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Archive for the ‘Capital Thoughts’ Category

What’s the difference between an investment and a grant?  The obvious difference is that one is to make money and the other is to make change.  What happens in social impact investing where the goal is to do both?  That question has been on my mind lately as I look at a couple potential social impact investments.

The current investment I’m looking at is a non-profit aiming to spin out a commercial enterprise to run a potentially self-sustaining (and even lucrative) social business.  The trouble is that the project is so early stage at this point that it’s questionable whether it’s an investable enterprise or should be considered a research project – the kind that if they were coming from the for-profit world we’d all be trying to get grant funded.  However coming from the non-profit world there seems to be a bit of a pinnochial urge to be a real boy and they’re determined to incorporate.  As someone who could write a grant or could make an investment I’ve been pondering which I’d prefer they be at this stage.  There’s a level at which I myself want to be a real investor and that makes it far more comfortable to write a grant because then I don’t have to measure my success based on the return. Research projects can be successful by proving their hypothesis unfeasible but that’s less palatable in early stage companies.

As a social impact investor I’ve gotten comfortable in the space referred to as “a concessionary return” – but for me that means lending at 2.5% to CDFIs.  I’ve gotten some looks at anticipated negative returns – I know of a fund that lends at 0% and covers the cost of operations out of the fund so inevitably it consumes a low but steady % of the capital on an annual basis.  I haven’t “invested” in that fund and my understanding is the original investors established it with a grant, wisely enough.  That reinforces my distinction that for an investment there should be the expectation, at least the opportunity, of getting at least the original capital back. With this new opportunity it is at least technically possible for me to get the capital back – there are no structural or legal barriers, it’s just a question of risk.  So I cannot categorize this as a grant situation by my one bright line rule.

From a tax perspective there aren’t many differences to my portfolio between making a grant and writing off an investment.  If it’s a grant, I can control the year in which I take the write-off, with an investment I have less control.  If it’s a grant then it’s part of my total granting for the year which is subject to a maximum % of my Adjusted Gross Income (although there are few years that I’m close to that), if it’s an investment loss I don’t think there’s an AGI limitation.

What is becoming clear to me as I think about this investment is that, when it’s an investment, I am more invested.  I inquire more deeply about the capacity of the organization to fulfill the mission, and I will certainly be doing better followup – at a minimum I need to figure out when I get to write it off.  In the ideal situation (which I think is actually rare) I’m monitoring performance and able to add help along the way. Perhaps this means I’ve been a second-rate grantmaker to-date, and this is why grantmakers have begun using investment language: to distinguish what they do as including these sorts of practices standard in their grantmaking. If I were to make this investment as a donation it would be much easier for me to walk away shortly after writing the check. All I need is the receipt.

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A nonprofit I’ve supported for many years has been working on payday lending.  It has become a big issue nationwide – the Bush administration capped payday loans to military families at 36% APR and many states have followed.  An obvious thought is, if it’s such a lucrative business then why can’t a more socially motivated but still financially successful business undercut existing players?  One investor suggested to me that as a lending business you either have to be really good at screening (not the payday convenience model) or really good at collections (not the socially motivated model!)  The basic model seems to be that you do some screening and you charge huge APRs so the fund can withstand big losses.  What’s a big loss?   A bank loan fund might normally be designed with a 2% loss reserve. Nowadays banks are probably reserving 3-5%.  A Community Development Loan Fund might design for a 7-10% loan loss reserve.  A payday loan fund might be designed for losses up to 40%.  That means many good citizens paying high fees to cover their bretheren (as well as the costs & profits of the middleman).

Credit is more than just getting loans.  Folks of all income levels use credit for “consumption smoothing” – basically helping match lumpy inflow (bi-weekly paycheck or irregular investment income/liquidity) to lumpy outgo (monthly bills, unplanned expenses, opportunities).    Credit is usually provided by a bank, but a significant portion of the US population is not getting their needs served. Access to credit and financial services is a concern to the FDIC, in a 2009 survey they concluded that 7.7% of all households are unbanked and 17.9% of all households are underbanked. A 2005 paper for the FDIC describes Alternative Financial Services (AFS) as including check-cashing, pawn shops and rent-to-own along with payday lending.  This is in contrast to the Financial Services sector of banks, thrifts (Savings & Loan), brokerages and mutual funds.

The FDIC defines “unbanked” as no one in the household has a checking or savings account.  “Underbanked” means someone has a checking account, but has used alternative financial services at least once or twice per year.  To the above list they also include money orders, and FDIC also considers someone underbanked if they’ve used a refund anticipation loan at least once in the last five years.  Other reading I’ve done notes that overdraft protection can be regarded as a kind of payday loan in that it is a short term loan with very high fees.  The challenge with overdraft protection is that its not always consciously chosen but accidentally done! This is enough of a problem that in November of 2009 the Federal Reserve issued new rules for banks to require customers to opt-in for overdraft on debit and ATM cards.

It’s the fees when annualized that make short-term loans so expensive.  Part of the bad reputation comes from the assertion that customers end up being repeat borrowers and rolling their loans over repeatedly and so paying those high rates for long loans. Do they?  A Washington State Department of Financial Institutions study from 2008 shows that just under 20% of borrowers are one-time borrowers. However that’s for a total of 2% of all the loans, because from there there’s a very long tail of repeat borrowers that get up to borrowing 19 times in a year before any group accounts for less than 1% of the total.  Add them up and 60% of borrowers have borrowed 4 or more times in a year.

Convenience & less hassle seem to be the big market drivers for payday loans.  According to Moneytree, all you need is proof of employment via paystub, though in California and Colorado they must also require an active checking account.   I’ve heard that payday lenders don’t report on your loan so if it goes bad it doesn’t impact your credit score.  The application process is minimal and the turnaround can be less than an hour.  I suppose the mainstream financial system equivalent is a credit card. A quick browse of Moneytree’s website shows a company that offers a huge menu of financial services: check cashing, payday loans, prepaid cards, coin counting, bill pay and more!  It seems to be the interface to the mainstream financial system for people who need it, and that’s what the industry argues: they provide a valuable service to customers who need it and shame on us for turning up our noses and trying to regulate them out of business.

I recently re-connected with a high-school friend whose life has taken a very different direction.  She has much more experience than I with living on the financial edge.  She was really frustrated by the automatic overdraft protection and is the one who told me her bank switched to opt-in recently.  She married a guy who has bad credit and collection issues. They’ve solved that by putting everything in her name but I get glimpses of what life must be like if you have bad credit. She told me that most of the “free credit report” websites are basically honeypots to collect personal data and pass it on to collection agencies.  She made some other comment about things they can’t do, I think one related to travel, because it might get the hubby identified by collections.  They’re both gainfully employed and decent citizens, but I have this image of a twighlight financial/legal status that, while probably not that melodramatic, definitely sucks.

Yesterday I stopped into my local Wells Fargo where I got my 2nd pitch to change my current account setup and this time I decided to bite out of curiosity.  I sat at the desk with the banker and heard about how I could set up a different checking account that would give me some number of free cashier’s checks and money orders, and if I set up an automatic sweep into savings and kept the money there it could earn 3% interest! Kudos to Wells Fargo for creating a savings incentive and at this miserable time 3% is quite impressive. (Did I ever tell you about the 8% CD I had at Navy Federal back in the 80s? Those were the days….)  I was curious about the heavy pitching of money orders and cashier’s checks,  I can’t remember the last time I got one personally, so I asked.  He said that more and more folks are using money orders and cashier’s checks instead of regular checks because the money comes out of your account at the time the check is issued. Apparently that’s easier for people to manage though he added that it’s much easier to cancel a regular check if it gets lost (so I gather that’s an issue).  He also said that 150 checks is a lot to have lying around if you’re not able to be responsible with them ( I guess from a security standpoint – roommates, family members?  Possibly a self-control standpoint?)   As I walked in the door at home 15-minutes later and fished out a still-undeposited 7-week-old check from a relative (d’oh! I was just AT the bank)  I found myself thinking that yeah, if you’re managing very close to the line the uncertainty of personal check cashing and clearing could be a pain.

Based on the above, my thinking:  if you have bad or no credit score (I’ll lump “in active collection” under this), if you live in physically insecure circumstances where you want to have your finances with your person at all times (so no checks or cards you leave at home), if you are not comfortable with accrual accounting or managing your check register and so live on a cash basis (which I think LOTS of people do: that crazy bestseller Rich Dad Poor Dad is basically about getting off of a cash basis for looking at personal wealth)  or frankly, if you’re just tired of putting your paycheck in a bank where they find a dozen reasons to ding you for small fees because as a small customer they don’t make enough money off you – minimum balance fees, overdraft fees, holding deposits for days, clearing things in the order that maximizes bounce fees and then charging them repeatedly while being slow to notify you – then you are trapped living on a cash basis – little access to credit for the float we all use, little access to automatic bill paying or online purchasing.  No wonder the FDIC is concerned –  is it healthy for our economy to say 25.6% (the Unbanked + the Underbanked) don’t get to be full players?

Hmm, maybe that IS the problem, that in a for-profit banking system, some people are just not profitable enough.  I know a credit union working to serve folks better, but interestingly it’s not tax-deductible (and might even be taxable!) to donate money to them.  Much material for future thinking and blogging!

Mark Flannery & Kathryn Samolyk, 2005, Payday Lending: Do the Costs Justify the Price
FDIC studies on the underbanked
Federal Reserve announcement on overdraft protection
Wa State DFI 2008 Payday Lending Report
FDIC small dollar loan studies
A feast of services from our local Moneytree. Regarding Payday Loans: “As an analogy, while you would not choose to take a taxi from Seattle to San Diego or Denver to Las Vegas, it is common to take a taxi for a short distance, such as from your hotel to a nearby restaurant.”

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In the last month I have listened  to two manager reports for some traditional private equity funds. I find myself ruminating about the structure of capital markets and how multi-layered they are.

The first call I listened to was for an international fund-of-funds. It was really interesting and even a little bit intimidating. It’s almost a stock-trader view of the world but from a next level up – As a fund-of-funds, their level of focus is on the marketplace of company valuations: entry and exit multiples (of EBITDA or Earnings Before Interest, Depreciation & Amortization… one common view of the value a company generates).  They compare private market multiples to public market multiples and the gap between the two.  So it’s much like stock analysis but instead of looking at P/Es they talk about EBITDA multiples.  (IE this company got bought for 1.5x EBITDA, then got sold some years later for 2.3x EBITDA)   They look at availability of investment capital (“market participants report high valuation due to significant dry powder in Indian PE market and strong public market recovery.”), They look at the availability of debt financing. They look at examples of exits and what the returns on those have been.  One speaker commented that “public market competition for buyouts creates valuation pressure.” To translate – a well functioning IPO market raises the cost of buying companies because they have an alternative exit opportunity for their investors, so buyers can’t set price as easily.  That suggests to me that our poorly functioning IPO market creates better buying opportunities for large corporations because growing companies have fewer alternatives.

Sources of investment capital, as well as activity in exits, were categorized as “buyout” “growth” “venture”.  They also note PIPE (private investment in public equity) financing as a significant (16-25% of total financing over the last 5 years) source of investment capital. I’m not sure if there are PIPE-focused funds, I didn’t notice any in their report.  This fund has done co-investments so they’re doing some direct deals.

For opportunities they look at countries and macroeconomics – GDP growth, consumer spending, net exports, inflation, government interventions.   In China, domestic IPOs are becoming a leading exit opportunity for Chinese companies on Shenzen SME board and ChiNext.  The government is also forming policies more friendly to foreign capital.

The intimidation comes in because I realize that this is a perspective and information flow that really understands later stage round valuations. Those valuations are essentially entry multiples for these funds who will grow companies more before looking for eventual exit opportunities. They are tracking those entrance & exit valuations as a market.  As an angel investor looking to invest in companies that might eventually get bought out to give my money back, I’m feeling like somewhat of a doofus to be making investments with no clue as to those larger market forces which will totally shape my own markup/down/exit opportunities.  What would really help me is to have quarterly calls with a fund like this one that is invested in US markets, in the same kinds of companies I want to invest in.

I also recently attended a meeting for a private equity fund.  This fund invests in companies at a later stage, grows them, and perhaps at one time a fund like this might have taken them to IPO, but this company seems to get “realizations” (IE money back out) through a mix of a couple IPOs, some additional investments from other capital players, and some complete sales to another larger entity.

The combination of these meetings really has me visualizing the current capital market space as a complex food chain – perhaps not unlike how I’m learning that beef cattle are brought to market.  Cows are born in a “cow/calf” operation and raised until they’re weaned.  Then they have a “stocker” stage where they’re raised until 600 or 800 lbs and that can often happen at a different farm. Then they’re “finished”, which for commodity beef usually happens at a feedlot – they’re fattened up with grain.  (This is where “grass-fed-beef” comes in, instead they’re finished on grass.) Then they’re sold to a packer who slaughters & butchers.  All different stages, often all different ranch operations adding value (weight) to the same cow.   In the corporate world, these layers are an intermingled mix of venture, private equity, and buyout funds, with larger corporations and, decreasingly, the IPO markets playing packer.

If this is a reasonable metaphor (though I’ll hazard a guess that the stages & players in the beef market are a little better delineated than those of the capital markets, simply by the process being older) then this poses serious challenges for bringing any business to scale, especially a socially conscious business.  Growing beyond a regional business means you need a pipeline of these later pastures.  If you’ve started out with your first layer of the capital markets being a CDFI funder or an angel group, what are the odds you’ve got connections into the next layer?   I now know of a few social-impact focused venture or early-stage private equity funds, but we’re missing the buyout funds that can play stocker or finisher.

At any level, smart investing is going to require being aware of who the next stage in the pipeline might be.  At the angel level, to build real-economy businesses, I think we need more focus on building regional businesses and exiting via cashflow.  To-date I’ve seen ONE deal with this focus out of several hundred.  J-curves that can exit without all this capital infrastructure are for intellectual property businesses like software and biotech that can have 90% net margins, the rest of us need to get the stars out of our eyes and focus on the business of business.

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Sister Judy Byron from the Northwest Coalition for Responsible Investment (NWCRI) came and spoke to the Seattle area SRI Happy Hour for March.  NWCRI is a  member of the Interfaith Center for Corporate Responsibility (ICCR) .  Pam Rivers noted you can follow ICCR on Facebook and they have good posts – check it out!

Sister Judy started her presentation with some background: ICCR was founded in 1971 and began by asking General Motors to divest from South Africa.  That eventually grew into the larger divestment movement, which Bishop Tutu cites as one of the five reasons apartheid finally ended.  Today ICCR has 275 institutional investor members. Members must be faith-based, though there are Associate members  who are not faith-based and who collaborate with ICCR in filing resolutions and dialoguing with corporations, and affiliate members like As You Sow.  NWCRI was founded in 1994 as a  program of the Intercommunity Peace & Justice Center. It was headed by Bruce Herbert for its first  four  years.

NWCRI members meet  3 times/year. The annual meeting  of ICCR is in June is where they review the past proxy season (runs about April-June, when most US companies have their corporate annual meetings) and talk about the issues they’re working on and want to continue working on.  In the fall they’ll file resolutions with companies.  Companies can accept the resolutions or appeal to the SEC to omit the resolutions.  Often times the filing of the resolutions will open a dialog with the company about the issue which may lead the filer to withdraw the resolution.  If the SEC lets the resolution stand, it will appear on the proxy ballot at the next company meeting.

An example –  A  resolution was filed asking  asking  Goldman Sachs to issue a report comparing the compensation of senior executives to the median employee wage at the company.  The resolution was co-sponsored by the Nathan Cummings Foundation and the Benedictine Sisters  of Mt. Angel, Oregon .  Goldman challenged the resolution on a technicality, saying it contained misleading statements.  The very day Sister Judy came to speak to us, the SEC ruled in favor of putting it on the ballot. If you’re a Goldman shareholder, look for it on this year’s proxy ballot.

To file a shareholder proposal, a shareholder must have held at least $2000 worth of stock for at least one year.  Multiple shareholders can co-sponsor a resolution to meet the threshold.  Once presented, if the proposal earns at least 3% of the vote it can be presented again the next year. The 2nd year it needs to earn 6% of the vote, and the 3rd year and every year thereafter if the proposal gains at least 10% of the shareholder votes, it can continue to be submitted to the ballot.   When a shareholder proposal wins a majority of the vote… nothing has to happen. Shareholder resolutions are advice to the company and are non-binding.  However, a significant majority can certainly send a message.

Sister Judy recommended a book called The New Capitalists as a good study of the movement.  She herself worked on the 2002 proposal to GE that it report on its greenhouse gas emissions, and was gratified to read in the book that after the resolution got the support of 23% of shareholders, GE was spurred to take a closer look which eventually resulted in the 2005 rollout of Ecomagination!

Sister Judy made a point that was particularly interesting to me- that the religious orders through their ministry work have sisters on the ground in developing countries with first-hand experience of the issues they’re trying to address.  That experience informs their shareholder work and gives it authenticity.  She gave an example of sisters working in Africa and having first hand knowledge of the devastating impact of HIV/AIDS.  That lead to the order filing a resolution with Gilead Sciences asking for a report on how the epidemic impacted their business and how they were going to address it.  The resolution got 30% of the vote two years running before the company decided to open a dialog.  That dialog resulted in the development of a leading AIDS drug, licensing to 3rd world countries via Indian manufacturers and working on drug access issues for developing countries.

Faith Based orders are working on many issues with companies: water footprints, pollution, child labor in cocoa harvests.  A helpful aspect of working on an array of issues is that companies prefer to negotiate with faith-based organizations because there’s a wider palatte of issues to dialogue about – if a company can’t discuss one issue, perhaps they’ll discuss another. As opposed to single-issue non-profits which have a more targeted goal when engaging with a company and thus less room for dialog.

How can you get involved?  If you own stock directly, you can look for proxy ballots in the mail these next couple months.  It will be a form with a chance to vote for the members of the board of directors, confirm the selection of auditor, and possibly have a few other issues to decide.  You will see the management recommendation and can choose to vote with, against or abstain.  One strategy is to abstain on directors if you don’t know, to give other shareholder votes more weight. Folks at SRI-HH mentioned Proxy Democracy as a good resource for individual investors to see how institutions are voting.  One interesting aspect of proxy voting – it occurs over a period of multiple weeks and the company sees the votes as they come in. Further, the company can lobby shareholders to change their votes!  I learned about this when reading about HP’s much-contested acquisition of Compaq.  At any rate, the advantage to the small investor is that you can sometimes see how larger investors voted while there’s still time to imitate.

For mutual funds, most likely they just vote the proxies for you.  By SEC rule they have to disclose to you how they are voting, you can choose a mutual fund and contact them for a report.  You could apply pressure by writing and asking them to support various resolutions.  The As You Sow Foundation, which promotes corporate accountability, will post a guide to this years proxy season on April 6th,, here.  Their website is a good source of general information.

See if you can vote one issue this year!

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Someone asked me today what kind of return “social” investors are willing to settle for. I hear that question often asked aloud.

-100%: I think I first heard this at SRI in the Rockies, or maybe it was from the Heron Foundation, but I’ve seen a few characterizations of donations as essentially being a social investment with a -100% financial return. From there, we can consider everything more substantial on the spectrum as long as the return discussed doesn’t involve body parts.

0%: That’s what folks get financially from Kiva. They also get photos and a story (which is often told dynamically in multiple parts). That puts them ahead of “adopting” a distant child or buying a flock of geese from Heifer where they also are getting a photo and a story but the -100% return.

(more…)

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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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Last month I had the opportunity to be a judge at the Sustainable Venture Capital Investment Competition (SVCIC) at the University of North Carolina. They are the long-time home of the VCIC, the the Sustainable version is now about 5 years old. It was started by Deb Parsons who now actually works for Investors Circle in San Francisco. A Venture Capital Investment Competition is different than a business plan competition. In the latter, students present business plans and compete for funding. In this competition, real entrepreneurs present business plans, and the student teams have to choose who to fund and how to structure the deal. Students act like VCs. I competed while an MBA student at BGI and it was challenging and fun. A friend suggested I try judging in the future and I’m really glad I did.

As the Sustainable competition, it’s really an opportunity to engage around what “sustainable” does or should mean. The presenting entrepreneurs had a range of how much they themselves promoted sustainability though all had businesses related to energy, materials or waste. Those all relate to sustainability, but a differentiator is where pushing sustainability falls within the priority list of the founder. Is she looking for new opportunities that advance sustainability? Or is she looking for new opportunities because of where she has leverage over others or where she has friends in business? It doesn’t have to be a case of business vs. non-business thinking: those could all be valid ways of finding new opportunity; it’s your priorities that determine which ones you look for. Businesses are now reaping energy efficiency gains that they could have before but it just wasn’t a priority, things like adding skylights to commercial shopping areas to cut lighting costs. It also helps to have it become a business-community-wide priority because there are more products and services to help you, and more leaders to watch and imitate. For would-be sustainable investors, the goal is to find those leaders.

The format of the competition is inevitably artificial: teams get business plans ahead of time; entrepreneurs present for 15 minutes, so far so good. But then each team gets 15 minutes to ask questions of their entrepreneur and that’s it. They have overnight to design their deal and make presentations for us, the judges, to see the next day. So judging is a little crazy – I watched 8 teams ask similar questions of the same entrepreneur for 15 minutes each and then had all of 5 minutes to write notes about it. Entrepreneurs who agree to this process definitely have to have patience!

It was fascinating to be a judge and watch how different teams posed questions. For example one team asked “aren’t your competitors going to make countermoves to put you out of business?” Another team asked “if you win in this business, who will be the losers?” Those are two very different ways to get into the same conversation. It was also helpful to watch different teams try to probe the entrepreneurs on their commitment to/interest in sustainability. It ranged from a single question of “you mentioned sustainability, what are your strong points?” to a multiple question drill-down that seemed very confrontational. As an observer I could really see how unhelpful it was to drill down. Either the entrepreneur has a priority of sustainability and will talk about it given an opportunity, or they don’t and trying to beat them up about it at best gives them an opportunity to catch on and greenwash and more likely just beats them up needlessly over a non-shared priority. There are businesses out there that are contributing to sustainability without focusing on it, but business is also about adapting to change and growing. If it’s not a priority at the top then I don’t think it’s really part of the company. Net, I felt like I learned something about improving the dialog between entrepreneurs and sustainably-minded investors.

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I was talking to a friend recently and he seemed frustrated by my insistence on making a distinction about the word “investment”. I would like ‘investment’ to only apply to situations where I’m definitely getting money back – I feel it’s been too blurred by people talking about grants and donations as social investments. I was reflecting later and decided that perhaps my friend was annoyed because not that long ago I had more of his perspective. I came back from Good Capital two years ago totally sold on Kevin Jones’s language around our “need to get away from two-pocket thinking” with the investment pocket and the philanthropy pocket, and instead think about the investments we make across that spectrum. The Heron Foundation also has great writings on full spectrum investing that I still respect enormously. So what’s changed for me?

I guess I shifted last year when I delved into PRI/MRI issues for foundations. Background in case you need it: Just over two years ago The LA Times did a beautiful slam on the Gates Foundation for donating tons of money to health via vaccinations in developing countries, but making that money by investing in the polluting industries in those same countries. Ah the juxtaposition! The Gates Foundation is just the most visible and the easiest to shin-kick, every foundation is guilty to some degree because the investments are managed solely to maximize return independently of the mission/grant-making side. So the pressure came on to do Mission Related Investing – align your investments with your mission, or at least try to make sure they’re not undermining your mission. Mission Related Investing is an aspiration, an idea, not a rule defined by anybody. How much return do you need to make? Well, you have to meet the prudent investor rule, and for most foundations that means generating a return of at least 5% + cover any additional costs, since that’s what they have to pay out. (Most foundations are trying to exist “in perpetuity”, so the inflow and the outflow need to balance).

Program Related Investing is an IRS regulation. A foundation can make a Program Related Investment and it must meet 3 conditions: 1) it must serve a charitable purpose; 2) it cannot be an investment you would make solely for the return; 3) the funds cannot be spent on anything remotely political (unlike a grant which can be used for some issue lobbying.) When the foundation gets money back, principal must be immediately re-granted, additional return can be returned to the endowment.
So that experience forced me to get much clearer (which is hardly to say crystal clear) on: what is a market rate return? What return does the investor NEED to get from this investment? I feel like that’s really where we start to get to brass tacks – presumably at some point I’m investing because I’m looking for a return – so what does that return need to be?

The Blended Return perspective (Blended Value is a leader) is that there’s a total I’m aiming for across all my “investments” and so maybe some things return -100% (straight up donations) and some things return 3% and maybe something returns 10%, conversely some things provide lots of social satisfaction, some things provide moderate, and some things provide none (or just add stress!)

As an operations/implementation type person, I began to find it confusing to continue to talk about a donation as an investment – there’s a pretty significant legal difference between creating Accion, Calvert Foundation, Kiva and MicroPlace, but perhaps to the customer the differences are more subtle.

Accion is a donation- you never get that money back. It’s just a 501c3. It’s mission with that money is to invest it, using market forces to do good.

Calvert Foundation is also a 501c3, but they do donor-advised funds so you have more ongoing influence over where the money goes, and they’re working on adding influence over how the money is invested. You still never get it back.

There’s a clear line above – you give money, you don’t get it back. You hopefully get some warm fuzzies. Done.

Kiva is also a 501c3, and to avoid the complication of becoming a broker-dealer they opted to not pay interest. So while you get your money back, you can’t get a return, so there’s an important distinction here, this is not an investment. However, because of how many players have entered the Person-2-Person loan space the SEC is revisiting this issue and at one point suggested that perhaps they could be interpreted as selling a security (perhaps a face-value zero-coupon bond).

So Kiva straddles a fuzzy line, you give money, you can get it back, but they don’t charge you a formal fee (people give “tips”) and you don’t make any money. So this is not an investment in terms of financial return. While I get warm fuzzies back, I want to use the term “social investment” to differentiate among investments where I can get a return, so I don’t like using it here.

MicroPlace did register with the SEC as a broker-dealer so they could pay you interest and so they ARE selling debt securities with low interest. Now this, in my current view, is an investment. We’re getting something back. We can quibble about the rate of return but it’s still an investment.

In all those cases, the end consumer is putting a chunk of money in a place that will make them feel good and hopefully connect them to inspiring stories but won’t do much for their retirement. Some folks will draw the line there – if it’s not doing much for my retirement, then it’s not an investment! Whether or not you can ever get that money back should be a meaningful distinction, but maybe folks are only doing amounts they don’t really care about, in which case we’re not really tapping the full spectrum of investment, we’re just getting more creative with contributions. Perhaps for me, investment implies relationship, where you both have something you need from it and cannot just walk away.

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For me, “charity” has come to symbolize a sympathy gift. The giver perceives a deficiency or difficulty for the receiver, formulates and offering and makes it. The receiver usually accepts because it is better than what they had, though not what they might have chosen or perhaps not the best solution for their needs. The gap between intention and solution is perhaps partly because the gift is made at arms length. Most philanthropists have recognized this phenomenon: an international example folks might recognize is that of installing wells in 3rd world countries only to discover folks are still using contaminated vessels to carry the water. Domestically non-profits have described a problem of sometimes being driven off-mission because of the constraints placed on available grants. Government welfare programs can set up catch-22 situations where they offer enough support to keep people housed, but benefits are quickly withdrawn once someone tries to bootstrap themselves up.

Many funders have instead moved to empowerment models which use community engagement to define mutually acceptable goals. I found this fairly challenging with our family foundation. I used a community advisory board to make grant decisions, but I couldn’t figure out how to work “with” them and defuse the power imbalance. It strikes me that here’s where it can be helpful to be/have foundation staff, because the power position bridges the gap better.

Some interesting principles for shifting from charity to empowerment come from the United Nations declaration on the Rights of Indigenous Peoples – there was a panel discussion at SRI in the Rockies 2008 that is available as a podcast on their website. The panelists talked about how a company will often set up a revenue-sharing agreement with the local government or community as their way of being socially responsible. However that’s more an example of charity – empowerment is more about the relationship between the company and the community, their ability to raise issues and get them resolved. In the UN declaration, indigenous peoples have a right to Free, Prior & Informed consent. Essentially, it’s the right to say no. This doesn’t come up so much with grant funding but is an issue with investing.

I can see why so few asset-holders would want to risk making this commitment. It’s difficult to move forward if everyone has veto power. We need instead consensus – the idea that the remaining few who still don’t agree will at least agree to not block the process in respect of the larger good. It seems like we get stuck when we don’t even share a vision of a larger good.

And that leads me nicely into “solidarity”, though it’s not how I got there in the first place. As I research and dialogue around how granting and investing combine with social justice, I find I have arrived at economic development and the concept of building community wealth. Success in that arena seems to be all about the network – consistent across what I read in small business and entrepreneurship, about career and job finding, and about housing – that old adage of “it’s not what you know, it’s who you know” crops up again and again. The network of customers, suppliers and lenders for a small business is what contributes to long term success. Good jobs are found through personal networks, not want ads. Successful housing for the formerly homeless means stable housing connected to services in a network. To be a funder or investor and make long term impact, I think the view needs to shift from project to network. Like in community organizing, the success or failure of each “action” is less important than how the creation and execution of that action helps build the community.

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Wells Fargo seems to be ahead of its time in implementing sensible bank policies which are now standing them in good stead as banks try to weather the financial crises. Perhaps they should thank Socially Responsible Investment and Community Welfare advocates, who began raising the issue over four years ago and targeting Wells Fargo because of their aggressive lending practices. A historical tour of this campaign is simply fascinating given the news today.

This very worthy read, a September 2008 review of SRI Activity, notes that attention to predatory lending started in 1999: “Shareowner activists took note of this trend as early as 1999 after a keynote speech at SRI in the Rockies by Martin Eakes, founding CEO of Self-Help, a North-Carolina-based community development financial institution (CDFI.)”

April, 2004 – from a report issued by the Center for Responsible Lending on “A Review of Wells Fargo’s Subprime Lending”.

“One of the biggest drivers in Wells Fargo Bank’s steady income growth is its mortgage business, which contributes approximately one-third of the company’s earnings year after year. Des Moines-based Wells Fargo Home Mortgage (WFHM) is one of the nation’s largest mortgage originators and servicers. At the end of 2003, WFHM originations hit $470B and mortgage servicing reached a record $664B. Wells Fargo’s subprime mortgage lending totaled $16.5B in 2003. While this is modest volume compared to Wells Fargo’s prime mortgage originations, the company now ranks # 8 among B&C lenders and generally has been doubling its subprime volume each year since 2000.”

This detailed 10 page report covers the merger of Wells Fargo and Norwest and many lending practices, ending with the sad conclusion “Lulled by favorable analyst reports, Wells Fargo investors may not realize they are subsidizing a predatory lender. In addition, limited regulatory oversight and loopholes in regulations have enabled Wells Fargo Financial to hide predatory practices from federal regulators. Sadly, the people who see these problems most clearly are the unit’s customers, who too often face the loss of their home or financial ruin as a result.”

April 14, 2005 Responsible Wealth issues a press release:

On April 26, at the company’s headquarters in San Francisco, Wells Fargo shareholders will vote on a resolution that links CEO pay to the company’s progress on eliminating predatory lending practices, such as excessive fees, poor disclosure and interest rates that are higher than warranted by customers’ credit scores.
The resolution was filed by members of Responsible Wealth (RW) [with support of many other advocacy orgs], a network of affluent investors. [Who advocate for greater social opportunity, one of their top issues is preserving the estate tax!] … Since a similar resolution was put forth in 2004, Wells Fargo has met with representatives of Responsible Wealth and the Center for Responsible Lending (CRL) to discuss changes in their lending practices.
Nevertheless, the company has lagged behind other companies that have eliminated predatory practices. For instance, following a similar campaign by RW, CRL, and the Association of Community Organizations for Reform Now (ACORN), Citigroup agreed to cap fees, reduce prepayment penalties and ensure that all customers received rates appropriate to their credit history, regardless of which division of the company handles the loan application. “

Now isn’t that interesting… Citigroup. And how are they faring today?

August 31, 2005 – Wells Fargo Implements Borrower Protections, LA Times.

Wells Fargo announces a series of changed lending practices, including “include more clearly defining and limiting upfront fees, easing penalties for borrowers who refinance or pay off loans early, and eliminating mandatory arbitration of disputes”. ACORN made a grudging statement “glad that the company has finally acknowledged the damage that their practices have been causing and have agreed to change them.” However, they weren’t satisfied, and only a couple months later were out picketing Wells Fargo’s national headquarters contending that the company’s lending still discriminated against minorities: “Nationally, black Wells Fargo borrowers are nearly four times as likely to pay extraordinary loan rates as whites, according to information compiled by Responsible Wealth. Nearly 30 percent of blacks taking out first-year loans from the company pay high interest rates.”

The Minority Wealth Gap is a real issue, but the changes Wells Fargo made at the time apparently satisfied at least one investor; what’s really interesting to me as I do this research, is the discovery that around Q3 2005 is when Warren Buffet decided to buy in, according to this report:

“Warren Buffett also revealed his holdings in Wells Fargo & Co. (WFC) today [Feb 4, 2006], after disclosing his holdings in H. R. Block (HRB) and Torchmark Corp. (TMK) in January. During the third quarter of 2005 Buffett kept his holdings in these companies confidential. As revealed by the amended filings of Berkshire Hathaway, Warren Buffett added his positions in Wells Fargo & Co. (WFC) by about 50%. Currently Berkshire holds 85 million shares of Wells Fargo. Wells Fargo is now the 4th largest equity holding of Berkshire Hathaway, behind Coca-Cola Co. (KO), American Express Co. (AXP) and Procter & Gamble Co. (PG).”

The stock wasn’t particularly pounded and “the street” wasn’t really paying attention. I checked the stock price on Yahoo (NYSE:WFC) and it had increased mildly over 2005, fluctuating between a high of 31 and a low of 29.

By 2007, at least one traditional investment newsletter was raving about Wells Fargo. Dan Ferris, of Daily Wealth reports: “Of all the companies involved in the subprime space, the one that really leaps out at me is Wells Fargo (NYSE: WFC). Wells Fargo is without a doubt the highest-quality mortgage underwriter I’ve found in my research.” He concludes “were I in the market for a large-cap stock, I’d back up a U-Haul and fill it with Wells Fargo common stock.”

It so clearly needs to be said, so I’ll say it: Thanks SRI Community!

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