More 'Patient Capital' for Social Ventures

An increasing number of venture investors are hunting for small companies that could yield social benefits as well as high profits

Gaia Herbs sounds like an unlikely candidate for venture capital. Ric Scalzo, a medical herbalist, founded Gaia in 1986 to produce, distribute, and sell organic supplements. The $16 million, 125-employee firm prides itself on its commitments to improving society, including funding education in the South Pacific islands and Sumatra, where the company sources some of its herbs. The alignment might sour most VCs, who train a strict eye on bottom-line benchmarks. Nonetheless, Gaia, in Brevard, N.C., received a $3 million venture investment in July to develop new products and expand its reach in the fast-growing natural products market—and for Gaia's new investors, Scalzo's social mission was a selling point.

"They have such an aligned vision with the growth and development of Gaia," Scalzo says of his new partners at TBL Capital, a venture firm in Sausalio, Calif., dedicated to funding companies with social missions. Venture capital fueled the companies that revolutionized such industries as semiconductors, biotechnology, and the Internet. Now venture capitalists want to use the same combination of financial might and business savvy to stem global warming, create jobs, and alleviate poverty. The idea of putting VC-style investing to work on social problems has been around for the better part of 20 years. What's changing, VCs say, is how much interest in social enterprises has grown—among both investors and consumers.

Indeed, a growing number of venture investors want to back companies that, in addition to financial returns, will also yield environmental or social benefits—a model called the double- or triple-bottom line. "The market has moved in our direction," says David Kirkpatrick, co-founder and managing director of SJF Ventures in Durham, N.C. He says the 10-year-old firm, with $45 million under management in two funds, has been investing in growth-stage companies that create jobs in low-income areas as well as such industries as clean technology "before it was cool."

Potential Social Impact

No one can say exactly how much social venture capital has been invested, partly because exactly what constitutes a social venture is hard to define. Many VCs who are agnostic about portfolio companies' social missions have nonetheless poured millions into ventures with other benefits—clean-energy companies, for example—because they see market opportunity.

On the other end of the spectrum, nonprofit funds such as the Acumen Fund make loans and investments based more on their social impact than on financial return. For example, Acumen has backed A to Z Textile Mills, a Tanzanian manufacturer of antimalarial mosquito nets, which now produces more than 16 million of the lifesaving nets each year at a final cost of about $5 per net. But even the line between Acumen-style enterprises and for-profit ventures is blurring, as entrepreneurs seek new markets in what University of Michigan professor C.K. Prahalad famously called "the fortune at the bottom of the pyramid." Investors have formed entire VC funds, such as the Monterrey, Mexico-based IGNIA, to back for-profit companies serving these markets.

Joshua Humphreys, director of the Boston's Center for Social Philanthropy, has tracked at least $7.3 billion invested in 100 socially responsible alternative asset funds, which include venture capital, other types of private equity, and hedge funds. Of that, he estimates that $5 billion 10 $6 billion is venture capital. That's still a small chunk of the VC world, which invested more than $28 billion in 2008 alone. But it includes funds from such marquee VC firms as Kleiner Perkins Caufield & Byers, a firm that backed Google (GOOG), Amazon (AMZN), and Intuit (INTU), and now counts Al Gore as a partner. "The brand-name, top quartile funds are investing in the very space we're investing in," says SJF Ventures' Kirkpatrick.

No Need for a Tradeoff

While some social VCs concede that they will accept lower financial returns for social benefits—particularly those who back nonprofit ventures as well as for-profits—others don't see the need for a tradeoff. Kirkpatrick says SJF Ventures has the same investment expectations as traditional VC firms, because his firm backs companies that have social and environmental benefits "fully baked into a sustainable business model," rather than as an add-on that they have to balance against making money. "SJF's focus is no compromise, financial or mission," he says.

The key difference between social VCs and those purely seeking profits is that mission-driven investors provide "patient" capital, says Mark Finser, general partner at TBL Capital, who raised the $50 million fund in 2007. "The highest tolerance is in their time horizon," Finser says. His fund, mostly raised from high-net worth individuals, invests in "companies that will be game-changers in that particular industry," he says.

Investors and entrepreneurs are still trying to resolve big questions about how to apply the venture capital model to social enterprise. For one, there is no clear way to quantify social and environmental impact so investors can measure their nonfinancial returns, though such tools as the Acumen Fund's Portfolio Data Management System and consulting firms such as Social Venture Technology Group attempt to do so. Another question for social VCs is what constitutes a socially responsible exit—that is, how can a portfolio company retain its social mission through an acquisition or public stock offering? "This is an experimental phase right now," says Meredith Walters, senior associate at social venture firm Good Capital in San Francisco. "People are trying different things. There's no accepted way to do it."

But it's clear that venture investors are becoming more interested in social entrepreneurs—not just in their products but also in their missions. Some industries in particular, where investors see potential for big profits and big impact, have received more attention than others: clean energy and green, organic, or natural foods and consumer products are especially in vogue. "There's more attention in this space, and with attention, more investors want to participate," says Deb Parsons, business development director at Investors' Circle, a network of angel investors, VCs, and foundations involved in socially responsible investing. "It becomes less a fringe and more acceptable. In a few years it'll be closer to mainstream."

More elements of this special report are available in the related items box on the upper right side of this page.

    Before it's here, it's on the Bloomberg Terminal.