If venture capital investors worked like not for profit funders

There is a need for innovation and accountability in the social sector but there are many challenges that get in the way. One of the major impediments is the way not for profit organizations are funded. To illustrate these challenges I will present a scenario where venture capital and angel investors work like not for profit funders.

Firstly, the investors wouldn’t solicit business plans from entrepreneurs as they do now.  Instead they publish a set of requirements of what it is they are looking for in terms of product description, target market and what expenditures funding would cover.  The applications would also have to be in prescribed form so that they can be evaluated easily.  Instead of receiving multiple business concepts from an unlimited number of sources they would only receive concepts that the investors could conceive of.  Most of these would be incremental changes from things that had worked in the past.  There would be no breakthrough ideas that nobody had considered before; the kind that go on to become Google, Paypal or Tesla.  Since they would all have to apply in the same format there isn’t even an opportunity to discuss innovative approaches to the requested business concept.

The investors would lay out exactly what the funding would cover.  There would be funds to hire programmers, acquire any materials needed and other direct product costs.  Marketing and management would be limited to 10% if it was allowed at all.  The applicants could have people working on products but no one to coordinate the business or get the word out to the market.  The applicants will go without any management team or hire at low salary levels resulting in inexperienced people or those that are not a good fit.

Since the funding would not be sufficient from any single investor or would require matching funds there would be a need to go to multiple sources.  But each investor group has a slightly different idea for what the product will entail or who the target market should be.  They will also have different restrictions on spending, application format and reporting requirements. The organization will spend an excessive amount of time filling out multiple applications in different forms and keeping track of results so that they can report individually to each investor in their specific format with their metrics.  There is then the issue of how to manage a strategy for an organization that is now being pulled in multiple directions and none of them leading to the target market.  Remember that the applicant has not been provided with the funding for the people who will be responsible for managing these conflicting demands.

Most early stage companies find that their original path does not work and they need to change directions. Paypal started out as a way to transfer money between phones and then shifted to a secure means to accept payments online.  Happily for their investors.  Under the scenario being presented here these shifts would be impossible without violating the funding agreement.  The company would choose between a path they knew wasn’t working or one that would maintain their funding.

The metrics would be a combination of staying within the spending restrictions and some contrived success numbers such as number of page views, downloads and probably customers acquired.  The company would again need to twists its operations so that they maximized page views and downloads even if they didn’t result in sales.  They would sell at low prices to get customers even is they were not profitable customers.  None of these strategies tends to result in a healthy and successful organization but it will create the illusion of success while maintaining funding.  There is no measure of impact (i.e. whether the organization actually made a difference with the funding they received).  Without impact metrics it is difficult to determine if the organization is providing real value, if they are improving or if there is another organization that can make better use of the funds.  The lack of a requirement for impact metrics is a good things since there was no funding provided to pay for people capable of measuring and reporting on impact or the systems needed to support that.

There will be a need to apply for additional funding next year since there is little chance organizations operated in the way we have described will be sustainable.  As long as they met the reporting requirements they will probably get another round of funding under the same terms as before.  That is unless the investor has run out of funds or decides not to offer another round.  There is no chance a more innovative applicant will be funded instead since the application process doesn’t allow for any innovation to be presented.  This takes us back to the beginning of a process that will repeat itself annually.

The venture capital process is not perfect by any means and there are not for profit funders that don’t fit this design but unfortunately not many.  Part of the attraction of social business is the need to move away from this process to one that more represents private sector funding.  There is also a movement towards self-sustaining models that don’t rely exclusively or at all on these funding sources.  The transition to these models will take time and there will always be challenges that don’t lend themselves to a private business model. If funders want more innovation, accountability and performance then they need to reconsider how they fund not for profits.


Social Business Part 1 — The stalled emergence of the social enterprise

The concept of the social enterprise is increasingly found in the news, social media and in the organizations arising to support them.  The social enterprise is expected to provide solutions to social issues while also being sustainable.  This sustainability is accomplished through a hybrid of not-for-profit and for-profit business models.  In my observation these entities start out on the drawing board as hybrids but tend to slide back towards traditional not-for-profits.   As this article will propose, we have not broken free from out-dated thinking that is needed for a new form of social enterprise to emerge.  I will present my thoughts in two separate posts.

The social sector has traditionally been not-for-profit organizations and government.  These groups addressed problems or needs where for-profit organizations were not engaged.  That is, there was no opportunity to make a profit so the private sector was not interested in investing.  The problem with this scenario is that the social problems and the cost of solving them has outstripped the supply of funding available.  On the flip side the funding that runs through the private financial system is building up and seems to be overrunning the investment opportunities in the private sector.  In parallel with these two trends the concept of social business and social finance has emerged.  Unfortunately, unlike the clear private/social poles that existed before, no one really knows how this new hybrid should work.

One thing we know from experience is that money flows quickly like water to where it can earn a return.  People and organizations don’t move at that pace.  They tend towards increment change.  As a result we are seeing social finance organizations emerging ahead of the organizations they need to invest in.  The band is starting to play but no one is on the dance floor.  We are also talking about impact investing before we fully understand what impact is and how we will measure it.  If we don’t solve this problem we will see poorly designed metrics and money chasing poor investment opportunities.  We need to shift our focus towards building sustainable social enterprises that we can invest in and we need them in large number.

For some there seems to be the expectation that existing not-for-profits and governments will tack on some form of impact measure and then carry on as usual.  This might be fine if what we have now is working effectively and efficiently and I don’t believe that is the case.  We have also seen private sector companies using superficial social measures to create the illusion of social impact.  Again most people don’t believe this is true on a wide scale.  The third alternative is the creation of a new set of organizations called social businesses.  They will have the joint social/financial outcomes baked in from the start.  The few that have been created tend to look like either a traditional not-for-profit or private sector company and mostly the former.  Founders tend to use one of these poles as a starting point when creating the business model.  With some exceptions they have not been very effective in creating large scale change or in being sustainable.

We need to break free from the status quo thinking that underlies the two primary business types in order to deal with social issues in a sustainable way.  In my next post I will discuss approaches for breaking away from these old ways of thinking that will enable us to successfully start building true social businesses.

The meaning of impact

We need to move towards a system that assesses social innovation based on impact.  This assessment holds for not-for-profits, government and businesses that profess to have social goals.  Most people agree with this need and we can hold nice conversations around moving from inputs to impact as measurements.  However few people have given much thought to what it means to measure impact.  Too often when someone describes what they have in mind the result is a list of high level statements like, we create jobs or a list of activities like, we deliver food to the elderly.   This response is understandable since effectively measuring impact requires a different way of thinking and a lot of hard work.

I will illustrate impact with an example I have been working on with a not-for-profit group.  We are still in the early stages of developing this metric and still have a lot of work to do.  There are also a lot of complexities around effective metrics that I won’t have room to cover in a blog post.  But my purpose here is to illustrate the difference between measuring inputs versus impact.

Our not-for-profit has been established to help build social ventures and social innovation in our community.  Our expectation is that jobs will be created and social problems will be addressed.  Our plan is to work with all ages ranges to build intergenerational ventures where the experience and knowledge of older generations is combined with the technical capabilities and unique viewpoints of younger generations.  We expect to create jobs for youth as well as seniors and everyone in between.  Some of the roles will be paid and some will be volunteer.  Some of the ventures will also focus on the problems of disadvantaged youth and those faced by an aging population.

The inputs and intermediary measures will be numbers of people mentored, numbers of ventures started and grown, jobs created and investment funds provided.  The measure we want to use for impact is based on the dependency ratio.  That is the number of people dependent on others for support divided by the number of people in the community.  Dependent people are children that are in school and not working, unemployed persons and seniors that are past traditional working age.  Increasing employment and volunteering across all population groups will reduce the number of dependent people.  We can measure our impact by working to keep driving that number lower.  We can also work at a dollar level by making the numerator the cost of dependency including unemployment benefits, healthcare costs, crime, etc. against the total fund flows in a community.  Both of these measures will be difficult to establish and track but it can be done.  Having this measure will enable us to determine the impact of our programs, and those of other organizations, on the prosperity of our community.

So I call upon people looking to make a social impact to start moving past easy conversations and into the hard work of developing true measures of impact.  I also encourage groups to work to together to share ideas and assist each other.  Metrics that can be used across programs to measure community health will align the multiple providers to move in the same direction, reduce duplication of effort and optimize the use of resources.

Business building should be open ended

In years past the business building process involved putting together a plan with milestones and deadlines.  Often the plan building process took months and was completed before any discussions with potential customers were done.  The entrepreneur stayed tightly within the bounds of the plan forging ahead even when things weren’t working.  If there was outside funding this adherence to the plan was even more strict.  The introduction of a lean approach to business building removed these problems by pushing the plan aside in favour of a learn as you go process.  But many who teach, mentor or incubate start-ups have introduced a new model that reintroduces some of these problems.

Classes on business building and incubator programs or competitions have set time frames with some end project such as a pitch or business plan.  Forced into this time box entrepreneurs are limited in their ability to explore or make course corrections as they become necessary.  Time is further compressed as the teams approach the end date and move from building their business to practising their pitch.  The team will also avoid any changes in direction prior to working on their pitch since the changes may hamper their ability to get the pitch ready.  So we can see that the process itself actually takes away from the likelihood of success for the business.

Business building has to be open ended letting the problem/solution testing and customer discovery process find its course.  The team will usually need to conduct many discussions with potential users before they adequately define the need, the solution that solves the need and the initial user base.  The time it takes to get through these processes can’t be reasonably predicted.  Trying to force closure before the process is completed increases the risk of failure.

The incubators and entrepreneur classes get most of the attention but the truth is most successful companies do not come from these programs.  Very few school projects become sustainable businesses after graduation and incubators tend to work with a very small proportion of start-ups.  There is no evidence to indicate that start-ups coming from incubators have any greater chance of success than they would have on their own.  While we look for short cuts and magic formulas sometimes it is old fashioned hard work that still makes the difference.

How to look at innovation from a user’s viewpoint

When we are developing ideas for innovation we often identify opportunities in isolated situations.  We need to put ourselves in the shoes of the end user and determine how they might make the decision whether to use our product or not.

For example, I worked with a group of entrepreneurs trying to decide how to apply wireless technology and sensors in a hospital environment.  There are a multitude of opportunities for this application in hospitals.  We set out describing a number of possibilities as though none of those solutions currently existed.  In fact there were quite a number of these concepts already available or in development.  What was needed was a way to identify gaps or opportunities to link solutions together.

What we should have done was to look from the perspective of a user in the hospital eco-system perspective and determine what they needed to do, what solutions were currently available or in development and what gaps existed.  Using this approach would create opportunities for applications but would also identify how they fit into the overall solution and who we could work with in getting adoption.

This approach might also enable us to become a distribution channel for solutions that are having a difficult time fitting into the current structure.  A combination of individual solutions taken together in an infrastructure could have a greater chance of success than any of the individual solutions.

As Clayton Christensen has pointed out, people hire products and services to do jobs.  If we look closely at those jobs and the people doing them we start to understand where opportunities lie and how to develop solutions.  This analysis also helps us to find our early adopters and product champions because they need the solution the most.

When big companies don’t innovate entrepreneurs need to

There are some unusual paradoxes taking place in the world these days.  We see massive unemployment and underemployment coupled with big companies making big profits and build up piles of cash.  But they aren’t using these cash reserves to fund innovation they are sitting on them letting them go idle.  If these companies are aren’t going to use these funds to build value they should distribute them where they can be redeployed.  We need to find a way to get them into the hands of entrepreneurs who will innovate.

That brings us to another paradox.  I often hear that there are more investment funds available than there are good ideas.  Yet we have so many problems in society that entrepreneurs can solve and more people than ever who want to purse entrepreneurship.  Maybe we need to combine those funds with a better support system for entrepreneurs.  An economy full of entrepreneurs creating new ventures, solving problems and employing people is how a market is supposed to function.

It is critical to build this entrepreneurial society for another reason.  When there are few alternatives available excess funds flood into the stock market or real estate where they push up price resulting in bubbles.  When the bubbles burst this value disappears from the economy.  We have to make investing in entrepreneurs more attractive than the alternatives.

As someone that believes in free markets it pains me to suggest that society may need to take steps to free up this idle cash.  If the markets won’t function as they should and allocate capital efficiently then we need to tax it away and redistribute it in other ways.  It is not ideal but if business won’t create value through innovation that benefits the society where they earned the profits then we need to find people who will.


Leadership with a 20 year horizon

We have talked about the need for a 20 year horizon to bring about systemic changes that are badly needed.  One of these changes is a building an entrepreneurial society in a region.  What we also need to consider is how, in this world of short attention spans and 144 character messages, that we do that.  Let’s start by considering the type of leadership we need.

When we turn to our existing leaders we run into the limitation of four year terms or the need to hit the next quarterly results.  We also tend to find people more into their own image or well-being than that of the people they are supposed to be serving.  So we clearly need a new leadership model.

When we go about trying to make a change with a 20 year horizon we can’t just come up with a 20 year plan and then execute.  Most of us don’t know what will happen in the next six months to a year let alone 20 years.  So we need someone who can start the process and continue to drive it using vision and experimentation.  This person has to be comfortable with learning as they go and with a lack of structure.  They also have to recognize that they may not be driving the bus when it starts to demonstrate the envisioned impact.

The process has to be designed in a way that people who take over in the future build on the learnings and progress made by those that came before them.  The current leader has to build such a system and the future leaders have to accept and build from there.  Contrast this style to the throw it out and do it my way of many politicians and business leaders.

One person does not have the time, knowledge and energy to make these kinds of changes on their own.  They need to let people in; lots of them.  Some of the people will be long time, fully committed participants while others will be more transient.  As the path winds towards its destination there will be a need for changing skills.

While the end result may be years away there have to be interim measures along the way that help us determine our progress and make course corrections as required.  It is not practical to wait twenty years before we find out if something has a desired impact.  We need to set interim steps with measures and use these to learn and act.  Based on the results of a chosen path we can decide if it had the impact we expected and if it appears to be moving us in the long term direction.

The leaders have to be able to communicate the vision and the short term measures to keep their teams, funders, beneficiaries and other stakeholders interested.  There will be times when this leader will have doubts and will need to dig deep to keep the faith.

There are many traits of great leaders that are discussed and researched by a vast array of people and I won’t repeat them here.  I wanted to highlight the unique elements a leader will need to drive a long term systemic change.  Anyone fitting this description can send their resumes to me or better yet to those organizations that need this type of leader for their future success.

Misuse the term disruptive at your peril

The term disruption comes up constantly in the world of innovation but often in the wrong context.  Most people think of it as a big, breakthrough technology that will become the next big thing.  Most of the time it isn’t that at all. It usually starts out as something very unremarkable but has the ability to unseat market leaders over time.  It is because of its humble beginnings that a disruptive technology or business model is so dangerous.  By the time you recognize them it is too late to respond.  That is why it is also important to have a solid grasp of the concept.

The term was made famous by Clay Christensen in Innovator’s Dilemma and expanded by him and his colleagues in several works since.  A disruptive innovation is most often cheaper and of lower functionality than incumbent products.  They are aimed at the low end of the market who can’t afford the existing solution or don’t have the ability to use it.  The market leaders don’t pay much attention to the product or the market segment since they are focussed on building increasingly better versions of the product sold to the high end of the market.  But two things end up happening over time.  The increasing features of the existing products begin to exceed the ability of the market to absorb them and the product becomes more expensive and complex to use.  Secondly the disruptive product has improved over time so that it is now good enough for the mainstream market and usually at a lower cost.  The disruptor often has a lower cost structure than the incumbents and can make profits at lower margins.  It is almost impossible to companies used to high profit margins to lower their cost structure.

An established company with existing products aimed at existing customers could come up with a breakthrough on that product line.  But that breakthrough is not disruptive.  It is a sustaining innovation since its impact is to make the existing product better.  Companies should be looking for ways to improve their key products keeping their most profitable customers happy.  But they also need to set up a separate group with its own funding to find the disruptive opportunities.  Those that don’t often find themselves being blind sided by true disruptive products or business models.

Large companies as platforms for enterpreneurship

Entrepreneurship is not something that often arises when we think of large companies.  Maybe that is because we think of the legacy products and large scale infrastructure when we think of a large company.  We see bureaucracy and a commitment to productivity over change.  That perception would not be wrong because in most instances that is what they are.  They have legacy products and services that absorb most or all of their resources and attention.  Some have entrepreneurial units intended to create new products for the future that are poor second cousins and often amount to nothing more than window dressing.

I have long been curious as to the mix of large and small companies and how they will fit together going forward.  There are many cases of large companies becoming irrelevant as upstarts disrupt their markets and push them out.  Others just fade away over time as their market erodes or their performance declines.  Only a few seem able to go on through all kinds of change and turbulence and that number is declining.  Most struggle with innovation and rethinking their business models.

What if we looked at big companies in a different way?  We might see the potential for real innovation.

Large companies have some resources that would be valuable to the entrepreneurs as they develop their business models and try to scale them.  Large companies often have global reach with distribution and people in markets around the world.  They have infrastructure that enables large scale production and distribution.  There are lab facilities and other means of building and testing products and services.  There are usually financial resources that can be used to fund and build new ventures.  Finally they have people used to running larger entities and systems and processes that early stage companies can graduate to once they prove their business model.

With that in mind we could look at large companies as platforms with pools of capital on which to start and grow new ventures.  Thinking from this perspective will give a whole new structure to the lifecycle of businesses and products.  The company would not be the products but would be the mechanism to create, scale and retire a constant stream of products and services.

Part of the company would continue to focus on operational excellence in delivery of active products by constantly finding ways to improve their access to markets around the world and to efficient production and delivery of products and services.  The strength of this part of the organization will be essential in the ultimate success of products being developed.

Under this model all products would lack permanence.  They would be in place until the next generation moves them aside and funds would not be spent trying to extend the life of a dying product through price cuts and advertising campaigns.  The role of senior management would be to manage a portfolio of products and ensure that the knowledge and resources flow between the venture development and operational sides of the business.

With the market access, core product and technology knowledge and scaling infrastructures these companies would incubators on steroids.