Why philanthropy is the best kind of risk capital

In 2001, we founded Acumen with the mission of changing the way the world tackles poverty. We believed that somewhere between pure philanthropy and pure capitalism there was a third way, a better way, to tackle poverty. It was called patient capital and it recognized that when it came to solving tough problems, neither markets nor aid alone were enough.

Here’s how it worked: we would raise philanthropy and invest it for up to a decade (or more) in intrepid entrepreneurs building businesses to serve the poor. We would measure not just financial returns but also social impact. And any money returned to Acumen would be reinvested in other innovations designed to help the poor.

Selling the patient capital idea at first was a challenge. “I make money here and give it away there,” one wealthy individual confidently told me. “Trying to merge the two,” he added, “is just bad business.” Even more than a decade later, people still question whether philanthropy is well-suited for investing in social enterprises, and if traditional investors considering getting into impact investing truly had to be “patient.” My answer to both of these questions was: Yes. Here’s why:

In 2012, Acumen and Monitor published the report, From Blueprint to Scale: the Case for Philanthropy in Impact Investing, in an attempt to paint a clear picture of why patience is necessary to accelerate inclusive businesses serving the poor. Most entrepreneurs are readily able to find capital for what we call the Blueprint stage. This type of capital typically is raised from friends and family, business plan competitions, angel investors and grants, and is used to help them establish their company's “proof of concept.” Once a company gets to the Scale stage, at the other end of the spectrum, it’s likely not only proven out its business model, but perhaps even repeated it across various geographies and/or demographics. Entrepreneurs have the least trouble attracting funding because at this stage because, having proven their models, it is the least risky stage of a company’s evolution.

We believe the greatest capital gap exists in validate and prepare stages — the second and third stages of the model where “risk capital” is most scarce. That’s why Acumen’s goal is to invest in companies at these stages in their evolution. A company has started to prove out consumer demand for the model and understand unit economics as well as the path to scale. It is also when a company requires more capital than Blueprint investors are willing to provide, but have not yet proven out its profitability potential enough to where more traditional investors or more return-oriented impact investors are willing to invest. This is one of the key challenges Acumen is working to solve—and why philanthropic capital is best-suited for these entrepreneurs. It is both risk-tolerant and needed.

Think of it like this: the role of patient capital allows a company like a social enterprise the time to understand the consumer demand, unit economics and path to scale. Patience is required because the markets where our companies work are so new, the customers so lacking in trust and accessibility, and the geographies some of the most challenging and corrupt in the world. It’s one thing to argue that patience is less needed in emerging economies, and another to argue that when it comes to, say, building a company delivering affordable solar lanterns to last-mile, off-grid customers who make between USD 2 to 4 a day in rural Pakistan.

We’ve learned through more than 15 years of investing more than USD 103 million in more than 96 of these kinds of companies that although it takes, on average, between 7 to10 years to scale, when they do, these models are truly transformative.

The good news is that we have started to see this shift take place in sectors like energy. Take East Africa where business models serving the poor are proving to be viable and scalable. As a consequence, we are seeing more return-oriented investors willing to invest. For example, M-Kopa, a solar home systems company in Kenya, is scaling rapidly. This company is now in its fourth year of existence and has attracted large sums of commercial capital. This is the result of patient capital at work, enabling M-Kopa to prove out its business model in the right way and with the right customers, build a clear path to scale and acquire the confidence of investors by hiring and maintaining a solid management team. As result of M-Kopa, a similar company in Tanzania, Off-Grid Electric, has been able to attract larger sums of capital to enable scale. But it’s taken them years to get there.

We believe that as unit economics and the path to scale are better understood, as we’re seeing with these solar companies in East Africa, more significant amounts of capital will move into this sector. As result of this shift, Acumen's philanthropic-backed capital will no longer be needed specifically for solar home systems companies because traditional capital has started to move in.

But what about the companies of tomorrow? Just as one company is scaling, another one around the corner is innovating and trying to create new solutions that solve the tough and substantive problems low-income consumers are facing. While investors are coming in to invest in proven models, there is still a sizeable need for philanthropic capital in those models that haven’t been proven. Capital for these types of companies working in the world's toughest regions tend to follow de-risked models, leaving behind those entrepreneurs solving for future challenges in the lurch.

To give you an example, here are some of Acumen’s newest investments where traditional investors were not willing to take the risk on new models serving low-income customers:

Nasra Public Schools in Pakistan and Seed Schools in India are aiming to provide high-quality education at an affordable price point in the K-10 grades to children coming from low-income families. They use methods like rent (vs. own) to keep their costs low and are integrating technology into their operations to allow integration and tracking of quality of delivery.

Our Family Clinic in India is integrating mobile technology into its operations to bring high quality medical solutions (typically heavily skewed to urban centers) to lower-income and more-rural consumers.

Devergy in Tanzania is bringing clean electricity to rural communities in Tanzania by running mini-grids in that country. Such power is used for consumption (lighting, mobile phone charging) but can also be used for simple productive uses.

These investments, along with many others, have allowed Acumen to learn what it takes to build companies serving the poor. Many of our companies not only have succeeded in transforming millions of lives, but they are also crafting a different narrative about poverty altogether. Some have created or redefined entire industries. Some have re-set expectations not only of the poor but among the poor themselves. All have enhanced lives and contributed to creating new narratives based on hope and possibility. All have changed the story of poverty in significant ways—most importantly, by creating dignity.

(Jacqueline Novogratz is CEO at Acumen and an alumnus of Stanford University Graduate School of Business)