The core job of an investor is timeless. Take the money that people have entrusted to them and find an investment vehicle that will return profits. The metrics for success are easy to measure and interpret.
However, the modern private investor must now confront a new set of imperatives that go well beyond pure financial metrics. While this has always been true for VCs, this is a major change for private equity investors, only accelerated by the COVID-19 crisis. Transformation driven by the intersection of technology and the desire to have a positive impact on the world are changing the rules of the game. Investors are being asked to weigh considerations such as digital transformation, sustainability, diversity, and how their decisions shape the future of the planet.
This is a welcome development. The growth in venture capital and private equity have established them as the dominant way to fund companies that have breakthrough ideas. As a result, investors have tremendous influence and power to decide which types of businesses will be created, grown and thrive. Those businesses will in turn reflect the values and priorities of the larger world. It’s a responsibility that investors must take seriously. The modern investor has a central role in the economy as a whole and in driving the existence and the growth of new models.
The stakes are enormous for the modern private investor. Every sector is going be affected by this powerful mix of technology and impact. For those investors who shrug this off, or cling to traditional views of returns, the risk is that they miss a massive opportunity as big factions of traditional industries fade and disappear.
Yet this challenge also puts the modern private investor in a difficult position. They are expected to put large sums of money in asset classes and business models that are new, and therefore don’t offer easy historical performance comparisons (and predictive cash flows). It becomes harder to invest with confidence when the frameworks around such businesses are so uncertain.
The modern investor must be able to navigate within these new imperatives. This investor has to learn how to satisfy the core mission of delivering returns while understanding how the world is changing and how he or she can have the right impact by making the right investments.
One of the biggest hurdles is assigning valuations to concepts that at first glance seem fuzzy of subjective. Harvard Business School is pioneering some fascinating work in this area as it develops “impact-weighted” accounting standards. The project notes: “We also recognize that some of the impact metrics and monetary valuation coefficients are far from perfect. But so are the financial accounting numbers that we have been using for thousands of years.”
This highlights an important truth: Judgments on things like value and potential have never exclusively been driven by data. There is always a need to make projections, estimates, and assumptions based on experience and the best available data.
The question, then, is how to create a framework for evaluating the way impact and technology may create value. At D’Ornano+ Co., we have established four criteria for helping our investment partners think about these opportunities:
Criteria 1: Innovation
Investors need to validate the capacity of the company to have an impact on how things are done. Whether it’s education, the environment, or communications, the investment target must represent a major breakthrough compared to the way things have traditionally been done. Here, innovation is not limited to technological breakthroughs.
Criteria 2: Growth
The next step is to evaluate the company’s growth. Is there evidence that this breakthrough idea has gained some kind of market traction? It’s critical not just to spot the right investments, but to identify them at the right time. There must be an alignment of the planets which suggest that the concept truly has the potential to change things. Timing is absolutely key.
Criteria 3: Profitability
There must be a path to profitability that the investor can understand. This doesn’t mean the company can demonstrate it will make profits in the short term. Such companies that have transformative impact will likely have longer horizons for their returns. Still, investors need to be able see a clear roadmap toward a sustainable business that delivers healthy returns.
Criteria 4: Positive Change
Until recently, impact has often been defined as not doing bad things or creating harm. This negative lens included such things as not polluting, not exploiting child labor, not employing just white men. That needs to be flipped around. The question of impact needs to be a positive one. How is the change being proposed going to make a sector better? Is there a solution for food waste? For water consumption?
Being Better Partners
The traditional private equity firm can help their portfolio embrace the digital transformation thesis and spot those companies that are going to have this impact. One of our clients has acquired a brick-and-mortar restaurant chain and is helping them to invest in serving their clients digitally, notably through the development of a “ghost kitchen” model.
There is a similar opportunity for PE and venture capital firms to invest in ways that accelerate the digital and the impact parts of new businesses.
The key is to understand the companies and the synergies that can be created through an investment or acquisition. During this stage, we help partners ask the right questions and validate the response as these bolt-ons have their specificities.
We see a growing number of clients starting to ask what they can do and what is the right approach. They are understandably asking for help because this terrain is new. Our goal is to give them a framework toward a method that is measurable, concrete, and actionable and not just based on gut decisions. That includes everything from exploring the high-level philosophical questions down to working to understand the right unit economics on models.
This represents a big intellectual challenge. There is a lot of complexity to tackle. We value the conversations with clients that help us better understand the breakthroughs that are happening. These clients are targeting the disruptors who have found the right blend of impact and technology.
The modern private investors are the ones who understand what triggers these valuations and how they can build an investment strategy around it. Not only will they unlock new value, they will fuel the pioneering companies that will find the right balance between profits and positive change. In other words, they are building the foundation of tomorrow’s new economy.