Posted: 28 Feb 2011 05:07 AM PST
If you haven’t read Pam’s recent post on investing in income derivative streams of first graders, you should. Personally, I’m not sure it’s ethical to allow minors (or even their parents) to commit future income streams (which are, at some level, equity derivatives). But the post, and new models like Lumni, highlight equity as an investment form that I think deserves considerably more attention.
To get a bit finance-y (and way oversimplified), senior debt sits at the top of the capital structure and takes losses last. It generally gets paid an interest rate untied to the business’s net income and is considered one of the safer investments. Less risk, less reward, less downside. Equity, in contrast, sits at the bottom of the capital structure and absorbs losses first. If the business does well, though, profits are owned by equity investors (shareholders).
Most impact investment that I have seen to date is in the form of senior debt provided to social enterprises in Africa and South Asia. Equity, when invested, seems to be offered in lower-risk social businesses and as a reinforcement to existing capital rather than seed funding. For the impact investment world to truly get serious about the “impact” part, a whole lot more of the “investment” part needs to be in the form of common shares.
Part of impact investing, in my opinion, is valuing social impact as a return and thus be willing to take on more risk without compensating higher returns (if this wasn’t true, commercial investors would go in; I simply don’t buy the argument that commercial investors are too scared of social enterprises to make good investment decisions at this point in time, it might have been true in the past). This can be in the form of discounted interest rates on senior debt. But I think it would be more effective in “overpaying” for shares on the equity side of the balance sheet and in taking real bets on social entrepeneurs who can change the future.
Anybody got the funds to help me start a venture capital fund for social businesses?
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