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Limited Partners in Impact Funds Are Calling the Shots, Research Shows

Kevin Jones December 6, 2012

Playing well together while the world is shifting cultural competency – rather than master of the universe bravado – will be the skills of the new impact investors.

Impact investors are digging ourselves out a hole caused by our ignorant rush toward a rigid, linear metaphor: the split between the “return first” impact investor and the “impact first” investor.
That’s one of the things I came away thinking after a talk with Jed Emerson and Cathy Clark about their continuing investigation into the nature of the impact investor, the fund manager, and the new breed of far more active “limited partners” in those funds. Talking to them, I learned a lot that helped me make sense of what I’m seeing in the social capital market.
“As fund managers look at managing for a broader set of performance returns – rather than simply financial returns – we are paying the price for the (framing) of impact investors being either impact first or return first,” said Jed Emerson. “That has perpetuated a bifurcated conversation. What we need is an integrated conversation about value creation,” said Emerson, who has put a lot of his thoughts about this topic on his Blended Value website.
The work of transforming a limiting metaphor and making a new metaphor function as the guide for managing performance is only one of the shifting dynamics that Jed and Cathy have uncovered as impact investing and its market continues to take shape. In fact, that is the message of their research at the moment: there are a lot shifting dynamics along multiple relational dimensions; evolution is rapid; and (given how complex the task of impact investing is) things are rather on course and on schedule.
In traditional venture funding, the general partner (or fund manager) is the one with the theory or thesis to test in the market, while the limited partner just hands over the money and has no control over strategy. So, the biggest take-away for me from their interim research is the realization that the limited partner is no longer limited. In impact investing, the party in what’s called the “limited parter” role – the foundation or aid agency or large non-profit – has become the active partner, the one who has the theory. And the fund manager (or general partner) is hired and charged with executing that strategy.
The relationship seems similar in many ways to that of strategic philanthropy: with the non-profit grantee being the service provider and the foundation the one with the strategy, the theory of change that’s being tested.
In strategic philanthropy, the foundation (or funder) has the strategy and the theory of change. Non-profits are “hired” or funded to see if that theory of change can be built out to show a proof of concept. The traditional pattern has been: once the concept is proven – in, typically, a three-year grant cycle – either another philanthropic donor will take it over, or government will see the service provided as its role. Social enterprise has arisen to fill the gap in the philanthropic market: to fund things that can go to scale, or at least be financially sustainable and provide the necessary infrastructure or service.
The role of the general partner as responding (rather than leading), with the fundamental goal and shaping of the fund being directed by an institutional limited partner (such as an aid agency or a foundation) is a big shift. The VC’s traditional role – or at least the myth they are playing out – is that of the risk taking, theory devising, swashbuckling leader. The dominant myth is VC as the master of the universe, though historically they might get looked as not a lot different from a pirate. They are used to relating to their limited partner investors in a “let the professionals be in charge, while you sit down, relax, and just be a truly limited partner, hearing how we are progressing to our goals,” kind of way. They are like cowboys bringing home the beef to the ranch.
They are used to thinking of themselves as the masters of the manor, and this new relationship could feel to some of them like being turned into a valet for the people with the real power and money.
Working with the institutional investors who are starting to move into impact investing (from the public sector or from the philanthropic sector), fund managers are valued by their powerful “limited partners” for their specific, differentiated expertise in a vertical niche. But it’s the institutional player (limited partner) who is running the chess board and using the fund manager (general partner) as one of its specialist pieces.
Playing that kind of role, with the power distributed in a new way, the fund manager has to endorse the goals of the limited partner. The fund manager has to sign for this new kind of game with a clear head and heart. And – like an architect reporting to a property owner and developer with a vision on what to build – the fund manager has to reasonably foresee being able to execute against those goals in the specific area the limited partner wants to see changed. As in the dialogue between an architect and a property owner with an idea, the property owner sketches out a vision and also brings many of the key co-creating partners, contractors, stake holders to the table to get the job done, And the architect is called on to advise what plan it would take to get there.
Impact investing is not a place for people who imagine themselves to be masters of the universe, or who just don’t like being told what to do. It’s for people who do well (and even enjoy) working in an extensive relational and collaborative dialogue, managing a lot of varying voices. Collectively working on impact is the way it will work. And this is a new way of operating for venture investors who take their myth from Silicon Valley, where the cowboys lead the charge. The new impact investor is much more like Ginger Rogers listening and gracefully responding to someone else’s lead than like Gene Kelly bouncing impetuously around the dance floor and expecting the partner to follow.
Business schools developing a curriculum that could lead students to careers in impact investing need to incorporate a whole new way of viewing what an investing professional is, and what kind of approach to relationships with limited partners will work. With the investor charged with implementing a strategy devised by a set of limited partners – who want more kinds of value created – the fund manager can no longer charge forward with a simple investment focus.
They will need the kind of 21st centure cultural competence that my friend Graham Leicester talks about in his new book Dancing at the Edge: Competence, Culture and Organization in the 21st Century. Cultural competency in managing stake holder relationships will be key for the new, blended-value-imbibing impact investors as the social capital market matures.
As reported in Clark and Emerson’s interim report on the research they and Ben Thornley of Pacific Community Ventures are doing, when a major foundations says “if they got in a learning dialogue” with the fund manager and the portfolio companies they’d consider it a win, that calls for a level of communication between the general partner and the limited partner that business schools will need to teach.
Finance is just a tool in the impact investing market, it’s not a game where the intermediaries can easily inflate their power beyond what is warranted. Is there a link between this, perhaps more appropriate, limitation in the general partner’s power, and the fact that fund managers are finding ways to be exceptionally creative? When trying to manage for blended value with a broad group of active stakeholders involved, and working on the toughest problems in the world, the report says that fund managers are finding work-arounds where the traditional venture and private equity models don’t work.
The reduction in direct agency for the professional, general partner, investor is not an aspect of the impact investing market that is likely to go away. That’s because an impact fund is managing to a multidimensional set of expectations: a blend of financial, social, and environmental results where the externalities and unintended consequences are increasingly integrated.
Making sure you and your portfolio companies are doing good in the way they treat their communities, their employees, their vendors, and in the positive impact created by their product or service means managing in a relationally dense ecosystem. It doesn’t mean charging forward to a single, simple goal of either high revenues and high profit over time or high and rapid exit.
Collaboration, communication, and cultural competency within multicultural settings will be what’s required to succeed. When you change a myth, and move toward the creation of integrated, blended value, rather than the bifurcated return first or impact first framing, you also change the skill set and the job description for a lot of people.

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