The success of an impact investor depends on its ability to access and participate in deals that allow them to deploy their capital with social enterprises that can deliver the financial and impact returns that the investor expects. As discussed in the previous chapter, fund managers must be able to demonstrate to prospective investors that they will be able to build and maintain a robust pipeline of potential investment opportunities, which will require fund managers to develop a strong profile in the marketplace and a network of contacts among the various sources of deal flow. This chapter focuses on what fund managers will need to do as they sift through their pipelines to select potential deals, conduct the necessary due diligence, complete negotiations with the founders, and other members of the executive team of the prospective portfolio companies on the economic and impact terms of the deal, finalize the legal agreements and commit the capital of their funds, and monitor and supervise the progress of the enterprises up to the point where it is appropriate for the fund to exit the investment. Selection, due diligence, and negotiation all take time, usually nine to twelve months, and once the deal is completed the fund should expect to be actively engaged in monitoring for three to five years, perhaps more, depending on the portfolio company’s stage of development at the time that the initial investment is made. In many cases, the fund will make a “follow-on” investment in a subsequent round of funding. Clearly, the fund and its portfolio companies will have a longterm relationship and what happens while they are “doing the deal” will be important in laying the foundation for mutual success.
Deal Selection
As noted above, a large pipeline of potential investments is important for fund managers and surveys indicated that established funds may have literally hundreds of prospective portfolio companies in their databases at any point in time. However, quantity is no substitute for quality and the fund managers need to implement screening mechanisms to weed out opportunities that are not aligned with the fund’s impact goals and objectives and, for those deals that survive the initial screening, identify key issues that will need to explored and resolved during due diligence in order for the fund to make a commitment. Surveys illustrate how demanding and difficult the selection process can be—for example, from the initial group of companies that have been placed into the fund’s pipeline during the run-up to the fund’s initial close and the months following the close, perhaps 25 percent will turn out to be a good fit the fund’s investment strategy and only half of those prospects will be selected for additional review due to resource limitations within the fund (e.g., the available time of the fund managers and their internal team). Only 20–25 percent of those companies will survive the additional review, which will include close scrutiny of impact data available from a review of the business plans offered by the promoters of the target companies, to move into the due diligence phase and of those companies it is likely that the fund may ultimately invest in 50–80 percent of them.1
If you do the math on the selection process outlined above it is clear that only a few companies—usually somewhere around 2 percent of all that started—will survive and end up in the fund’s portfolio. Not all investment opportunities are suitable, even if they ultimately turn out to be “successful” by some measure, and the decision for the fund managers will be based on their specific strategies, impact goals and objectives, and risk tolerance, among other things. According to the GIIN, some basic factors that fund managers should consider in their initial screening include the following2:
• For sponsors or owners, who are the driving forces and what are their motivations for managing the business?
• What is the market opportunity for the business?
• Can the company deliver its products or services efficiently?
• How is the company organized?
• Does the company operate transparently?
• Does this investment align with fund mission or impact objectives (ideally grounded in an organizational theory of change)?
• How is the company currently performing toward impact goals? Can it optimize for higher impact?
The fund managers bear the ultimate responsibility for the choices made during the deal selection process; however, as discussed in the previous chapter, it is common for funds to provide for the creation of an investment committee that includes representatives from the key investors in the fund who are available to provide input to the fund managers on the companies that are included in the fund’s portfolio and, as requested, the specific terms of particular transactions. The role of the investment committee, and the requirements of investment committee members regarding information and participation, will vary depending on the circumstances. In many cases, the investment committee will convene several times during the deal process, beginning with the point where decisions are made about which opportunities will move forward into due diligence and then picking up again when the due diligence is completed and it is time for the fund managers to negotiate the terms of investment and prepare and sign the transactional documents. Earlier involvement by the investment committee means that it will have more input into the design of the portfolio, but some investment committee members prefer to limit their participation to reviewing proposals that have already been vetted by the fund managers and their team, thus relying on the fund managers to do the hard work of sifting through the blizzard of potential deals that occurs when the fund is first formed.
Investment Criteria of Sustainable Investors
Sustainable investors are concerned not only with what companies are striving to accomplish, but also with the way in which those companies intend to operate and the values and methods that will be used by the principals of the companies. Specifically, sustainable investors look for individuals and companies that value and exhibit transparency and honesty and candor in communications among stakeholders; define economic success by social and ecological impact, not just financial results; have an entrepreneurial spirit and culture that encourages and fosters innovation and continuous improvement; and which are truly pioneers in their areas interested in building the fields in which they operate through collaboration and “open sourcing” of methods and ideas. Sustainable investors also tend to be particularly interested in developing and maintaining close, long-term relationships with their investees and providing them with appropriate support and resources throughout the investment period. One way this is accomplished is by matching entrepreneurs with local investors from the same community to develop a sense of shared responsibility and facilitate face-to-face interaction.
Enterprises seeking financing from social venture capital funds and other sustainable investors need to understand the criteria that these types of investors use when evaluating potential portfolio companies. A modest survey of the published investment criteria of various investors indicates that are looking for companies that:
• Have a primary, clear objective to achieve significant social change and a business model in which generating social impact is an essential and necessary part.
• Provide goods and services that meet human needs and have significant social impact (e.g., food, medicine, clothing, housing, heat and light, transportation, communication, recreation, renewable energy, and “green” products and services). These goods or services must be based on core technology that is economically better or create greater social impact than what is available currently through the market, aid, or charitable distribution. Sustainable investors prefer and expect evidence of customer feedback on the utility of the proposed goods or services.
• Have a clear business plan and model that demonstrates the potential for financial viability and sustainability within a five to seven year period, including the ability to cover operating expenses with operating revenues and generate a fair return for investors.
• Have a strong and experienced management team with the skills, will, and vision to execute the business plan, an unwavering commitment to achieving the desired social impact in an ethical manner.
• Demonstrate a clear path to scale for the number of end users over the anticipated investment period, and be positioned as one of the leaders in the market.
• Provide positive leadership in the areas of business operations and overall activities that are material to improving societal outcomes, including those that will affect future generations.
• Balance the needs of financial and nonfinancial stakeholders and demonstrate a commitment to the global commons as well as to the rights of individuals and communities.
• Advance environmental sustainability and resource efficiency by reducing the negative impact of business operations on the environment, managing water scarcity and ensuring efficient and equitable access to clean sources, mitigating impact on all types of natural capital, diminishing climate-related risks and reducing carbon emissions, and driving sustainability innovation and resource efficiency through business operations and products and services. Red flags for sustainable investors would include a record of poor environmental performance and failure to comply with applicable laws and regulations, activities that contribute significantly to local or global environmental problems, and/or risks related to the operation of nuclear power facilities.
• Establish an environmental management system with objectives and procedures for evaluating progress, minimizing negative impacts, training personnel, and transferring best practices to customers, suppliers, and other participants in the marketplace through trade associations and other collaborations.
• Contribute to the quality of human and animal life. Sustainable investors will not invest in companies that abuse animals, cause unnecessary suffering and death of animals, or whose operations involve the exploitation or mistreatment of animals.
• Contribute to the community through charitable giving, encouraging employee volunteering in the community, making products and services available free or at cost to community groups and supporting local suppliers and striving to hire locally.
• Respect consumers by marketing products and services in a fair and ethical manner, maintaining integrity in customer relations, and ensuring the security of sensitive consumer data.
• Respect human rights, respect culture and tradition in local communities and economies, and respect Indigenous Peoples’ Rights. Sustainable investors will not invest in companies that have exhibited a pattern and practice of human rights violations or have been directly complicit in human rights violations committed by governments or security forces.
• Promote diversity and gender equity across workplaces, marketplaces, and communities. Sustainable investors look for diversity throughout the organization, beginning with the board and senior management team, and will not invest in companies that discriminate on the basis of race, age, ethnicity, religion, gender, sexual orientation, or perceived disability or support the discriminatory activities of others in their workplaces, marketplaces, or communities. Red flags include a record of consistent violations of workplace-related laws and regulations and failure to adopt and enforce explicit policies against discrimination in hiring, salary, promotion, training, or termination of employment.
• Demonstrate a commitment to employees by ensuring development, communication, appropriate economic opportunity and decent workplace standards. Sustainable investors will not invest in companies that have been singled out for serious labor-related actions or penalties by regulatory agencies or that have demonstrated a pattern of employing forced, compulsory or child labor. Sustainable investors seek confirmation that companies have implemented and follow personnel policies that promote the welfare of their employees, adhere to internationally recognized labor standards, value employee welfare and safety, pay a living wage to its employees, and maintain a reasonable ratio of CEO earnings to average employee earnings, maintain cordial and professional relations with labor unions, and bargain fairly with their employees, and follow sustainable employment practices.
• Save lives by guaranteeing product safety while promoting public health. Concerns for safety and public health caused sustainable investors to reject proposals from companies engaged in certain “prohibited business activities” such as the manufacture and/or sale of tobacco products; the manufacture of alcoholic beverages or gambling operations; the manufacture and/or sale firearms and/or ammunition; or manufacture, design, or sale of weapons or the critical components of weapons that violate international humanitarian law.
• Provide responsible stewardship of capital in shareholders’ best interests.
• Exhibit accountable governance and develop effective boards that reflect expertise and diversity of perspective and provide oversight of sustainability risk and opportunity. Sustainable investors will shun companies that have demonstrated poor governance, including failure to practice transparency in disclosures to shareholders or respond to shareholder communications or proposals, or engaged in harmful or unethical business practices.
• Commit to an external code or standard or a set of business principles that provides a framework to measure the company’s progress on environmental and social issues.
• Integrate environmental and social risks, impacts, and performance in their material financial disclosures in order to inform shareholders, benefit stakeholders, and seek their ideas and views and contribute to company strategy.
• Lift ethical standards in all operations, including in dealings with customers, regulators, and business partners. Sustainable investors require that the companies in which they invest adopt and rigorously follow codes of conduct that are based on recognized global best practices to guide their policies, programs, and operations.
• Demonstrate transparency and accountability in addressing adverse events and controversies while minimizing risks and building trust.
Sustainable investors often focus their activities on companies engaged in addressing needs, problems, and challenges in a specific societal domain and/or geographic area. Popular target societal domains include agriculture, education, safety, demography, community, poverty, environment, health and well-being, housing, and ethical goods and services. Geographic areas that have attracted substantial interest from sustainable investors include East Africa, West Africa, India, Pakistan, and Latin America.
Given the nature of some of the requirements described above, it is not surprising that many sustainable investors are not interested in pure “startups” and are looking for companies that have advanced to the “early stage” of development and have identified a stable business model that has already achieved some minimum level of revenues.
Many sustainable investors have developed “exclusionary criteria” that list activities and other characteristics that will disqualify companies from investment consideration. For example, a sustainable investor is quite likely to rule out funding companies that:
• Are involved in the extraction of carbon based resources, such as coal, petroleum, and natural gas, for the production of fossil fuels;
• Are primarily involved in producing or distributing alcohol or tobacco products;
• Develop, manufacture, or profit from weapons, including conventional, chemical, biological, and nuclear weapons;
• Generate nuclear power;
• Genetically modify seeds or living organisms (although such activities may be allowed with a showing of countervailing social benefits such as demonstrating leadership in promoting safety, protection of Indigenous Peoples’ Rights, the interests of organic farmers, and the interests of developing countries generally);
• Are involved in the gambling, gaming, or adult entertainment industries;
• Have primary business practices that involve the inhumane treatment of animals; or
• Have profited from conspicuous consumption, land speculation, predatory financial practices, or privatized detention facilities.
Source: The criteria identified and discussed in the text draws upon a review of published criteria of various social venture firms and investors including Calvert Group, Acumen Fund, City Light Capital, and Root Capital. Each investor has its own specific set of requirements based on its goals and objectives. For links to information on other social venture capital firms, see Cause Capitalism “15 Social Venture Capital Funds That You Should Know About,” http://causecapitalism.com/15-social-venture-capital-firms-that-you-should-know-about/#sthash.A7KQmImG.dpuf
Due Diligence
Careful selection of potential deal opportunities should bring the fund managers to the point where they can devote their resources, and the skills and experience of their team managers, to conducting comprehensive due diligence on the prospective portfolio companies and their managers. Due diligence is arguably one of the most important activities that the fund managers will undertake and a solid process of conducting due diligence should be in place before it all begins. According to the GIIN, due diligence serves a number of important purposes: including as a risk management tool, an opportunity to identify ways to add value to and improve the impact of an investee, a way to identify the social or environmental impact, or both, of the business, and a means to respond to the expectations of the fund’s investors.
In order to realize the benefits of due diligence, consideration must be given to the key elements identified by the GIIN3:
• Current, historical, and projected financial performance
• Overall business strategy and market position and environment
• Overall impact strategy
• Financial management strategy
• Operating efficiencies and inefficiencies
• Potential externalities
• Integrity and background checks for sponsors, owners, and managers
• Potential financial, environmental, and social risks analysis
• Legal due diligence
• Governance structure and company management
• Opportunities for growth and improvement
There is no universal standard for conducting due diligence and the sequencing of the focus on particular elements depends on the preferences of the fund managers and the availability of information from the prospective investees. In most cases, several elements will be investigated simultaneously and the due diligence will require request and review of documents, completion of questionnaires, interviews and inspections, and inquiries of the company’s business partners. In addition to the fund’s internal team, due diligence may also be conducted by outside professionals such as attorneys, accountants, and consultants with expertise in a specific sector and familiarity with the techniques associated with impact measurement.
Risk Management
The limited partner investors in a fund rely on the fund managers to identify, manage, and mitigate the risks associated with the deployment of their capital, assuming that the fund managers are better placed to fulfill those responsibilities as a result of their experience and the resources that they have collected in putting together their team. Risks should be assessed in a number of ways during the due diligence process and the results of the risk analysis should be used to determine whether to proceed with an investment and, if so, how the investment should be structured in order to fit within the risk profile that the fund managers have presented to their investors. The first step is to identify all of the risks associated with the prospective portfolio company, which can include macro, market, human resources, products, operations, financial, and ESG, and assess the company’s ownership and financial structure (e.g., how is ownership and financial distribution preferences already allocated among debt and equity holders, as well as outside lenders). Once the risks have been identified and quantified, the fund managers can take steps to mitigate the risks through the choice of the investment instrument, pricing and creating options for exiting the investment (either completely or through conversion into another form of investment instrument with different risk characteristics). Another strategy is the fund managers to condition the fund’s investment on certain risk mitigation actions by the portfolio company, such as purchasing insurance to cover a specific potential risk.4
The due diligence phase is the first time that the fund managers have an opportunity to interact directly with the founders and executive team members of the prospective portfolio companies and the all parties should use this as an opportunity to develop a foundation for the fund managers adding value to the business, assuming that an investment is eventually made. For example, if potential problems are discovered during the due diligence, actions will certainly need to be taken to resolve them or mitigate their impact in order for the fund managers to be comfortable with proceeding. However, the fund managers can facilitate this process by making specific suggestions to the leaders of the company and perhaps introducing consultants and other resource providers who can offer specialized assistance. The fund managers may also provide input on possible changes to the company’s business model and strategies that will improve its overall financial and impact performance. In addition, certain requirements imposed by the fund managers at the behest of their own investors, such as expanded impact measurement and reporting, will also lead to improvements in the company’s transparency and its ability to communicate to other stakeholders. Depending on the situation and the investment terms that are eventually negotiated, one of the fund managers may join the company’s board of directors, providing him or her with a direct and formal role in the stewardship of the company. The due diligence phase is an opportunity for everyone to see whether that sort of relationship would be workable. Even if the fund does not have a representative on the board, its fund managers should be comfortable that they will have access to the management team to provide counseling and share experience and expertise.
Identifying and Measuring Impact
Investors considering placing their capital with the managers of traditional venture capital and private equity funds certainly expect those managers to carefully analyze the business and financial models of prospective portfolio companies to determine a reasonable risk-adjusted financial return on investment. When it is intended that the fund engage in impact investing, another layer of review is added: identifying and measuring the environmental and/or social impact that can be expected from an investment in a portfolio company. An initial impact screening should occur well before companies are selected for the more intense due diligence phase and fund managers should create an “impact committee” that includes members of the internal team and experts recommended by the fund’s investors to focus specifically on the proposed impact thesis and theory of change for each of the companies that the fund managers are considering moving forward to due diligence. At this stage, since due diligence has not started, the group will have relatively limited information on how the company is actually performing; however, the impact committee can compare the company’s business model to the fund’s own impact goals and critically review the projections made by the company regarding growth and projected impact and the company’s assumptions regarding risks and challenges. If the company’s business plan raises too many questions, the fund managers may pass on the opportunity. On the other hand, if the impact proposition of the company is solid and the assumptions are reasonable, it may be moved forward into more extensive financial due diligence. In close cases, the fund managers may request additional impact-related information from the company before committing to full-blown due diligence. Another output of this process is ideas that the fund managers can provide to the company on improving their messaging and strategies relating to impact.5
Investor Expectations
The primary goal of the due diligence process is to make the best decisions regarding the deployment of the capital provided by fund’s investors to the fund managers. Once an investment is made in a portfolio company, it cannot easily be undone. If adverse information about the company comes to the attention of the fund managers after a deal is closed, the fund may have legal rights; however, this is not a productive path for any of the parties. As such, the fund’s investors will expect that the fund managers will put in place a comprehensive and professional process for both financial and impact due diligence that is clearly aligned with the issues and best practices in the sectors in which the fund will be operating. The scope of the due diligence should also demonstrate a recognition and understanding of the specific risks and operational issues that are most commonly found among the typical target portfolio companies. The fund managers should create and maintain a record of the due diligence investigation for each of the portfolio companies and be prepared to share with the fund’s investors how they identified and managed potential risks and the steps that they are taking to monitor issues that may have been identified during the process (including covenants for post-closing actions by the company and its management included in the deal documents).
Company’s Due Diligence on Prospective Investors
An integral feature of sustainable entrepreneurship and corporate social responsibility is ensuring that the resources required to establish and operate the business are sourced in a responsible manner that does not impair the integrity and reputation of the company. While transparency regarding sources of funding is relatively robust among public companies, which are subject to extensive reporting requirements imposed by governments and securities exchanges, the same is far from true in the startup world and the risks for sustainable entrepreneurs are increasing as rogue investors dangle capital in front of them at the same time as employees, customers, and other stakeholders demand that founders be able to explain how their businesses are funded. Founders need to understand the techniques they can use to conduct due diligence on prospective investors and ask questions to prospective business partners to determine how they are funded and the pressures they may be under from their own investors.
The robust economic conditions during the mid-2010s have encouraged many fledgling venture capitalists to hit the road to attract capital for their initial funds and they have often been advised to go after so-called “easy money”: billions of dollars available from sovereign wealth funds managed by Middle Eastern countries such as Saudi Arabia and Abu Dhabi looking to become major players in Silicon Valley and other innovation clusters around the United States and in Europe. The strategy seemed to make sense and, in fact, appeared to have been endorsed by major investment players such as SoftBank, an investor in Uber and other high-profile Silicon Valley companies that had accepted a commitment of $45 billion from Saudi Arabia’s Public Investment Fund. However, even before news of additional repressive political tactics in those countries came to light in 2018, fund managers, increasingly sensitive to calls for responsible investment, were hesitant about taking money tied to those countries and were instead focusing their fundraising on wealthy individuals, nonprofit organizations, universities, and pension funds committed to conforming to international standards for investing in an environmentally and socially responsible manner.6
More and more investors must now contend with questions from founders and executives of their existing portfolio companies, as well as questions during the courting process with prospective funding targets, about where the money they are investing came from. In particular, founders are asking investors whether they have received money from sources that are connected to foreign governments with poor human rights records or from foreign investors looking to effectively “launder” profits from illegal and unethical business activities in their home countries. Another concern is funding from government-supported sources in countries such as China and Russia where there are significant risks that one of the purposes of the investment is to gain access to proprietary technology and strategic business information. Venture capital firms have traditionally been less than forthcoming about their own investors (they are under no legal obligation to disclose the information, often keep it secret for competitive reasons and may actually refuse funding from public pension funds that publish the results of their investments); however, it is becoming clear they may often not have a clear idea about where the money is coming from because they have failed to ask the right questions themselves and/or investors employ sophisticated schemes such as shell companies to mask where the funds are actually controlled.
Some founders, with the support of their investors, have extended their concerns about financial and business support from repressive regimes beyond investors to include partnerships with customers, distributors, and suppliers, announcing that they would not do business with companies that have taken money from such regimes and/or conduct significant amounts of business with affiliates of such regimes. Companies are also concerned about doing business with firms that have board members designated by “questionable” investors since sensitive details of transactions are often distributed and discussed at directors’ meetings. In addition, lack of clarity about ownership and control of investment vehicles means that a founder may discover that one of its investors has also provide capital to competitors through affiliates as part of a broader scheme to gain access to the details of all proprietary technology relevant to a particularly promising sector regardless of which companies own that technology or whether any specific company will be most successful.
Investors have always conducted extensive due diligence on the founders of prospective portfolio companies and their proposed business models, seeking information on the company’s governance, management, and finances and often meeting with customers, distributions, suppliers, and other business partners; however, the founders themselves have rarely asked too many questions about potential investors, perhaps fearing that aggressive “reverse due diligence” would cause investors to back away. However, experts caution founders about being too timid, noting that the relationship with an equity investor is akin to a marriage that cannot easily be undone and thus must be entered into only if and when there is trust on both sides. Recommendations for reverse due diligence provide by one experienced adviser to founders include getting a perspective from peer investors; personally visiting another startup funded by the investor; doing research on investor visibility via Google and social media; inviting the investor to dinner or a fun-related activity; and conducting a routine credit and background check.7 In addition, founders need to be direct and clear about asking investors to explain the source of the funds that are to be invested and not be satisfied with vague and elusive answers.
Selecting the Investment Instrument
As the fund manager completes the due diligence process and moves toward a decision about whether or not to invest in a particular company, consideration must also be given to selecting the investment instrument and negotiating the specific terms of the instrument relating to the use of the funds, distributions, preferences, or subordination in relation to the company’s other financing instruments and exit mechanisms. Each side has its own interests to consider in selecting the investment instrument and the fund managers will obviously need to take into account the expectations of the fund’s investors as to the types of instruments the fund will be including in its portfolio. As discussed in a previous chapter, the parties must determine whether the investment will take the form of debt or equity. Debt, of course, means that the fund will be lending money to the portfolio company with the expectation that the principal amount will be returned in full by a specific maturity date. Equity financing involves selling the fund an ownership interest in the business. There are positive and negative aspects to each type of financing. The cost to the company of each type of funding is different, as is the way they are treated for tax purposes. The interest on borrowed money is deductible by a business for tax purposes, which reduces the effective cost to the company. Dividends that might be paid on the same investment in stock would typically not be tax deductible by the company. In selling stock there usually is no firm commitment to pay the money back but the fund will insist on extensive contractual rights to have a voice in the management of the company. Financing may also be structured as a combination of debt and equity when appropriate to fit the specific needs of the company.
Funds vary significantly in their preferences regarding the types of investment instruments that they purchase. For example, funds may specialize in investing through fixed income securities, typically debt instruments, or equity securities that are traded in public markets. The discussion in this chapter focuses on impact investment funds following a strategy similar to traditional venture capital funds, which means that the capital will be deployed through equity financing (including debt instruments that can be readily converted into equity securities upon satisfaction of certain conditions). When assessing an investment in a company that is in its early stages of development, fund managers generally consider the following types of instruments8:
• Convertible Notes: Convertible notes are frequently used for early-stage financings and should be thought of as debt securities (i.e., including principal amounts due at a maturity date, accrued interest provisions, and a claim on the company’s assets as an unsecured creditor (although in rare instances a convertible note will also be “secured”). It is intended that the notes will eventually, prior to the maturity date, convert into the same preferred equity security that the company issues in its first round of equity financing to a larger and more sophisticated group of investors, often referred to as the “Series A round” because the company will be issuing Series A preferred stock. The terms of that conversion will depend on provisions negotiated by the company and the noteholders, including a discount rate and a valuation cap. Provisions are also included to address what happens in the even the company is sold prior to a Series A round and what happens if the notes remain outstanding on the maturity date (i.e., the company failed to close its Series A round as scheduled). Not all impact investors are willing to invest using convertible notes, preferring to wait until the company has matured to the point where it is able to attract sufficient interest among investors to raise money in a Series A round.
• Preferred Stock: The holders of preferred stock have preferences over the other shareholders with regard to distributions in the form of dividends and upon the occurrence of certain “liquidity events” such as the sale or dissolution of the company. Distributions on preferred shares may be tied to a fixed schedule or the achievement of certain milestones relating to the company’s business. Impact investment funds typically prefer “convertible preferred stock,” which provides the holders with protections and superior rights in relation to common shares but also the opportunity to realize a larger return on their investment by converting their preferred shares into common shares when a market for the common shares emerges (i.e., upon the occurrence of an initial public offering). When convertible preferred shares are issued to impact investors, the company will grant additional rights to the investors in the charter documents and by contract including information rights, rights to vote on and approve certain matters as a separate group, registration rights, rights of first refusal and co-sale, price-based anti-dilution provisions, drag-along rights, and rights to designate a representative on the board of directors.9
• SAFEs (Simple Agreement for Future Equity): Safes were developed as a company-friendly alternative to convertible notes that have the same conversion features of notes (and the same variables to consider, such as discount rate and valuation cap) without a maturity date or interest accrual. Safes seem to be more prevalent among “hot” deals where investors are scrambling to be included and have less leverage to negotiate more protections like those normally seen in convertible notes. Safes were developed to provide a quick and low-cost solution to seed financing, and this can be accomplished if investors understand what they are buying. Investors seeking some protections or rights while accepting a safe can bargain for information rights, rights of first refusal, and so on, to be included in a side letter.
• Common Stock: While not frequently used for raising capital from impact investors during the early stages of development, companies can issue common stock, which is the same security that will be held by the founders and employees of the company and subordinated to government claims or taxes, regulated employee claims (e.g., pension obligations), all trade and bank debt and any preferred shares issued by the company. The main reason for using common stock is simplicity and relatively low legal costs. However, while investors issued common stock can be given voting rights and rights to receive dividends and distribution on liquidation, they would generally not have the same rights, preferences, and privileges given to later round investors unless those are negotiated separately, which would increase the cost of issuing the common stock. Moreover, issuing common stock significantly complicates valuation of those types of shares for equity incentive purposes. All in all, common stock has drawbacks for both sides of the transaction—founders and investors—and it is therefore unlikely that common shares will be used for early-stage impact investments.
When considering companies that have passed through the early stages of development (and have perhaps already issued one of the forms of instruments discussed above, such as a Series A round), impact investors may invest through different types of instruments including the following10:
• Participating Loan: The investor makes a loan to the company on terms which provide that payments to the investor will be based on the company’s profits over the term of the loan. In some cases, the parties will also agree that the investor will be entitled to fixed-interest payments that are not tied to profitability.
• Equity-Like Debt: Equity-like debt is similar to the convertible notes described above, but with more elaborate covenants. Often referred to as “bonds,” the holders have the right to convert into equity securities of the company or cash of equal value at an agreed-upon price and up to a specified expiration date. Interest payments during the term of the bond may be required to mitigate the investor’s risk, with the amount and timing depending on the company’s stage of development and ability to service the payments. In lieu of the conversion feature, investors may be issued a warrant, which is a security that provides the holder with the right to purchase equity securities at a preagreed exercise price (either by tendering cash or surrendering the bond as consideration for the exercise) until the expiration date of the warrant.
• Mezzanine Finance: Mezzanine financing is a combination of debt and equity financing used by companies that have already taken on debt financing from commercial lenders that have taken a senior position with respect to security interests in the company’s assets. Since the investor’s rights are necessarily junior to the senior lenders (but senior to claims of equity holders), it bargains for a financial return that is higher than that of the senior lenders (but still lower than a pure equity investment) including a higher interest rate and rights to convert into equity. Common forms of mezzanine finance include subordinated loans, participating loans, convertible bonds, and bonds with warrants.
Deal Terms
The terms of the deal should align the financial, strategic, and impact goals of the company to those of the fund and should be based on strong and clear communications between the fund managers and the company’s management team. The deal terms will vary depending on the form of investment instrument that is used, debt or equity, the requirements of the investors, the stage of the company’s development and the terms upon which the company has previously raised capital (including loans from commercial lenders). The key issues for the parties generally involve the duration of the investment (repayment of a loan or mandatory redemption of an equity investment); payments over the term of the investment, such as interest payments on a loan or dividends on equity securities, which may be tied to various measures of performance; preferences upon liquidation of the business or the sale of the company; voting rights including the right to vote separately on specified transactions; rights to convert the instrument into different securities of the company; and covenants relating to the use of funds and other operational activities of the company. The GIIN recommends that investors work with the managers of their prospective portfolio companies to set impact goals and expectations; define evidence-based investment strategies that target specific environmental and/or social problems such as affordable housing or clean energy; select metrics and establish targets using generally accepted tools such as IRIS; and measure, track, use the data and report.11
Burand noted impact investors have experimented with a number of structure and investment terms in an effort to align the timing and amount of their financial returns from investment in portfolio companies with the business models of those companies. Examples offered by Burand based on the results of extensive studies of innovative deal structures for debt and equity impact investments, as well as grants, included12:
• Grant funders developed “repayable grant” facilities that, upon the occurrence of certain agreed milestones, often operational or financial targets, converted their grants into loans that the grant recipient was expected to repay to the donor.
• Some lenders offered borrowers more flexible repayment schedules by rejecting a traditional fixed payment schedule in favor of variable payment structures that were triggered only if and when the borrower achieved certain thresholds of revenues or cash flows.
• Lenders also provided generous amortization schedules, lengthening the periods to ten years of more, offered grace periods of eighteen to twenty-four months before any payments on their loans were required and agreed to forego prepayment penalties or, in a few cases, offer prepayment discounts.
• Impact investors deployed a “demand dividend” structure that did not guarantee dividends to the investors but established a formula for variable payments that included the following features: (1) a payment schedule that is tied to the cash flow of the investee, (2) a honeymoon period (grace period) where repayment obligations are deferred, (3) a fixed payment obligation that is calculated as a multiple of the amount lent to the investee, and (4) covenants focused on ensuring that the investee reached and maintained a positive cash flow.
Another strategy that is used by impact investors in monitoring the activities of their portfolio companies through provisions in the deal documents is the use of covenants. For example, investors may require specific language in the documents regarding the steps that the company will take to ensure that its operational activities are consistent with the expectations of all parties regarding the company’s social impact and its relationships with the ultimate beneficiaries (e.g., consumers or community members). In situations where the company will be providing underserved communities with access to financial services, the impact investors will require not only that the company comply with all applicable laws and regulations, but also demonstrate that it has provided clear and comprehensive information to all of its customers. The impact investors will also demand that the company refrain from unfair or harmful debt collection practices. Impact investors also commonly insist on detailed reporting provisions that obligate portfolio companies to provide quantitative and qualitative information on the social impact of their operations.13
The Impact Terms Guide, a joint project of the Introduction to Social Entrepreneurship course at Harvard Law School and the Impact Terms Platform, focused on how to incorporate the broad principles and practices applied in impact investing into the agreements used to document the terms of an impact investment.14 The Impact Terms Platform also includes a library of case studies and term sheets that can be consulted for other strategies that might be used in drafting impact-related terms for investment documents.15 With regard to incorporating requirements on enterprises in investment documents relating to tracking “quantified impact” the Impact Terms Guide suggested several approaches:
• Obligation to develop a formal program to measure impact in order to ensure that measurement is sustainable and transparent using language such as the following: “The Company must develop a program to measure impact in partnership with the Investor, utilizing available tools such as IRIS, GIIRS, or other tools mutually agreed upon by both parties.” or “The Company must develop a program to measure social impact according to the ‘IRIS’ methodology and indicators, including two visits per year. The Company must also get certified by GIIRS as a GIIRS Rated Company.”
• Obligation to regularly notify/report on relevant impact metrics to the investor using language such as the following: “No more than thirty (30) days after the end of each quarterly accounting period, the Company shall notify the Investor in writing information on the state of the business, including total employment metrics, key performance metrics, and other measures of impact, plus non-quantitative information inclusive of major accomplishments and major lessons learned.”16
• Obligation to regularly deliver social and environmental impact reports using language such as the following: “At least once a year, the Company shall submit a written social and/or environmental impact report that includes a minimum of 3–5 impact metrics (which must include reporting on the number of underserved entrepreneurs funded (including by race, gender, age), number of funded companies located in an economically distressed or disadvantaged area, amounts invested originally and as follow-on funding, and number of low-income individuals employed) which will be based whenever possible on existing reporting metrics and practices and which will incorporate IRIS metrics, as feasible and appropriate.”17
• Obligation to obtain third-party verification of the company’s impact reporting using language such as the following: “Each impact report required to be delivered to the Investor hereunder shall be audited by a third-party organization with relevant expertise, selected by the Investor and reasonably acceptable to the Company. Costs of the audit shall be borne by the Company. If mutually agreed, the findings of the audit may be publicized by the Investor and the Company.”18
• Obligation to regularly complete impact certifications based on a reputable third-party impact assessment and rating system using language such as the following: “The Company hereby agrees to complete an impact certification on behalf of the Global Impact Investing Rating System (GIIRS) at least once annually post-Closing.”19
With regard to incorporating “specific purpose” into investment documents the Impact Terms Guide suggested several approaches20:
• Include a social investment purpose covenant to express to all parties involved that the investment is being made with specific purposes in mind in addition to monetary gains using language such as the following: “The social purpose of [the impact investment] is to [accomplish a specific purpose] for [a target population and geographical area], by [using a certain method].”21
• Obligation to respect a social business commitment in the company’s charter document and/or bylaws using language such as the following: “The promoters shall respect a Social Business Charter, in the form attached hereto, which will provide that the managers of the Company will encourage social and environmental impacts, identify the indicators of such impact and prepare and distribute reports on such impact.”
• Restriction on use of proceeds in accordance with a specific management plan that will lead to the accomplishment of the agreed social purpose using language such as the following: “The proceeds of the investment shall be used as operating capital in accordance with the management plans of the Company delivered to the Investor for implementation of the Company’s products with mutually agreed upon partners, including development and testing of the Company’s product and development of mobile features to make the product more accessible to low-income people.”
• Awareness and endorsement of the social investment purpose using language such as the following: “The Company acknowledges that it is aware of and agrees with the Investor commitments in the area of ethics and sustainable development.”
The Impact Terms Guide also described various incentives and disincentives that can be built into the terms of the deal and the investment agreements to ensure that the founders and other members of the management team are focused on pursuing and achieving the investor’s social investment purposes. Examples included the following:
• Increase in founder/management equity stake relative to investor by providing for forfeiture of a portion of investor’s equity if specific performance milestones are achieved using language such as the following: “[For every] OR [Upon completion of [specify impact target], the Company shall have the right to cause the forfeiture of up to [X Preferred Shares] or [X percent of the Preferred Shares], which forfeiture may be structured as a redemption of Preferred Shares at an agreed upon nominal value.”
• Increase in founder/management equity stake relative to investor through alteration of redemption price to reflect the company’s social or environmental performance using language such as the following: “[For every] OR [Upon completion of] [specify impact target], the redemption price per Share shall be reduced by X percent, provided that the price shall not be reduced below [$X per Share] OR [the Purchase Price] OR [a redemption price per Share equivalent to an X percent return per year on the Purchase Price].”
• Reduction in interest rate in debt transactions based on achievement of specific purposes using language such as the following: “[For every] OR [Upon completion of] [specify impact target], the rate of the Accruing Interest shall be reduced by X percent. In the aggregate, the interest due on the Maturity Date shall not be reduced by more than the total amount of the Accruing Interest.”
• Increase in interest rate in debt transactions upon failure to achieve agreed performance metrics using language such as the following: “If during the term of the Loan the Company fails to cure the violation of [specify the penalty trigger] within X days, the interest rate shall be increased by X percent, provided that the interest rate shall not be increased above the Initial Rate plus X percent.”
• Forced repurchase of investor’s shares, through redemption, following a continuous failure of the company to achieve its specific purpose using language such as the following: “As long as any of the Preferred Shares remain outstanding, if [specify the redemption trigger], the Investor may require redemption of [all or any portion of the Preferred Shares held by the Investor] OR [all but not less than all of the Preferred Shares].”
Other approaches for embedding social mission and impact into deal structures and investment documentation mentioned by Burand included incorporating a social mission definition into the deal documentation; restricting the use of proceeds of the investment to financing those business operations that are driving social impact outcomes; establishing a governance structure for the investee that includes the appointment of a board member with the responsibility to oversee the investee’s social impact; correlating financial returns to social impact outcomes actually achieved by the investee—either directly (i.e., the higher the social impact, the higher the expected financial return) or inversely (i.e., a lower financial return is required if a higher social impact return is achieved); and preserving the social mission objectives of investees, even at exit, through various techniques that have been referred to collectively as “mission lock”.22
Mac Cormac et al. offered a menu of strategies that impact investors could draw upon to protect themselves against deviation from social mission by portfolio companies. For example, when the investment takes the form of convertible debt the following steps should be considered23:
• Require that the company’s mission be memorialized at the time of the investment (e.g., in a new corporate form, corporate charter documents, shareholders’ agreement, voting agreement, or in the debt instrument itself)
• Include affirmative covenants (e.g., borrower shall use the proceeds of an investment only in a mission-aligned fashion) or negative covenants (e.g., borrower shall not change its mission-aligned business plan; borrower shall not incur any material capital expenditures for activities that conflict with mission)
• Include material deviation from the company’s defined mission as an event of default which triggers repayment of the outstanding debt, as opposed to a cross-default with other debt instruments that would have a catastrophic impact on an early-stage venture, and a supplemental remedy for investors in case the debt is not repaid, such as turning control of the board over to the investors
• Provide that a higher interest rate or prepayment will automatically apply if the borrower takes certain actions inconsistent with its mission
• Provide that equity conversion will not apply automatically in the next round of financing if the borrower takes certain actions inconsistent with the mission
• Require detailed reporting by the company to debtholders on mission and impact
• Appoint a standing special committee of the board tasked with oversight of mission that reports to the board and the investors if there has been material deviation
• Establish the company’s mission with reference to a thirdparty standard and provide for audits of the company’s compliance with the standard by the third party on a regular basis
Mac Cormac et al. noted that it was important for the parties to include procedures for determining whether a “material deviation” from the company’s defined mission had occurred, given the significant consequences of a default. One approach is for the investor to have the right to make an initial determination, but provide the company with an opportunity to object and have the dispute turned over to a designated independent third party to resolve. The third party audit referred to in the list is also a good way to reduce disputes.24
When the investment takes the form of preferred equity, Mac Cormac et al. advised impact investors to consider the following steps25:
• Enter into shareholder voting agreements that require that certain investors approve actions which are mission- (or not-mission-) aligned
• Create separate classes of stock for mission-aligned investors and founders, in conjunction with class approval rights for certain key actions such as material changes in the company’s business plan, including changes to mission; a sale of the company, along with triggers for drag-along rights; or any action out of the ordinary course that could have a material impact on mission
• Guarantee board representation for mission-aligned investors or have an impact investor board designee have specific veto rights at the board level
• Include redemption rights in the event of a material deviation from mission which would require the company to repurchase investors’ shares or face specified penalties, such as ceding board control to the unredeemed investors until the redemption price is paid26
• Include information rights related to mission and impact reporting
• Provide for changes to the conversion formula or conversion ratio from preferred stock to common stock in the event of a material deviation from mission, which would result in the investors receiving more common shares upon conversion and increasing their ownership stake relative to the founders
• Specify that dividends to preferred shareholders will become cumulative (i.e., will have to be paid regardless of the company’s profitability) in the event of material deviation from mission, which also increases the number of common shares received upon conversion and the liquidation preference of the preferred shares27
• Provide for changing the waterfall and/or the return upon liquidation (including a sale of the company) in the event of a deviation from mission28
While impact investors should expect to make long-term commitments to their portfolio companies and hold their securities for a significant period of time, consideration needs to be given to exit strategies even before the deal is closed. One of the goals of impact investing is to create value for both the investors and the companies in which they invest, and value can only be measured and realized when the securities issued to the investors can be liquidated (e.g., sold in a public offering or sale of the company, redeemed by the company or, in the case of a debt instrument, retired by payment of outstanding principal and interest). The fund managers should press the managers of the company to create an exit plan based on realistic assumptions regarding the progress of the company toward its business, financial, and impact goals and the company’s ability to raise additional capital to execute its strategies. It may be necessary, and expected, that the investor provide additional capital to the enterprise; however, as a general matter, the timeline of the investor’s involvement with the company should extend no longer than the period during which the investor can make a significant contribution to the company’s progress. The exit plan should, also address how the company’s impact objectives will be maintained after the investors have exited and investors should be prepared to provide company managers with a reasonable amount of flexibility in terms of the timing of an exit transaction and the selection of a buyer in order to ensure that the impact-related activities of the company will be continued under reliable stewardship.29
Post-Investment Management
Impact investors choose and rely upon fund managers to not only make good choices about the selection of portfolio companies, but also to help and support the managers of those companies to achieve the mutually agreed financial and impact goals once the deal has closed. The terms of the investment should include commitments from both sides regarding post-investment management and communications and the fund managers should have a full team and formal structure in place to be sure that the fund can adequately support all of the companies that are included in the fund’s portfolio. Each of the main fund managers will have a group of portfolio companies that he or she is primarily responsible for and the fund manager will need to have sufficient time to interact with the managers of those companies and oversee those members of the fund’s operational team that have also been assigned to those companies. In addition, the fund managers must be prepared to leverage external resources and independent experts to support portfolio companies, such as by facilitating access for those companies to the networks of the fund’s investors and providing those companies with introductions to outside parties that can offer technical and operational assistance to build their business capacities quickly and efficiently. Other suggestions from the GIIN for developing professional monitoring processes for portfolio companies include establishing annual portfolio monitoring cycle: quarterly review of investee reports and regular valuation; early identification of issues and problems: regular monitoring and early warning signs; taking early action to resolve issues and building capacity in portfolio monitoring teams to deal with issues when they arise; and offering optional common shared services for investees including finance, accounting, reporting, human resources and recruitment.30
The GIIN suggested that one area in which fund managers can provide useful and specific assistance to portfolio companies is with identifying specific risks confronting the companies in their operating environments and developing appropriate risk and crisis management programs. Specific risks depend on a variety of factors including the company’s business model and the locations in which they are operating. Companies may find themselves challenged by natural disasters, societal upheavals, political tensions, labor disputes, and breaches of legal responsibilities. Fund managers need to work with the managers of their portfolio companies to create contingency plans and mitigate the loss of value to the fund’s portfolio. Fund managers also need to be able to make specific contributions to the responses of portfolio companies to a crisis, either directly or through their networks.31
Fund managers often provide proactive support for their portfolio companies by serving as members of their board of directors. In their role as a director, the fund manager can take a number of steps to strengthen the company’s governance framework and processes including requesting an evaluation of the company’s governance to achieve best practice; reviewing or establishing a code of ethics, veto and other rights; defining the company’s charter and decision-making processes; clarifying the role of the board of directors in the form of a charter; and ensuring that all directors and officers understand their duties and responsibilities to the company and its stakeholders. Even though the portfolio company may still be relatively small, the closing of an investment by an impact fund should be a point of transition toward a more focused approach to governance that includes the formation of specialized board committees addressing issues such as audits, compensation and remuneration, governance, and organizational development.32
Regardless of whether a fund has a representative on the board of directors, the fund managers and their team members should commit to continuous support of the management team leveraging the fund managers’ experience and strong knowledge about the industry and sector in which the company is operating and the technology and operational strategies upon which the success of the company depends. The GIIN noted that fund managers can provide their portfolio companies with guidance by33:
• Advising on the company’s business strategy, including product design and marketing
• Using gap analysis to uncover new functional needs for a growth company
• Helping to attract and retain quality senior staff
• Improving financial systems, including accounting, audit, and reporting procedures
• Introducing the company to other sources of financing
• Improving its governance and transparency34
• Introducing the company to new technology
• Establishing new supply and distribution relationships
• Helping the company effectively measure and manage for impact
• Helping the company to use social and environmental impact data to strengthen sales and impact performance
• Identifying and planning for exit options
Guidance opportunities and priorities can also be broken out into functional categories: strategy (help define growth strategy and business plan and develop impact measurement and management plan); human resources (bring in CFO or financial manager, if needed, and surface the best talent available within budget); governance (strengthen governance at the board level and identify board members who are aligned with the company’s environmental and social mission); operations (improve and develop products, identify improved production methods and review relationships with suppliers); and finance (review financing structure and identify areas of improvement, help identify sources of capital, and introduce information management systems and budgeting processes).35
1 https://thegiin.org/developing-a-private-equity-fund-foundation-and-structure/ (Figure 11: Filtering the Investee Pipeline)
2 Id.
3 Id. (Figure 13: Important Elements of Due Diligence) See also McCreless, M. 2014. “Social & Environmental Due Diligence: From the Impact Case to the Business Case.” Root Capital, (https://rootcapital.org/resources/social-environmental-due-diligence-from-the-impact-case-to-the-business-case/)
4 https://thegiin.org/developing-a-private-equity-fund-foundation-and-structure/ (Figure 14: Managing Risk)
5 The GIIN has assembled a list of various resources that fund managers can use to integrate impact considerations into their investment management including The Impact Management Project, Navigating Impact Project, IRIS and the Impact Toolkit. Id.
6 Griffith, E. 2018. “Suddenly Questioning Easy Money For Start-Ups.” The New York Times, November 3, 2018, B1.
7 Zwilling, M. 2018. “5 Steps to Due Diligence on Your Potential Investors.” May 9, 2018, https://blog.startupprofessionals.com/2018/05/5-steps-to-due-diligence-on-your.html
8 Adapted from 2017. Startup Seed Financings: Overview. New York, NY: Thomson Reuters Practice Law Corporate and Securities.
9 The terms of the convertible preferred stock described in the text are generally associated with so-called “Series A Preferred Stock”, an important steps in a company’s development. It should be noted, however, that companies may issue some form of convertible preferred stock, rather than the convertible notes described above, in the later stages of seed financing and/or when the size of the financing is relatively large and the investor group is experienced and sophisticated and each investing fairly large amounts of money (i.e., over $100,000 per investor). The instrument is often referred to as “Series Seed Preferred Stock” and will include several of the same protections and rights afforded to investors in the Series A round such as information rights and rights to vote separately on certain actions proposed by the founders as common stockholders. At the same time, Series Seed Preferred Stock typically does not include some of the more complex terms seen in Series A rounds and the liquidation rights of Series Seed Preferred are typically limited to a return of the purchase price before distributions are made to common stockholders, with a right to convert to common stock and waive the liquidation preference.
10 https://thegiin.org/developing-a-private-equity-fund-foundation-and-structure/
11 https://thegiin.org/developing-a-private-equity-fund-foundation-and-structure/
12 Burand, D. 2015. “Resolving Impact Investment Disputes: When Doing Good Goes Bad.” Washington University Journal of Law & Policy 48, no. 55, 61–63, https://openscholarship.wustl.edu/law_journal_law_policy/vol48/iss1/9 (citing D. Propper de Callejon et al., Innovative Deal Structures for Impact Investments (2014) (report) (on file with author)).
13 Id. at 64.
14 https://impactterms.org/impact-terms-guide/
15 https://impactterms.org/case-studies-term-sheets/
16 The language on reporting on relevant impact metrics would be in addition to the requirements for providing customary information rights including audited annual financial statements, unaudited quarterly and semi-annual financial statements, cash flow statements and reports on usage of funds, quarterly commercial report in the specified format detailing the commercial progress made by the company with respect to its main KPIs and an annual budget. Specific dates for delivery of each of these reports will also need to be determined and specified, such as requiring that audited financial statements be delivered within 90 or 120 days of the end of the relevant fiscal year and that the business plan be delivered no later than 30 days prior to the beginning of the next fiscal year.
17 The Impact Terms Guide recommended that written narrative impact reports should contain details relating to the social and/or environmental impact of the company’s activities including analysis of impact metrics, anecdotes related to the impact of the company’s activities, case studies, changes in social impact thesis or criteria, and other related impact outputs and outcomes. In addition, the Impact Terms Guide called for reports to contain detailed explanations of the company’s policies and activities in relation to ESG matters and in the absence of such systems, a clear and reasonable explanation for not doing so or steps being undertaken to put such policies in place. The report should contain analysis about how much change occurred as a result of those policies and activities.
18 In some cases, the parties may agree that audits will only be necessary if requested by the investor and the cost of the audit may be allocated to the investor if a request is made more frequently than once every two or three unless the audit discloses substantial reporting errors.
19 GIIRS uses the B-Lab’s B Impact Assessment process to deliver a comprehensive accounting of a company’s impact on workers, customers, communities, and the environment using IRIS metrics in conjunction with additional criteria. For further information, see https://b-analytics.net/giirs-funds. Measurement may also be conducted using other frameworks such as the IRIS, the Sustainable Accounting Standards Board Standards, Global Reporting Initiative Standards and the International Integrated Reporting Council framework.
20 In addition to the contractual strategies outlined in the text, impact investors can require that enterprises operate as a benefit corporation (as discussed in the previous chapter) and/or that they specifically commit to pursuit of purposes aligned with universal standards such as the UN’s Sustainable Development Goals.
21 A breach of the social investment purpose covenant should explicitly be called out as an event of default in the investment agreement that would trigger specific consequences detailed in the agreement.
22 Strategies used to establish and enforce “mission lock” include granting veto rights to the company’s founders, who are presumably the parties most interested in maintaining control of the company’s social mission, to block investor exits that conflict with the company’s mission; termination of valuable licenses or hikes in the royalties/fees to be paid for such licenses; and the company’s choice of legal form (e.g., benefit corporations, which are governed by guidance that allows directors to take into account all corporate constituencies, not just shareholders, when weighing offers to purchase the company, which means that a sale to the highest bidder is not mandated) and/or provisions relating to the purpose and authority of the entity included in the company’s charter documents (e.g., provisions detailing specific socially-related public benefits and/or provisions that explicitly prohibit the company from taking certain actions in order to generate profits). Burand, D. 2015. “Resolving Impact Investment Disputes: When Doing Good Goes Bad.” Washington University Journal of Law & Policy 48, no. 55, 65–67, https://openscholarship.wustl.edu/law_journal_law_policy/vol48/iss1/9
23 S. Mac Cormac, J. Finfrock and B. Fox, “Impact Investing” in A. Gutterman et al. (Editors), The Lawyer’s Corporate Social Responsibility Deskbook (Chicago: American Bar Association, 2019), 234–235.
24 Id. at 235.
25 Id. at 235–236.
26 The risk that the company may be unable to fund a require repurchase may be managed by granting the investors the right to sell their shares to a co-investor who serves as a guarantor in the event of mission deviation.
27 The number of common shares received upon conversion will increase because the amount of cumulative but unpaid dividends is added to the original amount paid by the investors for their shares. Similarly, the liquidation preference for the shares would be increased by the amount of cumulative but unpaid dividends.
28 For example, provision could be made for changing the liquidation preference of the preferred shares from one time their original investment to a greater multiple, such as two times). Alternatively, or in addition, the preferred shares may be adjusted so that they become participating preferred rather than nonparticipating, which means that they would receive a greater share of the proceeds upon a sale of the company relative to the founders and other common shareholders. For further discussion, see A. Gutterman, Launching New Businesses: A Guide for Sustainable Entrepreneurs (Oakland CA: Sustainable Entrepreneurship Project, 2019) and C. Harvey, “Financing a Business” in A. Gutterman and R. Brown (Editors), Emerging Companies Guide (3rd Edition) (Chicago: American Bar Association Business Law Section, 2020), 213.
29 See Schiff, H. and H. Dithrich. 2018. Lasting Impact: The Need for Responsible Exits, 20–23. New York, NY: The GIIN, January 2018, https://thegiin.org/research/publication/responsible-exits
30 https://thegiin.org/developing-a-private-equity-fund-foundation-and-structure/
31 https://thegiin.org/developing-a-private-equity-fund-foundation-and-structure/ (Figure 15: Crisis Management)
32 Id.
33 Id.
34 Fund managers can provide advice on governance issues related to environmental and social issues, even if not directly related to the specific impact objective of the investment. See, for example, How to Set Up Effective Climate Governance on Corporate Boards: Guiding Principles and Questions (World Economic Forum, January 2019), http://www3.weforum.org/docs/WEF_Creating_effective_climate_governance_on_corporate_boards.pdf
35 https://thegiin.org/developing-a-private-equity-fund-foundation-and-structure/ (Figure 16: Adding Value Across the Investment Lifecycle and Figure 17: Adding Value: Function Model)