Why impact is an important new force in private equity


Recently, David Brooks wrote an op-ed for the New York Times entitled “How to Leave a Mark,” which was all about the rise of mission-driven businesses and the new “impact investors” that finance these companies.

His article nicely captures the exciting potential of this emerging sector. But one important point gets overlooked: Far from requiring investors to make a trade-off on financial returns, impact can actually be the key to finding growth and value in an increasingly crowded marketplace.

As Brooks notes, there is an increasing number of businesses looking to solve social problems or address underserved markets. Take Bridge International Academies, which provides affordable, high-quality education in sub-Saharan Africa; or Toms Shoes, the fashionable footwear brand whose “One for One” model involves giving a pair of shoes away for every pair they sell; or Warby Parker, whose business model seeks to disrupt the eyeglasses market but whose brand has benefitted from its high-impact “buy a pair, give a pair” model.

All three are high-growth companies that have already attracted the attention of private equity and venture capital (they’re backed by NEA, Bain Capital and Spark Capital, respectively). And importantly, they see their growth as being intrinsically linked to their impact. As Warby Parker co-founder Neil Blumenthal puts it: “We’re trying to build a company that’s doing good in the world, and we’re finding that resonates with customers.”

There is strong demand from investors for investment products that align with their social and environmental values. This interest goes back to the late 1970s, with the creation of socially responsible investment funds; and it continues today with a generation of high-net worth individuals who believe there’s an opportunity to use private capital to solve massive global problems.

However, among fiduciary investors and advisors looking at impact investing, particularly within private equity, there is still some skepticism about whether managers can deliver both market-rate returns and social or environmental benefit. These businesses must be slower-growing, they argue; or the margins must be worse; or it must be more costly to invest; or exits must be harder to find; or valuations must be lower.

Clearly some investors do prioritize impact over returns, like those financing social impact bonds to support innovative public sector programs, or those working with the economic base of the pyramid in emerging markets.

But companies like Bridge and Toms are proving there doesn’t have to be a trade-off. So too are the growing number of B Corps, which commit to considering community and environmental stakeholders alongside their shareholders (Warby Parker is one; so are Etsy and Change.org).

The other common refrain from impact investing skeptics is that there aren’t many managers with a track record of making money in this space. True, there are not a lot of second- or third-time impact investing funds in the U.S. But the venture capital pioneers in the U.S. and Europe heard a similar refrain 30 years ago. Get beyond the circular logic of “you can’t make money doing this because no one has ever made money doing this,” and it’s clear some funds are starting to demonstrate the attractiveness of investing for social and environmental impact.

Most managers now recognize that strong ESG programs can drive real bottom-line value. But some go even further: They see impact as a lens that can help them spot underserved markets where others aren’t looking; to work with mission-driven management teams who would otherwise be wary of private equity; and to build economic value by thinking deeply about, and measuring clearly, the social or environmental returns that move in lock-step with earnings growth.

To take just one example, venture capital fund DBL Investors just raised over $350 million for its second fund, which invests in high-growth companies that are located in underserved communities or have strong environmental, community or workforce practices.

It’s still early days for impact investing. But given the growing number of mission-driven companies that are combining impact and returns, those skeptics who dismiss it out of hand should think twice. They may be missing an important new force in private equity.

Brian Trelstad is a partner at Bridges Ventures, a specialist sustainable and impact investor.

This article first appeared in Buyouts. Go here to subscribe.

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