Rethinking VC Return Models for Investing in Mission-Driven Companies
The most popular way venture capitalists currently seek and expect returns are through as-fast-as-possible exits via acquisition or IPO. Fair enough. They give startups money and would like to get it back, and then some, as soon as possible.
Here’s the problem. These popular return models aren’t a good fit for mission-driven businesses, which is potentially keeping VC investors from investing in them.
Mission-driven companies, by ethos and definition, are not meant to rise up to then be absorbed by another company and its mission, nor dictated to by stakeholders seeking hyper short-term returns on Wall Street.
No, the very reason for starting the enterprise was to commit to bettering something — the planet, working conditions, animal welfare etc.. This is what drives the entrepreneurs starting these mission-driven companies.
The investment return model for mission-driven companies needs to change to reflect those companies’ longer-term expectations.
Rather than returns through exit, VC impact investors should seek returns through preferred dividends that grow over time as the company, and its mission, sustain and succeed.
The best mission-driven companies realize that profit is just as important as planet or people to the company.
Without it, they would not sustain themselves, which would terminate their mission. So, while profit distribution return terms have grown unattractive to a VC world bruised by growth before profit, the dividend model is ideal for mission-driven companies.
This isn’t a new model, just an unpopular one. The crowdfunding site Kickstarter recently kick-started a dividends return model in the VC favorite sector of tech. The company shocked the market when they opted for dividends rather than an IPO or acquisition in 2016.
Many argue that this approach could hurt the growing business, as profits should be invested back into the company. But, this is only a problem for companies that had the upfront capital in the first place. With a no-exit future acting as a 10,000-foot hurdle for mission-driven companies, their problem is the opposite. They want to get to a place of profit sharing as fast as possible, because doing this is the only way that they can get the initial investment these businesses need.
What’s more, the current VC model is based on high risk, high reward, where investors bet on many and expect a few to return big investments. They generally want profits to be invested back into the company to help it grow, no matter whether it remains profitable or not. Being a financially sustainable company is not what gets investors their high returns, but being a risk-taking high-growth company that reaches a higher valuation and IPO’s or sells will. What this all means is that VC investors are not rooting for many of their portfolio companies to survive long-term, they want them to risk everything to either crash and burn or exit and deliver the desired return.
If it’s not already obvious, this doesn’t jive well with a future full of mission-driven companies. The future needs those companies to stick around to see through their mission.
The solution to this issue is to create a return model based on sharing the success of company profit growth and financial success. This could be in the form on dividends or other profit-sharing agreements.
As mentioned earlier, this model is uniquely fit for mission-driven companies. They will then focus on profit more than most other businesses because it is only through profit that their business can grow and, therefore, their mission can succeed.