Trust Founders to Release Impact Investment

Inspiration from Spearhead

Oct 19, 2022

Hi Friends,

I spend a lot of time thinking about how to support social innovation and entrepreneurship, and how to make philanthropy more effective. I know. Not breaking news to you, my readers.

Here is my crazy idea of the week.

Founders are customer obsessed. They are experts in their markets. The successful ones have big networks of other entrepreneurs.

What if we let Founders pick which early stage impact investments to make into companies in their markets?

This would be an efficient and groundbreaking use of philanthropy. It would be good for impact investors and for entrepreneurial ecosystems in emerging markets. And I’ll show you why it’s not such a crazy idea after all.

Founder Investors Are Not New

30% of startups make it to the ripe age of five. At this point, we founders have collected a lot of stories, like “The Time My Lead Investor Pulled the Term Sheet the Day Covid Hit Kenya” or “The Time My Marketing Manager Almost Got Arrested Because the Head of Standards Had Not Initialed Every Single Flyer She Was Carrying.” We have also collected deep market expertise.

In the US, after a founder is persistent and successful for long enough, they might just have the chance to exit. And after reaping some financial reward from their years in company-building mode, many go on to angel invest in other startups.

Exits don’t really happen in much of Africa.

So philanthropists and impact investors fill part of the angel and seed stage funding gap.

Africa receives around half of global impact investment dollars (these are investors looking to create some sort of social good in addition to generating a financial return). In Kenya, over half of it comes from overseas. This adds up to a lot of people looking to do good with their money in markets where they have not necessarily lived, worked or built networks.

We should tap into the power of un-exited founders in these markets who have proven themselves through growing their businesses and impact.

VC’s “Best Bet”

Founded by the well known investor, entrepreneur and creator Naval Ravikant along with Jeff Fagnan, Spearhead VC is democratizing angel investing. They select great founders and give them $1 - $2 million as a micro-fund on Angelist to invest while still running their companies. The Spearhead model has led to early investments in cool companies like the community platform Circle and social networking star Clubhouse.

Founders make investment decisions on their own timelines. From health tech networking dinners to talking through a tough board situation for a few hours with a friend, many of us founders are connecting with and helping other startups anyways. Angel investing is a way to give deeper support in these conversations, not a distraction. And the Spearhead model provides mentorship and community to improve founder investment acumen.

Spearhead’s VC makes follow-on investments in fast growing companies. Founders are incentivized through carry (a percentage of the fund profits after initial capital is returned). From the outside, Spearhead’s fund model also looks incredibly efficient. Two people run a fund with access to a wide, diversified portfolio of early-stage ventures sourced by founder-angel investors. Naval Ravikant calls it “the best bet in Venture Capital.”

A Better Bet for Impact Investors

Why in the world would we not do this in Africa where the cost of diligence and complexity of new markets is huge? I want entrepreneurs to spend less time fundraising, and I want customer obsessed entrepreneurs (not powerpoint obsessed entrepreneurs) to be the ones rewarded with capital.

We need a Social Spearhead for impact investing. It would solve a bunch of the current challenges: slow deal timelines and decisions, small, foreign funds trying to be experts in a bunch of markets at the early stages, the impossible balancing act of risk and impact. And the solution, like most transformative ones, is elegantly simple: Trust founders to release capital and release impact. Let me show you how that would work.

Impact Investing is Hard

Small teams at small funds struggle to work across diverse markets and back a whole range of “good” businesses from a waste management technology to a franchise network of preschools. Even within the healthcare fund I worked with, we were evaluating medical device companies, blood banks and hospital logistics, pharmacy chains, electronic medical records and more.

The mandate most impact funders have to balance commercial returns and impact creates a kerfuffle where founders trade notes on “I’m too much impact but not enough returns” and vice versa, leaving no one quite sure where investors are focusing. Compromises are made behind closed doors. Entrepreneurs spend a lot of time trying to understand exactly how impact investors think and what they are looking for.

Diverse markets, a pile of risks to contend with, and an impossible mandate of balancing market returns with improving the world is a recipe for indecision.

Slow decision making has a catastrophic impact on founders, who spend a ton of time raising even small rounds. Time that could have been spent hiring, selling, talking to customers. Time that could be building their market knowledge, businesses, intuition. Moving slow is also not great for return on investment (a VC model requires a lot of bets) and it is not great for impact (money sitting in the bank waiting for a safe deal that is fully understood by the team isn’t making much of a dent in access to education or sanitation services). Current founders could make faster investment decisions using their market knowledge and customer intuition.

The Founders’ Edge

An investor of mine dumped his entire portfolio into one WhatsApp group. Almost every question (How have you sorted out Google Play Billing integration and payments?) is met with an answer from the experience of, or just as likely, from the products of the portfolio (“if you are integrating with multiple providers and methods, maybe we can help. Check MoneyHash.io”). It provides us all a space to test new ideas and offer discounts, for example lower cost recruitment services for startups. In addition to being useful, this gives other founders unique insight into the local startup ecosystem as we are all testing and using each other’s companies as customers. This makes it easier to source investments on the basis of product quality and customer pain points.

Impact investing, which remember, almost always leverages philanthropic capital, can aim to support the entire entrepreneurial ecosystem. This is often done by creating accelerators, hiring experts and teaching skills to startup founders. But the ecosystem support could be much more direct and decentralized than that.

Investing also helps founders get better at running their businesses. It teaches unemotional analysis of a businesses moats and role in the market.

Designing a Social Spearhead

Spearhead is designed to make money. They don’t operate in Africa (or any emerging markets), and don’t want to see Benefit Corporations (for-profit companies that declare they are going to balance profit and purpose). It is focused on tech founders in NYC, LA, Silicon Valley and Boston who have raised from the “top” VCs already. This makes sense for the current Spearhead capital providers, but disqualifies every founder I know solving systemic problems in Africa.

Philanthropic capital is necessary to start a social spearhead.

Currency risk alone makes angel investing (and, most investing) difficult. Other challenges such as exit timelines and return expectations slow down the flow of capital from angels into social sector start-ups. This all boils down to risk.

African ventures often have a higher risk profile than investors are comfortable with. We need new frameworks to evaluate and think about risk in the social sector, and a model that puts active, success founders at the helm is a good place to start.

Philanthropy does not mean charity. Similar to how many impact investing funds work with foundation money to get going, a philanthropic kick-off for a social spearhead would prove the model and take on the currency risk so that founders can focus on backing deals that they believe in. The fund could be Evergreen, with a goal of capital preservation and recycling.

There are a few open design challenges.

Finding the best: Being good at fundraising and pitching isn’t necessarily the same thing as being good at running a business. This is both where we want founders to help – but also where this idea could get stuck (choosing the best founders to work with). For starters, we would look for:

Product market fit in the current businesses, with a track record of growing customer demand and satisfaction.
Network metric: five businesses that you are going to look into investing in as part of the application.

Incentivizing impact: We don’t want to back the next generation of gambling apps. But we do want to see investments going to real businesses that can make money and grow. We would have to balance the profit incentive with Social Spearhead as an impact investor through selection and investment guidelines:

Founders should have a carry incentive so that they benefit when they find something really good, but Social Spearhead will have investment guidelines for the types of problems we are most interested in solving.
Pattern breaking thinking. Another metric of founder selection will be finding people fed up with the status quo.

Efficient fund model: Angelist is a great resource for US-based investing, but the costs go up substantially when the investments are done overseas. We need efficient fund management platforms for micro-funds in emerging markets so a Social Spearhead wouldn’t spend too much on back office management.

All of these questions have easier answers than “how do we manage waste in Kenya’s sprawling slums” or “how can we – the types of questions being asked by the businesses I’m trying to better support.

Trust Founders to Release Impact

Building a Social Spearhead would be an efficient and effective use of philanthropy - it is at least worth trying and measuring!

The first time I wrote about this idea, my friend pointed me to the brilliant Adam Mastroianni and his essay on Trust Windfalls. He ends with this quote:

And if Trust Windfalls fail, I’d rather fail because I trusted the goodness of humanity than scrape by because I covered my ass from all directions.

I’ll leave you with something similar:

And if a Social Spearhead fails, I’d rather fail because I trusted the people working their ass off building impact businesses than scrape by because I was too terrified to try something new.

(1) For my readers outside of emerging markets impact investing: Unlike Silicon Valley, it is very rare for investors in the impact space and in Africa to have built and run businesses before. Not unseen, but not the norm.

Where’s Melissa?

After four cities in five weekends (DC, New York, Mainz, and London) it feels good to be in London for the next month. The weather is crisp and sunny and I’m exploring my new neighborhood, Balham.

Let me know what you think!

Do you have thoughts on democratizing early stage investing?

Thanks for reading,

Melissa

The Vital Neighborhood

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