Song Investment Advisors: Building purpose-driven organizations on financial sustainability
Finance First: A Brief Case Study
There is no such thing as “mission-first” investing – sound financial stewardship is at the heart of impact.
One hypothesis among impact investors is that “underserved” markets may attract return-oriented capital if investment opportunities more closely target the burgeoning ranks of “aspirers," or lower-middle class populations that make up the earth’s middle 3 billion inhabitants—those who already participate in some form of a market economy, but who still lack access to basic products and quality services at affordable prices.
Song Investment Advisors, founded in 2008 to provide growth capital to small and medium-sized enterprises (SMEs) in India, directly tested this hypothesis. Leading and advising the first-time fund (mostly program-related investments, but not exclusively), Vishal anchored his investment strategy in building commercial, formal-economy businesses to improve the quality of life of the aam adami (“common man” in Hindi). As an initial baseline, Song primarily targeted communities with household incomes less than INR 10,000 per month—that’s between $6 and $13 per day per breadwinner, depending on how you convert it (nominal or PPP—there are arguments for both).
The next few posts in this series will focus on the fundamental message that while commercial capital seeks opportunity in these rapidly growing markets, impact capital can leverage this momentum to build purpose-driven businesses; addressing the core needs for targeted constituencies while providing compelling returns for non-concessionary investors.
In this post, we look first at the genesis of the fund itself and the governing theory Vishal brought with him to the impact investment space. In subsequent articles, we will examine specific investments, why Song made them, and the challenges they created for the fund managers.
Song Investment Advisors
From the outset, Vishal positioned Song as an investment advisor seeking to create positive financial returns for its investors. With this constraint, the investment committee developed a charter focused on three principal tests for the fund to retain its focus on underserved communities. First, the committee established the target income level to guard against the natural inclination to chase transactions further up market. Second, they agreed to focus on investment opportunities that would promote blue-collar job creation and/or cater to consumption needs by building profitable SMEs that marketed goods or services according to income level. Finally, the ultimate test was the ability to catalyze further investment in these communities by bringing in additional commercial capital (debt or equity) to support growth in their portfolio of businesses.
To make the long story short, Song’s investment experience generally supports its initial hypothesis. Between 2008 and the end of its initial investment period in early 2012, Song has produced substantial gains for the fund. Most significantly, new commercial capital providers have been attracted to individual portfolio companies, further strengthening their growth prospects.
Why this is important
The principal theory underlying the Song approach is to “design for purpose” so that operating professionals can “execute for profit” at each portfolio company. Thus, as the investment team seeks transactions that fit the mission criteria, the operating team can focus on building the business. This streamlines communication between Song (the investment advisor), its investors, and the management team of each portfolio company. It further promotes a unified framework for everyday metrics of sales growth, job creation, and retained earnings as performance targets. All parties understand that by executing these fundamentals correctly, they are satisfying the purpose-driven mission underlying each investment.
What separates Song from “profit-maximizing” organizations is its self-imposed discipline on investment criteria, which prohibits pursuing financially attractive opportunities that operate mainly outside the income parameters of the target constituency (the defined purpose). With similar discipline, Song does not invest in mission-first social enterprises that cannot support a return on capital. As Vishal is quick to note: “Song may be purpose-driven, but it is not philanthropic.” In other words, the mission is to invest as low down on the economic pyramid as possible while still building financially sound, growing businesses.
The importance of his approach indirectly leverages the overwhelming amount of profit-only growth capital flowing into India. Song is riding the momentum of market growth but purposefully “undershooting” the markets where all the big money is headed. This allows Song to concentrate on the marginal communities within its mission while avoiding the risk of overheated, mainstream investing competition. This market in India, comprised of lower-income service and production workers, represents a rapidly expanding base of “aspiring” producers and consumers. Their needs are in direct correlation to their desires—an attractive element to any investor, impact or otherwise.
Investment opportunities in this space are compounded by the size of the markets. In 2008, India had already been growing its GDP by 8 percent or more for several years, and consultancies such as the McKinsey Global Institute were forecasting the creation of more than 600 million new middle-class citizens before 2025. Vishal notes, “That means that in fewer than 15 years, more than one-third of India’s population could move from being a part of a ‘deprived’ underclass to being part of an ‘aspiring’ class (earning INR 7,500 to 15,000 per month).”
Any growing middle class brings with it a significant demand for more goods and services, and in this context, choice—not merely need—drives demand. Building new formal businesses in that portion of the pyramid where at least some market characteristics of discretionary demand exist affords purpose-driven investors like Song a chance to satisfy consumers and create new blue-collar jobs. Longer-term, the hypothesis is that formal business entities will beget more businesses as they create their own demands of an ecosystem comprised of suppliers, distributors, vendors, innovators, and competitors—all of which need some form of return on some amount of investment to continue improving the breadth and depth of that ecosystem.
From the perspective of investment opportunity, this is scale by any definition, but it is not without complexity. In future posts, we will look at some of the challenges inherent in this space for which successful fund managers need to be prepare.