Social VCs: Time for real impact4 min read . Updated: 31 Jul 2015, 12:36 AM IST
The biggest problem that the social venture capital industry faces is the absence of an effective voice
“It’s easier to raise four $20 million funds than one $100 million fund," the founder of one of India’s leading social venture capital firms remarked to me recently over lunch. He has been on the road for nearly 10 months to raise his latest fund and is yet to hit the ‘first close’ milestone.
In the venture capital and private equity universe, the first close denotes a certain threshold of money that a firm raises for a new fund before it can start making investments. The threshold is generally half or a little more of the target corpus. In an ideal scenario, the first close is usually achieved within six months of launching a fund.
For social venture capitalists (VCs), also known as impact investors, ideal scenarios are virtually non-existent.
Such investors typically back businesses that target consumers at the bottom half of the pyramid. That limits the capital pool that is available to them. Their primary sources of capital are global development finance institutions (DFIs) such as World Bank arm International Finance Corporation (IFC) and the UK government-backed CDC Group, Dutch development bank FMO, and corporate endowments such as the Michael & Susan Dell Foundation.
Over the past decade, these institutions have distributed $1.6 billion across more than 30 social venture capital firms currently active in India, according to data compiled by New Delhi-based Impact Investors Council. Most of this money has been invested in seed- and early-stage companies.
That’s small change compared with the more than $12 billion raised by mainstream venture capital investors since 2006. Last year alone, mainstream venture capital investors raised over $2 billion across 13 new funds. Most of these mainstream funds have been closed within six-eight months of launch. Such investors usually raise capital from global public pension trusts, corporate endowments, fund-of-funds and financial institutions. These institutions don’t normally invest in social venture capital funds since they seek higher returns than those offered by social funds.
However, that said, social venture capital funds aren’t strapped for funds because their usual sources of capital don’t have adequate resources. The problem lies elsewhere.
To begin with, barring exceptions, most limited partners (investors in venture capital funds) focused on social funds allocate anywhere between $2 million and $5 million in each fund. Such allocations—which are nearly a decade old—were fine as long as the funds themselves were small. But, over the past decade, social venture funds in India have grown significantly in terms of investment portfolios and impact.
This isn’t unusual given that, along with the mainstream start-up ecosystem, the social entrepreneur universe has also expanded. This is playing out across a range of sectors including financial inclusion, agribusinesses, healthcare, education and clean energy. Rough industry estimates put the total number of social sector start-ups currently active at nearly 3,000.
Take for instance, Mumbai-based Aavishkaar Venture Management Services, the largest home-grown social venture capital firm in India. It started in 2001 with a ₹ 5 crore (less than $1 million) fund and is currently raising $400 million across two new funds. Along the way, it has invested in nearly 50 companies and currently has $200 million in funds under management. Delhi-based Lok Capital started with a $22 million fund in 2000 and is currently raising a $100 million fund. Since inception, it has invested in more than 20 companies.
If small allocations aren’t enough of a problem, social venture capitalists have lately been dealing with a new challenge— competing for deals with their own limited partners. DFIs such as IFC and CDC Group, among the largest investors in social venture capital funds, have now started investing directly in social enterprises. On the one hand, this brings more capital into play on a deal-by-deal basis for start-ups. However, it also means that there is less capital available for social venture capital funds that may be competing for the same deals.
Part of the reason limited partners are investing directly in social enterprises, alongside social venture capital funds, is the lack of returns on prior investments. Poor returns are a universal problem for limited partners invested in the Indian private equity and venture capital market. Social venture capital funds, in particular, are still recovering from the after-effects of the 2010 microfinance crisis that all but wiped out domestic microfinance institutions (MFIs).
MFIs account for 56% of the $1.6 billion invested by social venture capital funds over the past decade, according to Impact Investors Council. Lok Capital’s first fund, the $22 million Lok Fund I, for instance, invested almost all its capital in MFIs. Even global funds, such as Mumbai-based Acumen, which is a non-profit that invests in for-profit enterprises, hasn’t had a smooth ride with its investments here. Industry executives say that it is now trying to transition to a for-profit model, similar to Lok Capital and Aavishkaar.
The biggest problem that the social venture capital industry faces, though, is the absence of an effective voice. As an asset class, social venture capital’s issues and priorities are different from mainstream venture capital. A decade in existence should be enough to convince all stakeholders, including limited partners and regulators, of its significance in the context of the larger ecosystem. Time for social investors to join the venture capital lobbying bandwagon.
Snigdha Sengupta is the founder of StartupCentral, a digital news and analytics platform focused on venture capital. She also periodically contributes stories on venture capital and private equity to Mint.