Entrepreneurship has the potential to transform society and spur dramatic social change. Yet in emerging markets across the world, entrepreneurs solving global problems struggle to get the early funding they need to get an idea off the ground. This is the “Pioneer Gap”.
Village Capital recently launched VilCap Communities, a new initiative to bridge this gap. We gathered the top investors, foundations, and institutions who are investing in the “rest of the world”, for a conversation in Amsterdam.This is Part Three in a three-part series on what we learned (read part One here and Part Two here)
In our last blog post we discussed the challenges facing intermediary organizations in emerging markets — the accelerators, incubators and other organizations supporting “pioneer” entrepreneurs. In this post, we’ll look at the other side of the coin: grant funders and investors.
This February in Amsterdam, Village Capital gathered grant funders and investors who work in emerging markets and posed the following question:
“If we agree that Pioneer Gap is a problem, why aren’t you, and people like you, doing more to close it? What’s holding you back?”
Over several days of conversation, three themes emerged.
Larger investors won’t invest directly (the need for aggregation)
We gathered over 50 investors who collectively deploy millions of dollars in entrepreneurs in emerging markets each year. Yet very few said they were actively supporting seed-stage ventures. Why?
With large dollars to get out the door, many investors have little incentive to make small investments — whether they are an investment fund or a development finance institution. Yet many intermediaries in those markets are only equipped to handle smaller amounts of capital. This is a fundamental mismatch in priorities and incentives.
One development finance institution who joined us in Amsterdam said that they wanted to invest in emerging market early-stage funds, but had, by rule, a $5 million minimum investment size, and couldn’t commit more than20% of the capital to any fund. These strictures make sense — and indeed would be very attractive — to a $200 million private equity fund. But they can be unworkable for a Pioneer Gap seed fund. Let’s say, for example, that you have a $25 million venture fund, and 5 years to invest it all. That means you’re required to invest an average of $5 million a year (otherwise you need to send the money back to investors — which signals your inability to find good investments) . So you have little incentive to invest in companies at a $50,000 level.
Yet one thing we learned was that most intermediaries were also too small to absorb capital from funders. Nearly all investors in our conversation referenced the fact that they needed larger ticket sizes, and the opportunities to absorb larger ticket sizes were small. Despite the booming growth in emerging market accelerators and seed funds, most were still too small for serious direct investment. The average VilCap Community leader who was hoping to raise a seed fund was looking for between $2M and $10M — for nearly every investor present who invested in funds, even those funds were too small to meet fund investment criteria.
One potential solution: better aggregation. One development finance institution mentioned, for example, the willingness and interest in putting $15 million into a $60 million vehicle designed to support intermediaries — and that vehicle would have the ability to disaggregate to smaller early-stage funds in a strategic way. Capria, a fund of impact seed funds who was present at the gathering, is one intermediary doing just this, but we see the potential for many others.
Intermediary organizations need improvement: the need for a “seed-stage tithe”?
As one very active grantmaker investor told us, “We prefer to invest through intermediaries — but most intermediaries we’ve met are not that good.”
In our last post we discussed how the quality of intermediary organizations — incubators, accelerators, seed funds, and other support organizations in emerging markets — varies wildly between organizations — and even year to year within a specific organization, due to low salaries and high staff turnover. Without sustainable business models, intermediaries have an especially difficult time attracting and keeping great people who can manage capital and support entrepreneurs.
Jim Sorenson, founder of the Sorenson Impact Center, reminded us in Amsterdam: most intermediaries are “in the pioneer gap” themselves — and funding that closes the gap has increasingly gone towards companies themselves rather than intermediaries, in both the public and private sectors.
Yet the investors around the table recognized that very few people were taking proactive action to resource intermediaries (and most of the people who had taken action were in the room). Many investors who want to close the “Pioneer Gap” — and people who want to make impact investing work in general — have unrealistic expectations about how difficult it is.
Liesel Pritzker Simmons of the Blue Haven Initiative, for example, told us how she has a specific, direct investment program, managed by Lauren Cochran, with very clear commercial return expectations — but it would be “ludicrous” to expect that Blue Haven could cherry-pick great commercial opportunities, such as M-Kopa, without investing in the ecosystem at large. Because of this reality, Blue Haven also manages a philanthropic pool of capital to make grants and low-return-expectation investments in intermediaries and ecosystem support organizations that can build a greater pipeline for others.
Tom Bird, founder of Farm Fund, talked similarly about how his organization has a donor-advised fund that makes grants and philanthropic, low-return investments in ecosystem organizations to ensure collaboration.
As one idea to close the gap, Pritzker Simmons suggested the baseline expectation of impact investors should change. She brought up the idea of a “seed-stage tithe”: everyone serious about impact investing, Liesel said, should make a ‘tithe’ — whether it’s 1% or 10% — to the seed-stage ecosystem building activities, because that investment would repay itself many times over through the discovery of great companies.
We’ve got emerging networks — now we need marketplaces
Silicon Valley has a very effective functioning marketplace — AngelList. Companies can post when they are raising money, investors can transparently see who is raising and who else is involved, and investors have all the information they need (including timing!) to make a decision to actually deploy cash. But Silicon Valley has one thing that most impact investments do not — a highly competitive and liquid funding environment. If you don’t move fast as an investor, you lose.The sense of “Fomo” — “fear of missing out” — is the most powerful motivator to closing investment rounds in Silicon Valley, but rarely exists in the US.
The direct investment landscape is different for “Pioneer Gap” markets — in a way that doesn’t necessarily work for entrepreneurs. Entrepreneurs have very few funding options, so investors can suffer from “analysis paralysis” — taking months to make a decision that, in a more competitive funding environment, would take days.
Investors can have a due diligence nightmare, too. They’re looking at disorganized deals, with very little information, and not much understanding of co-investment. There is only rarely an active investor leading on due diligence — and most investment firms looking to invest in the pioneer gap need to spend a ton of their own time and resources for what is a relatively small investment. As a result, there’s no incentive to move quickly — or take disproportionate risk. And finally, because most impact investors are geographically dispersed, people don’t know who else is funding what.
So — how do we make the “Pioneer Gap” marketplace function better? In discussions with investors, we heard as out three specific roles that intermediaries could play:
The role of marketplace transactor is one that accelerators and intermediaries can play — really taking the time to get to know investors, and instead of sending deals across-the-board to the investor universe, helping curate and specifically send highest-interest deals to ventures. And, assuming incentives are aligned, intermediaries can help close deals: seed funds through co-investment, and accelerators through (potentially) syndication.
Philip Varnum from the Lemelson Foundation pointed out a second comment: intermediaries themselves can play a major role in closing the Pioneer Gap by introducing their funders to each other — common transactions form a relationship. Philip mentioned how Lemelson had met its best co-funders through introductions from entrepreneurs: they met the Michael and Susan Dell Foundation, for example, through an introduction from the Unitus Seed Fund, and have done one more deal (and counting) with them since then. Most organizations are protective of their funders — but the takeaway was that they shouldn’t be. Pioneer Gap funders and investors want to get to know each other better.
Perhaps one of the largest problems that investors found was that the companies who were getting funding weren’t always the best.Investors who joined us in Amsterdam complained about entrepreneurs who were classically “on the circuit” — raising millions of dollars in grant and investment while delivering sub-standard results on the ground. Investors acknowledged that many of these companies were founded by people who went to great schools in the West and moved to emerging markets — and were able to fundraise because they had great networks and were good communicators, rather than had great businesses.
At the same time, these investors recognized that hundreds of emerging market entrepreneurs within the VilCap Communities network alone who are going un-funded because they don’t have a Western education, or don’t have the polish to impress decision-makers halfway around the world. The funding world rewards those who know how to fundraise the best — not necessarily those who run the best businesses.
The preliminary results of the GALI survey provided evidence that this is gap can be closed. The report showed a direct relationship between the amount of time that accelerator programs spent on networking and communication skills for an entrepreneur, and the amount of funds they raised. For entrepreneurs who have solid fundamentals, investment-readiness may only be a matter of communication: a teachable skill.
So what’s holding investors back from closing the pioneer gap, and how do we solve it?
The three barriers holding investors back can all be solved. The ticket size issue is a structural one — and intermediaries that support intermediaries happen all the time in Silicon Valley (see the fund-of-funds universe), but need development in the impact investment world. The lack of quality intermediaries probably requires investor action — whether it’s a seed-stage tithe or another strategy, investors need to get real, and recognize that great companies won’t happen without great people who are supporting them at the levels before they’re comfortable personally investing. And finally, intermediaries should develop investor-facing marketplaces-and investors should participate in the best ones.
We look forward to sharing additional lessons learned, and getting your feedback on what we’ve seen with these investors.
If you’ve read this far, you likely have ideas on how you can be involved too. Please write me at [email protected] with feedback; I would love to see how we can collaborate.