by Eva Helene Yazhari and Mathilde Beniflah
There are more venture capital funds today than ever before, including an encouraging amount that have a focus on social or environmental impact. However, impact investors should be aware of how the very structure and incentives built into venture capital funds can detract from generating impact. Founders often complain of venture capitalists who self-brand as “founder friendly,” while offering little support beyond an investment check.
Being an impact investor is about much more than metrics and measurement. It also includes questioning the structures that govern how we do business, and the power dynamics we sometimes play into.
In a traditional VC transaction, the general partner of a fund invests in a company to provide cash that will help scale the business. Yet, for the founder, such investments often result in ceding control to an investor that prioritizes short term returns over the long-term sustainability and the possibility for purpose-driven business. The founder can feel pressure to dedicate all her energy towards becoming a “unicorn” as soon as possible and maximizing the investors’ profits, rather than focusing on the long-term success of the company. This can commonly include forcing exits for founders, aggressive pressure on founders with little value add, and creating markets where company ownership is uneven and extractive.
What are traditionally considered successful investments from the general partners’ perspective, don’t always translate into successes for the founder or the local market. Imagine a founder left with little equity after years of building a business, simply because the only capital available was venture capital funding. Especially in emerging markets, where most of the investors are based in the U.S. and Europe, the profits generated by successful VC investments are often repatriated, rather than staying in the local market. These extractive measures can result in the company’s mission being overshadowed by the demands of the venture capitalists, and stymies local wealth creation.
Solution
Beyond Capital Ventures is pioneering Equitable Venture, a strategy evolving venture capital by giving founders the opportunity to become co-owners in a fund, and thus align the investor and founder interests. At its essence, Equitable Venture levels the playing field in the power dynamic between the investor and the founders. Beyond Capital recognizes that ultimately, founders work harder than venture capitalists. By offering a stake in the fund’s performance, it is recognizing those efforts.
Founders will receive a profit share in the GP carry based on predefined milestones. By sharing the upside of the fund with the founders, it allows them to become a partial owner in the fund, alongside other portfolio company founders. This concept provides support and incentives from each end of the financial spectrum: immediate capital to grow their business and a long-term stake in what evolves.
Finally, Beyond Capital Ventures is employing Equitable Venture as an incentive to further its focus on gender-smart investing. It will award a bonus of carry points to companies with women on management teams and gender-positive policies.
Implementation
Beyond Capital Ventures has implemented Equitable Ventures by allocating a portion of the GP’s total carry pool to portfolio founders who meet predetermined performance milestones.
The fund will establish a Carry Partnership, or the Carry Pool, as the legal holder of the carried interest generated in the fund, typically a 20% share of the profits generated by the fund, once the limited partners have returned their original investment amount.
Traditionally, the Carry Pool only involves the General Partners, who have been involved in the fund management, and the Venture Partners who have been mainly involved in investment selection.
Beyond Capital will reserve a portion of the Carry Pool, ranging between 5% and 10%, to be allocated to the founders of the portfolio companies invested by the Fund. Portfolio companies that reach the Series A stage of investment will receive an equal share of the Carry Pool. The share is dependent on a series of business and impact metric targets to be assessed over a period of time. Furthermore, company funders will vest over time, so that funders who leave early or on negative terms would not earn their share of the Carry Pool.
Additionally, Beyond Capital Ventures has pioneered the use of a “gender bonus” in equitable venture as an innovative tool to spur reform. Its team wanted to go one step deeper with equitable venture, to have it function as a tool to address gender diversity, one of the fund’s key impact themes. To encourage the investees to promote women into management roles and adopt gender inclusive policies, Beyond Capital is offering an additional bonus to companies that meet certain additional criteria, which include:
- Having women being at least 25 percent of all full time employees in the company;
- Having at least one woman on the executive management team, or in a senior management position for at least one year prior to the Series A fundraise;
- Having at least one woman on the capitalization table;
- Gender sensitive policies in place and enforced with regard to all aspects of the business;
- Governance structure and mission statement that supports women in the business;
- Positive impact of business model on women across the value chain (e.g., suppliers, consumers, etc.).
Companies that meet these criteria will be entitled to a 100 percent bonus of Carry Points relative to companies who do not meet the criteria. These additional criteria will be assessed at the time that the carry points will be allocated.
Replicability – What is Beyond Capital vision around Equitable Ventures and its potential to be replicated and adopted broadly in the impact investing ecosystem?
The goal of Equitable venture is to change the way venture capital behaves in an ecosystem of founders and investors. Beyond Capital views Equitable Venture as a crucial part of a commitment to a holistic, impactful model of investing. It is a seamless structure to integrate, requiring a simple side letter between the General Partner and the founder. Equitable Venture means recognizing the underlying value entrepreneurs create for the fund – and not investing an extractive manner.
Equitable Venture can also supplement an investment strategy. By enabling founders to have a direct stake in our work, you can build an active community of partners who will support each other, and provide high-quality referrals to supplement deal flow.
Finally, Equitable Venture also presents an interesting structural innovation to combat the power dynamics at play. Oftentimes, venture capitalists are the ones who hold all the power. Equitable Venture demonstrates that investors are thinking about the founders. It’s a way to combat the transactional nature of the investor-founder relationships by sharing upside with portfolio companies, as they are the ones working the hardest to generate that upside.
Additional Resources
Equitable Ventures Briefing Note
Read more about Beyond Capital Ventures’ inclusive approach to Capitalism on The Conscious Investor