downside risk.

I find myself thinking that lending institutions are like Ice-Nine – that in order to interface with them you have to conform to their structure. Their structure is driven by minimizing downside risk and unsurprisingly has a narrow interpretation of what a successful business looks like – ratios like the quick ratio and the current ratio, debt-to-equity ratios and turns on payables and receivables are all expected to fall within industry norms. Businesses who need credit will find themselves shaped into a box where success is known to have been achieved before.

There is recognition that businesses will vary across industries and so norms are by industry. The RMA is a national association for banks that has existed since 1934. One of its services is that every year member banks submit the (anonymized) financials of their borrowers and RMA compiles them and produces Annual Statement Studies that summarize key ratios by NAICS code, broken down into buckets of company sizes (by sales or assets) and split out into top quarter, median, bottom quarter values. Most libraries have a copy in the business reference section, and it’s a way to see how successful businesses (that use bank credit) are structured financially. It includes things like gross & net profit margins too.

Understanding high-probability success is a great thing, particularly because the flow of value internally in a business is complex. Small businesses by their nature of having few employees have more generalists than specialists so roadmaps are helpful. However roadmaps will only take you the same way everyone else is going. If you want to run your business differently – having stronger relationships with your supply chain and perhaps carrying more than industry standard inventory or paying your employees more than industry standard wages and benefits, you’ll need to find specialized partners willing to hear you out on why your differences are better.

To some extent community development lenders fill this gap – as non-depository institutions they can take a little more risk in the name of supporting the local economy. A few creative banks are in this space as well, but they’re so few that while looking at a socially responsible investment, when they mentioned they had some traditional bank debt I was able to name the bank on the first guess. Building confidence in different models is another system change that needs to expand to support community stakeholder businesses, and perhaps building examples of financial models, and new ratios to watch will be part of that. Better yet, we need lenders that aren’t just be open to different models, but can also mentor to them.

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A friend is an independent Registered Investment Advisor. That means she works with clients and helps them plan their investment strategies and carry them out. To do this, she needs to work with a brokerage to get access to the stock market and execute trades. Most online brokerages like Fidelity and Schwab and others have the concept of an Institutional Account – a single account for the investment manager that then has sub-accounts for each client, allowing the investment manager to easily access client accounts to execute needed trades and to pull the agreed-upon fees on a quarterly basis. This infrastructure is a core part of her ability to do business and she currently works with Fidelity. However her experience is that these large platforms are raising her fees to an unsustainable level and have frankly admitted their goal is to get rid of small accounts like hers because they deem it not worth their costs. This seems crazy since it’s almost all software – she noted she rarely speaks to a person at their company.

I’m in a small-business financing class currently and our instructor does consulting with large companies that use distributors for their product – some gas/oil companies and some beverage companies. One company he is working with has decided to cut off all distributors that are smaller than 1 million a year in business because it’s not profitable to work with them. From one perspective I can see this as a shining example of getting smarter and more efficient from the perspective of the central product company, really understanding cost and revenue matching and shedding business that is holding your profitability back. Yet I also see this as another death of opportunity for small business, another avenue closed.

When I think about the obstacles to success in small business, I see more and more obstacles that aren’t related to capital, and certainly aren’t related to willingness to work hard, but are instead formed around lack of connections to friendly infrastructure: mentors, suppliers and distributors. In my readings about international microfinance, a cited advantage of loan groups or associations is that the group also forms a supportive first market for budding entrepreneurs – an economic nursery log. I’m also coming to see festivals that way – I’ve seen a few food businesses start out as booths and build a clientele before jumping into a restaurant. We need more opportunities like that, more reefs for businesses to build on if we want to have a thriving economy.

I’m planning to go to a conference this fall on “The Economics of Peace” . In the brochure there was a quote ““Most Americans don’t realize that a middle class is created and maintained by direct intervention in the marketplace by a democratic government, including laws protecting labor, defining minimum wage, and taxing great wealth” by Thom Hartmann. He elaborates here. It’s a broad statement, but it resonates for me.

I’m not sure what the fix is for the above situations: I don’t want to suggest that government should interfere directly in private companies, government’s role should be in constructing the playing field. Howver increasingly our playing fields are provided by private companies (like Google) because controlling a marketplace is a great route to profitability: think the Apple iTunes store. The problems come when that market owner uses their power to squeeze the players, (I’m thinking of the palm precursor to the iTunes store called Handango) creating lots of dislocation, and yes, opportunity for the next market maker, but small businesses are left trapped in a tumble cycle – a few will grow their way out and many more will wash out.

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