Impact Investors Need to Share Power, Not Just Capital

(Photo by iStock/Baris-Ozer)

Lack of capital access and ownership is a historic and systemic barrier to equity, especially for Black, Indigenous, and other racial groups, and women. A number of efforts are underway to address this issue: Investors and foundations representing more than $1.88 trillion in assets under management signed Confluence Philanthropy’s 2020 Belonging Pledge, and hundreds of foundations have committed to increasing philanthropic allocations to community organizations and initiatives led by the people most affected by the social issues being addressed.

But moving capital to communities of color or women, on its own, does not achieve equity. The way capital is shared, and the power dynamics underlying that process, is equally important. Uninterrogated investment processes risk replicating legacy systems and values in how investments are made, and may put misplaced trust in the power of capital alone to create equitable outcomes. A recent example of this is Opportunity Zones, which, since 2018, have funneled more than $12 billion into so-called “distressed” areas across the United States through community development finance institutions (CDFIs) or other Qualified Opportunity Funds (QOFs). Investors were enticed into these schemes through various tax deferrals or benefits. However, Congress never designated the conditions for the responsible deployment of this capital, nor an agency to analyze the impact. Much of Opportunity Zone investment has gone to projects like luxury housing, failing to improve—and in some cases worsening—the lives of low-income residents in the areas, according to an Urban Institute report.

As investing in gender and racial equity gains more interest from institutional investors and foundations, we need tools to reveal and analyze how capital is allocated—not just where. Otherwise, power imbalances will continue to create inequitable outcomes. As Rodney Foxworth, CEO of Common Future has said, “We have to make sure that we’re marshaling resources and capital to the types of things that will make change in communities and [also] shift and disrupt power dynamics.”

The Criterion Institute (a think tank focused on social finance, where one of the authors is an advisor) recently published a way to evaluate power dynamics in investment processes. The approach emerged out of partnerships with Australia’s Department of Foreign Affairs and Trade (DFAT) and the Canadian government’s Social Finance Fund (SFF). Both organizations wanted to apply an equity lens to funding ambitious solutions to social problems, and Canada’s SFF is leveraging the framework to guide investments worth more than $800 million CAD ($635 million USD). By answering the method's seven key questions, organizations can get a better idea of how equitable their investment processes are.  

1. Whose Knowledge Is Valued?

People working in social finance expect to pay for input from financial experts, yet generally ask social change organizations or beneficiary communities to contribute their insight for free. This devalues the time and perspectives of those outside of traditional finance careers. As a result, investors lose important information about the markets they're considering, community organizers and leaders lose possible sources of income, and funded interventions are less well informed, reducing their likelihood of having positive impacts. Investors must recognize—monetarily or in other explicit ways—the value of all types of expertise, or they risk perpetuating inequitable norms and values. Social, cultural, and practical market knowledge can mean the difference between the success or failure of an investment, and should be compensated accordingly.  

Organizations trying to assess how they are valuing knowledge should track how much they spend on different types of expertise and whether the proportion is equitable. They should also track the number of social issue experts or members of affected communities present on investment committees or on key decision-making bodies with voting power. Investors can track this when designing investment products, funds, strategies, and mandates in order to ensure that knowledge from outside of traditional finance is valued, compensated, and embedded throughout the process.

Adasina, an investment management firm that aims to bridge financial markets and social justice, provides an example. It is majority-owned and operated by women, people of color, and members of the LGBTQ community. To help create its social justice public equity exchange-traded fund (ETF) and other fixed-income products, Adasina paid social change organizations to provide insight into systemic risks it believes other investors often miss. For instance, communities alerted them to the use of mandatory arbitration clauses in employment contracts—a practice that harms workers, especially those experiencing sexual assault. Adasina then created a publicly available list of companies engaged in this practice, so other investors can exclude them from impact funds. Adasina also incorporated this data into their ETF. This approach is a first of its kind in the impact investing space, demonstrating that valuing insight from those on the front lines of social change movements can lead to more innovative and effective social finance products.

2. Who Is Seen as ‘Worthy’ of Access to Capital and Resources?

An abundance of research shows that most investors view white, Western-educated men as "most worthy" of investment across a number of asset classes. In 2020, venture capital investments in women-led ventures in the United States was $4.9 billion—2.3 percent of industry totals. Statistics are even worse for women founders of color. Over the last decade, LatinX women-led startups have raised only 0.32 percent, and Black women have garnered only .0006 percent of all venture capital investment. Indigenous-led businesses are not even tracked.

Investors should ensure they prioritize the inclusion of underrepresented groups of various intersecting identities (such as race, ethnicity, and gender) and measure the percentage of organizations, companies, or investment portfolio firms led by underrepresented groups that apply for funding, along with the percentage of those that are awarded funding. Investors should also evaluate their own due diligence processes or selection criteria, to look for barriers that may inadvertently prevent underrepresented founders from accessing funding.

SheEO is a nonprofit venture capital firm that supports women-identifying entrepreneurs focused on the Sustainable Development Goals (SDGs). It has strived to lower barriers to entry for venture founders by designing an inclusive screening and due diligence process. SheEO does not use credit scores or an investment committee to evaluate which businesses it lends to; instead, its community of thousands of global investors democratically vote on which ventures receive funding. It does not ask founders to have "skin in the game" by investing their own money into their businesses, as this is not an option for many founders without intergenerational wealth.

SheEO has also taken steps to educate its investor network on issues related to race and ethnicity bias, and adjusted the voting form to emphasize equity and diversity as a core value that the community should consider when selecting investees. All of this has led to organically improved results, as the values are embedded in the design of the process, and not imposed in quotas or rigid structures. In 2019, 75 percent of Canadian finalists being considered for investments were Black, Indigenous, women of color, and/or 2SLGBTQI+, up from 43 percent in 2018. This past year, all five of the selected US ventures were founded by Black women. SheEO also increased the diversity of its venture applicant pool by building relationships with Indigenous communities in New Zealand, Australia, and Canada through the Indigenous Women Entrepreneurs (IWE) network, which is part of the Indigenous LIFT Collective. SheEO demonstrates that intentionally creating equitable processes and building genuine relationships across racial, cultural, and economic boundaries can produce "power with" (as opposed to "power over") outcomes for the entire community of investors and investees.

3. Who Decides?

Capital holders typically have the most potent decision-making power across every stage of the investment process, which creates a power imbalance between investors and capital recipients. One way to rebalance power is to share control of important decisions in the investment process—like structuring deal terms or expected outcomes. To see if they're achieving this, investors should keep track of how many of their meetings on the project include social issue experts or members of the community, and the percentage of dollars allocated with explicit community consent and input. Investors should also assess—using surveys, verbal check-ins, or other methods—investee's or a community's experiences related to a sense of empowerment throughout the process. Were they satisfied? Did they feel like their input was heard and acted upon? If it wasn't, do they have clarity as to why?

Candide Group, for example, launched the $40 million Olamina Fund in 2019 to make debt investments that support racial justice, social equity, and Black and Native communities. Notably, a minimum of 80 percent of organizations in the fund’s portfolio must be led by people of color and women. Olamina's governance structure is led by a community advisory board, whose members were selected by a committee that was representative of the communities that Olamina serves. The board advises on the fund’s strategy and reviews investment opportunities and, as part of the credit committee, loan approval must be made with the board's consent. The Olamina Fund's approach has flipped typical decision-making power dynamics with its goal of having the community advisory board shape the fund's governance structure and future investment thesis.

4. Whose Time Frame Matters?

Capital holders can afford to drag out an investment process until they feel comfortably informed, while capital recipients don't have the same luxury. Engaging with funders and investors is time-consuming work that can take time away from building a fund, business, or nonprofit. If capital recipients are to be equitably included, their scheduling preferences and needs must be accounted for and prioritized. Investors aiming for a more equitable time frame should measure the actual duration of each phase of the investment process (application, capacity building, due diligence, the delivery of the funds, and others) compared to the schedule they initially set. They should also tally how many hours applicants spend on the investment process relative to the amount of money involved. Overly burdensome and time-consuming processes that invest or grant small amounts should be re-evaluated.

SheEO, for example, streamlined several parts of its investment process to serve time-strapped founders from a wide variety of backgrounds. The landing page for its loan application—just 10 short questions in plain language that was refined over the years with input from the community—says it all: "No pitch decks. No attachments. No jargon." SheEO also demonstrates its consideration of an entrepreneur's needs by consistently taking, at most, only three to four months to make an investment decision. This process might take more typical organizations three to 18 months, if not longer.

5. Who Gets to Know What, When?

In a typical investment process, doing due diligence largely means gathering data to help capital holders make decisions, while leaving enterprises and communities less informed about their fit for the funds. To make a process more transparent and equitable, information must be shared more openly with everyone involved. How can investors assess their performance on this? For one, they should calculate the percentage of applicants who meet their basic criteria — if many potential investees fail the first screening, there may be information asymmetry. Secondly, investors should assess how often they're communicating with other stakeholders. If they are not setting and sticking to a reasonable and clear schedule (“you’ll hear from us within two weeks” versus “soon”), the process is opaque to capital recipients and again demonstrates a prioritization of the capital holder’s process and timing.

Marigold Capital is a Canadian venture capital fund and impact investor that invests in women and underrepresented founders with an impact focus. Marigold has built transparency into its processes by clearly stating their detailed investment criteria directly on their website. On initial calls, Marigold walks founders through their selection criteria and three investment phases, discussing what they are looking for at each stage. This contrasts against the seemingly opaque or black box set of investment criteria put forth by many funds. Marigold also encourages founders to have calls with their other funded ventures and even Marigold limited partner investors, so founders can perform reverse due diligence on them as potential investors.

Another exemplar of transparency is the venture capital firm, Bloomberg Beta. It published its website on GitHub—a  software development platform—so that anyone can view in real-time the firm's operations manual, investment documents, portfolio companies, and criteria for evaluating investments (including non-negotiables). The team even shares its reading list.

6. Who Is Taking What Risk?

Investors typically prioritize their own perceived financial risks over those of capital recipients. As a result, chosen investment structures may work against stated impact goals, and risks to investors are evaluated more rigorously than risks to communities, founders, or social organizations.  To share risk more equitably, investors should seek to understand and identify the risks faced by entrepreneurs or communities and assess what could be done to mitigate them. Risks will vary widely depending on the context, but some common ones may include: financial risk to a credit borrower, disruptions to a community's informal economy, or the erasure of community cohesion, history, and culture if new investments push out residents and landmarks. Investors should determine how many risks investors face relative to capital recipients and subsequently reassess traditional notions of "risk and return."  

One example of more equitable risk-sharing comes from the Boston Ujima Project, a community-led fund that invests locally. In its approach, outside backers and local residents invest together. However, community members get a higher return on their money in order to redraw traditional risk and return arrangements into a more just shape. This helps address the fact that communities of color have borne the brunt of unjust economic policies for decades, taking on different forms of risk that wealthier investors have been largely sheltered from. It also accounts for the possibility that community members are less able to take on financial risk compared to more established investors, who are accordingly subordinated in Ujima’s investment terms.

Community Credit Lab, a nonprofit that supports the design of no- or low-interest lending programs for community-focused organizations, challenges the notion that impact investor returns should be prioritized above the fundamental needs of borrowers. It uses blended finance structures—like having philanthropic organizations cover loan defaults or nonpayments—to address the "poverty premium," which describes individuals with fewer resources, and subsequently greater risk, paying more in interest. The poverty premium has unjustly hurt low-income borrowers for decades and will be reversed only if investors are willing to reassess traditional notions of risk and return.

7. Who Is Incentivized to Do What?

Social finance often privileges high-growth, scalable opportunities over slower-growing, steady businesses that may have outsized impacts over time. When funders start this way—focusing on the type of investment rather than the social problem they want to solve—they can end up undermining stated impact goals and building the wrong incentives into their deals. Investors aiming to make sure a deal's incentives align with their goals should ensure that both the financial and the impact objectives of the investment transaction show up meaningfully in the deal terms. One form this can take is a "mission lock"—a governance deal term that prevents shareholders from pressuring leadership into financial decisions that could compromise the social mission of the organization.  

The Boston Ujima Project’s model of due diligence and approval rests on early identification of alignment between community members and investees. It has community members participate in due diligence and the development of reports on investment opportunities that are shared with wider audiences, offering a platform for locals' interests to be heard. Once an investment's potential benefits are clear to the community, local Ujima participants vote on whether to pursue it.

SheEO goes even further to align incentives with the design of its funds. It asks its network of investors to enter a deal without any expectation of return. As a result, investors and investees possess shared values from the outset and a sense of goodwill toward a project.

Beyond Capital Alone

Process metrics have been used widely in the nonprofit sector, but many impact investment models have failed to integrate them into their evaluation. As a result, the potential of capital to make positive impacts has been compromised.

Investors and funders must abandon the idea that capital alone is sufficient to transform inequitable systems. They must interrogate the power dynamics underlying their decisions and operations to meet the complex challenges of racial, gender, and economic inequality, moving from a "power over" to a "power with" approach. Failure to integrate this analysis will likely prevent deep and lasting change.

Correction: April 29, 2021 | The structural relationship between Candide Group and its Olamina Fund was clarified.

Read more stories by Alyssa Ely & Denise Hearn.