Conversation with Venture Avenue: A Decade to Embark on the Journey of Impact Investing

Interviewee: Zhang Hongyan, Founder partner, board member of Venture Avenue.

CASVI: Looking back over the past decade, in what aspects have your views changed significantly?

Zhang: I think the first change is on impact investing. In the beginning, I looked at impact investing from a more generalized perspective, with more emphasis on investment. Now I think I focus more on the IMPACT, the social impact. The reason is that I think when the definition of impact investment remains unclear, people need to find the original driver behind what they are doing, and to me the core is IMPACT.

Secondly, regarding social enterprises, I used to think that the founder’s original intention was very important. Social entrepreneurs embarked on solving social issues. T, therefore, the importance of their original intention was even greater than that of the business logic. However, now I think business logic is a hard threshold, and entrepreneurs need to make it clear while their original intention is in second place.

CASVI: At the moment, some commercial enterprises are embedding social missions into their business strategies. From this angle, what exactly is a social enterprise?

Zhang: First of all, I think, unlike B Corp which was defined by people, it is impossible to define "social enterprise" because it was born without a definition. Social enterprise emerged as a concept, a spirit, and a belief. I was firstly inspired by social enterprise mainly because of its core feature, namely using business as a means to solve social problems.

As long as everyone agrees with the concept of solving social problems via commercial means, then I think the purpose of bringing up the concept of social enterprise is achieved.

If we have to talk about what kind of enterprise is a social enterprise and what is not, I think we need a new name to define it.

In addition, I think it is still necessary to promote social enterprise as a spirit and a concept to entrepreneurs: business is not only about making money but also about solving certain social problems. It doesn't matter whether the intention to solve social problems comes first or second, but entrepreneurs must have such a sense of responsibility.

For most entrepreneurs, it is fine to just have a basic understanding of social enterprise. Because the concept of social enterprise is like a big umbrella, under which there can be enterprises putting profits first, enterprises putting profits second, and enterprises that even don't want profits. For NGOs and grassroots organizations, to start social enterprises means that they have to cherish every penny, make an impact from everything invested, and measure what the return on investment (ROI) is.

In general, now I prefer to treat the social enterprise as a kind of generalized spirit, rather than trying to unify it into a strict definition, which we cannot achieve by discussion. Social enterprises basically solve social problems by commercial means. In other words, solving problems in a better and more sustainable way. This is the essence of social enterprise.

CASVI: How do you see the current position of foundations or philanthropic organizations in the impact investing industry?

Zhang: The difficulty for foundations to engage in impact investing arises because they are ahead of the curve and willing to take risks. Although I don't necessarily agree with their current investment approach and targets, they have already taken a bold step forward in this area. For example, many foundations are helping poverty alleviation, and some of them are investing in companies that they (foundations) are managing. So I think foundations are ahead of the curve in terms of hands-on involvement in impact activities. There are also some public foundations that want to explore further in the field of impact investing. However, there are problems with both willingness and ability., And these two should be discussed separately. Now China’s Regulations on the Management of Foundations have clearly defined legitimate investment behaviors, and foundations need to consider whether they are willing to take some risks. If they are willing to take the risks, they have to be prudent and evaluate whether they can carry the risks. In terms of risk tolerance, I think public foundations are probably a bit weaker than private foundations.

Overall, I think there will definitely be a role for foundations to play in social investment, but it will not be significant. Because the foundation segment is not large enough, they can only make a few paradigms. Even if all the foundations are engaged in this field, it is still a small testing ground. The testing ground is necessary for the show-case, but it does not have enough impact. The sector still relies on the tremendous capital to scale the impact up

CASVI: In your opinion, what are the differences between the development of the Chinese impact investing market and the international experiences in terms of development process and format?

Zhang: The development of the Chinese market is not comparable to that of foreign markets, and the special characteristic of the Chinese market determines the current development state. One of the differences between the Chinese impact investing market and the U.S. market is that impact investing in the U.S. has developed out of a very mature market, including mature philanthropy sector, business sector, and third-party service sector. In such a mature ecosystem, the emergence of impact investing certainly answered the need to expand the market.

I think the greater impetus comes from the need to solve social problems more deeply with innovative methods. The demand for innovation and specialization is much greater than the demand for expansion.

On the contrary, China does not have a mature market. On one hand, there is a lot of money but few good projects. On the other hand, the economic situation in these two years is not good, and it is getting more difficult to raise funds. At the same time, the "midstream" is very weak, lacking good third-party professional service institutions (to connect money and projects). Therefore, overall China’s domestic industry environment is not comparable to that of the United States. At the initial stage of China's impact investing industry, people are curious that since there is a sector in between philanthropy and business, namely solving social problems via business solutions, why shouldn’t we try it. So, there were a lot of NGOs wanted to transform to social enterprises and investors who thought it was better to participate in such experiment instead of putting capital on pure philanthropic projects (including some leftist investors). I think the time of going deep in a small testing ground has gone. The need for impact investors now is more about how to expand the base and how to make this field more innovative and attractive, with good stories for investors. In the current Chinese market, the demand for expanding the base is higher than the demand to make the business socially innovative and deep. I think this is the biggest difference between Chinese and U.S. markets.

CASVI: What do you think is the root cause of this difference between the Chinese and U.S. impact investing markets?

Zhang: Firstly, I think Chinese people tend to look for grand things grand. No matter the upstream or downstream, all participants want to grow big from the very beginning. Secondly, I think the current impact investing is more of a capital-driven market in China. Investors are interested in topics such as elderly care, education, and the environment, which can absorb large amounts of funds. At the same time, the impact of projects in these fields is relatively easier to be articulated clearly.

I think now in China a more effective practice is to search incremental volume in the existing field, and it's more about how to include existing investments into the field of impact investing. Previously, investors might not even know what impact investing and social enterprises were. After the concept of impact investing was recognized by mainstream investors, the whole base of impact investing can grow bigger quickly. One of the advantages is that we can quickly look at various ecosystems in a large pool. With a larger base and more deals to look at, it is easier to come up with a system that includes metrics and other tools. The downside is that a big pool contains diversified cases which made it harder to be understood. Some people just come to participate and show presence in impact investing; some raise funds in the name of impact investing, but their invested targets remain unchanged.

I think the development trends reflect that the market is driven by impact investors instead of social entrepreneurs. And such a capital-driven market is malformed. I prefer to see a situation where social entrepreneurs know what they're doing and use a bottom-up approach. Adopting the top-bottom approach, investors are more likely to talk by themselves. But when the pool gets bigger, there will inevitably be a lot more capital-driven approaches in the pool.

CASVI: Do you think Chinese investors in the capital market have the motivation to make impact investments not only for financial returns but also for sustainable development goals?

Zhang: There is definitely such motivation. Capital can make an impact by investing for fame, money, or sustainable development. Often times the motivation is mixed. So it is better not to judge its initial intention and just look at the results.

In my opinion, for the time being, there is no need to think about what the so-called original driving force is.

Whether it is done by a foundation or a commercial organization, in small volume or large volume, with whatever the original intention, making good things happen is the most important. The motivation can be put in the second place while the result must be clearly stated first.

Years ago, I was willing to listen to the original intention and often moved to tears. I thought as long as people were reliable, their business logic could be of lower importance. But now I think we cannot do it this way and the results matter a lot. Even if an investor is doing impact investing for fame or money, as long as he or she invests in a few very good social enterprises with positive social impact, I think we should still congratulate him or her. We can't say that if a person is doing this for fame and money, then it's definitely not right. We have to abandon this kind of leftist assertion and put impact first. As for commonly accepted models by the sector, it can be further debated. I think as long as the impact story is clearly stated, it doesn't matter if it’s for broader public interest or specific social impact.

CASVI: How can the market make impact investing more substantial? Does the field need to have certain standards to constrain it?

Zhang: When we talk about constraints, we need a system of metrics and a very clear path that allows companies to communicate with the public or with their own investors. I think communicating impact to the public clearly is the best constraint mechanism.

CASVI: Many people believe that there is a demand for professional and credible third-party organizations that provide impact services, such as impact evaluation. What is your opinion on that?

Zhang: I think this demand has always been there. And I remember I described the whole path of impact measurement at the Skoll Forum 10 years ago because it's one of the most critical elements. Everybody agreed at that time and I guess everybody still agrees now. But we just haven't found a good and appropriate way to do this. So, the need for impact measurement is clear, but what is the solution?

Perhaps there is progress in other markets, but I still think there is a lack of a clearly defined and relatively simple tool for everyone to understand and adopt. And if we can get this done, it will be revolutionary. It is feasible both to use such a measurement tool by SEs themselves or a third party, although it is better to use a third party for impact evaluation. If the company has a very strong brand and high credibility, the company can do impact evaluation by itself. To summarize, I don’t think it a key issue whether the evaluation is conducted internally or externally.

CASVI: Venture Avenue has invested in the field of impact investing for ten years. How do you position your business in the future?

Zhang: After a series of discussions two years ago, we decided to complete all investments, manage the six portfolio social enterprises, so as to give closure to our "small but beautiful" pilots. At the same time, we also started to do offer impact services such as impact measurement, project sourcing, and portfolio management, where we can leverage our expertise.

Our third option is actually to raise funds while providing services, continue to do impact investing directly. Now we are actually trying this option, but it is critical to find like-minded investors. On impact investing we chose to embark on a narrow concept of "social impact" that can be described clearly, instead of general "public interest". I insist on this, especially when there is a lot of ambiguity in the market. The narrow concept of "social impact" means that there must be the bottom of the pyramid (BoP) in our target social enterprises, in other words, those people shall be the main beneficiaries. I hope to do the “traditional things” well first and then extend the fund later. So our new fund will be more traditional, small, and beautiful, and clearly target a BoP group. In addition, we need to learn from previous lessons.

Our future investments must not only have very good concepts and ideas but also have strong business logic and cash flow.

If we can combine these two points well, having a clear target of BoP and a strong cash flow, it is fine if these investment targets are small. I am more willing to invest in such projects and nurture them to grow up.

As a consulting firm, Venture Avenue has been providing various strategic consulting services. These are things we are familiar with, and we do that in the field of social enterprise and impact, which we are good at. Therefore, we are very confident in getting things done properly. But the challenge is whether impact investors are willing to choose a professional third party that is not free. I think most Chinese impact investors still want to use internal resources to complete everything. In contrast, some international impact investors are more used to leveraging advisory services. For example, we have cooperated with some international investors including Asian Development Bank (ADB) and IFC. We have been providing them with both strategic and operational consulting services for several years to accumulate experience in this area. But we do not have domestic impact investor clients yet. Although there are two potential clients in contact, I think we are still at the exploration stage.

To summarize, Venture Avenue is considering providing services and set up a new impact investment fund at the same time. Our strategy is to try both of them when the path is not clear.

CASVI: In your opinion, what is the current business logic of Venture Avenue’s impact services and impact investment respectively?

Zhang: The business logic of impact services in the Chinese market is a bit unclear at the moment, which is different from foreign countries. Foreign investors are more willing to use a relatively professional third party, while Chinese investors are not yet ready to use third parties yet. However, Venture Avenue has spent ten years telling people what third-party evaluation is and what strategic planning is in the nonprofit sector. Although impact investing is still in its infancy in China and I am not very sure when third parties will be used, I am willing to wait while piloting.

From the perspective of funds, the size of the fund must be large enough to be financially viable. If you manage a fund on a very small scale, like our funds of 10 million RMB in the past, you can't break even with a high management fee, or you could only sustain for three to five years. In that situation, you have to rely on subsidies. For us, there are two ways to support the team to make impact investments. One is the fees from the investors. Another is adopting a hybrid model, relying on the traditional consulting businesses to support the team. In reality, there are not enough suitable projects to sustain the size of the fund, or investors need to tell the company what its impact is. But I don't want to do this. So, in our opinion, a viable business logic would be to try a small fund first, relying on other businesses to support it. Of course, that is our past business logic, and hopefully, we can go for a new business logic now because the downstream market is becoming active.

CASVI: Could you please tell us about the new impact fund that Venture Avenue is going to do next?

Zhang: The planned size of our new impact fund is about 100 million yuan. Our original fund was very small in size, so we would rather invest in small social enterprises with clear impact. This time, with expanding fund size, the size of our investment targets will no longer be particularly small, most likely would be medium-sized companies. Moreover, if we expand our horizon and include some inclusive business, there are quite a lot of investable targets with a clear impact in China. In terms of sector, we are now looking at agriculture and education sectors with targets along the value chain, including upstream, midstream, and downstream.

CASVI: Do you think there may be a conflict between financial performance and impact mission in the new impact investments you plan to make, and will the invested companies sacrifice some financial growth because of impact?

Zhang: I can only say that we expect a reasonable level of financial returns. It won’t be huge and it also can't be zero. As to what is a reasonable level, it depends. Anyhow, we certainly won't adopt a model that maximizes financial returns.

CASVI: Do you think there are some specific risks associated with impact investing compared to traditional investing? Has Venture Avenue considered the issue of exit in the future for invested companies?

Zhang: Compared to commercial investment, the biggest risk for us to make impact investments comes from internal, that is whether we can stick to the impact and be able to hold ourselves in the face of temptation. The second risk is how to differentiate our impact investments from investments made by others and make a clear impact story about our investment. There is, of course, a prerequisite here that there are like-minded investors (LPs) and the overall fund structure is clear and well organized. If this is not valid, there will be big risks of potential conflict with the LP.

I have not particularly considered the issue of exit.

I think impact investing itself should be a patient fund, and our purpose is to make the business bigger, not necessarily to think upfront about how to exit in the future.

I do not deny that the issue of exit certainly needs to be thought about. However, in my opinion, as long as the business is bigger and better, an exit will naturally happen. I do not agree with the logic of planning how to exit first and then grow the business.