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Social entrepreneurship & finance

Tag ‘ Michael Chu ’

Following the interview of Michael Chu, here is a more detailed description of IGNIA Fund, the social venture fund that he co-founded and manages.

Founded in June 2007 and headquartered in Monterrey, Mexico, IGNIA Fund is a social venture capital fund that supports social enterprises with high growth potential. IGNIA builds bridges between financial markets and the « Base of the Pyramid » by providing capital to enterprises of this sector. Traditional investors are usually reluctant to invest in this sector as the incubation period is longer than for regular companies. As a consequence, social enterprises face major underserved financing needs. IGNIA’s founders believe that the market constituting the « Base of the Pyramid », has a huge potential. In Latin America, it is composed of more than 360m people whose purchasing power is valued to $520 billion.

In May, IGNIA completed his third closing bringing its equity commitment to $40,7m. The round was led with $5m from Soros Economic Development Fund, created by philantropists investor George Soros. According to Michael Chu, IGNIA’s fund raising have not been affected by the current economic slowdown. Moreover, it made it possible for IGNIA to come closer to its objective of $50m - $75m in equity. If we also consider the credit line of $25m provided by the InterAmerican Development Bank, IGNIA will have a total of $75m - $100m that can be invested in initiatives dealing with the most urgent problems of our planet. The invested amounts will vary between $2m and $10m for a period that lasts 12 to 15 years. In IGNIA’s founders’ opinion, this is the necessary period for having a major social impact.

IGNIA does not only focus on a specific industry and is willing to have a highly diversified portfolio. On the geographical level, its ambition is to go beyond Mexico and to participate to the development of the « Base of the Pyramid » in South America as a whole.

In addition to a major social return, IGNIA also wants to offer above average return to its investors (e.g. IRR 30%). If the two founders, Michael Chu and Alvaro Rodriguez, are convinced that social enterprises represent the future of our society, they also believe that a sustainable change can only be obtained through the development of entire industries (requiring the emergence of numerous companies). As the development of industries implies superior financial return, maximizing financial value is, together with having a social impact, one of the two pillars of IGNIA’s investor proposition.

IGNIA’s first investment is an equity investment of $3m in Primedic‘s capital, a Mexican firm based in Monterrey. Primedic provides healthcare to the most destitute people through an innovative membership program. The capital provided by IGNIA will allow Primedic to extend its services to other cities of Mexico. Up to now, the performance of this investment exceeded IGNIA’s expectations.

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The development of social entrepreneurs is made possible, among other things, by the financial support of institutions willing to have a social impact through their investments. They are the kind of financial agents that will build a more ethical and responsible financial sector. If they do not stand as the main source of financing for social entrepreneurs yet, the number of them willing to combine social and financial return is growing. Given the recent, innovating and promising character of these actors, Fair Street wanted to learn more on their investment strategy and on their ability to combine social and financial return.

Fair Street had the privilege to interview Michael Chu, co-founder and managing director of IGNIA fund, one of the first social venture fund active in South America (profile to be discovered in the « financial agents » section).

Senior lecturer at the Harvard Business School, Michael Chu is an expert in social entrepreneurship and in the sector of the « Base of the Pyramid ». Graduated from this same business school, he worked for the private equity Kohlberg Kravis Roberts after having begun his career at the Boston Consulting Group. During six years, he was the CEO of Accion International, an organisation that aims at fighting poverty through microfinance. In collaboration with Alvaro Rodriguez Arregui, he founded the social venture IGNIA fund in June 2007.

Fair Street : Can you explain what is a social venture fund  (or more broadly a social investment fund)? How do they differ from classic venture funds? In your opinion, are social investments riskier than traditional investments? What are the criteria’s for a “good” social investment?

Michael Chu: In my view, in its most basic definition, a social investment fund is a fund that focuses its investments on enterprises whose activities are deemed to have a positive social impact. This is the key difference with classic venture funds, in which the primary purpose is financial returns. From there on, there can be many different types of social investment funds. The IGNIA Fund which I co-founded, for example, is dedicated to invest in commercial enterprises dedicated to low-income sectors which will generate high social impact due to their activities (e.g. healthcare, housing, education, basic services for the base of the socioeconomic pyramid and supply chains that incorporate low income producers) and also above average financial returns.

I do not think that risk is a defining characteristic that distinguishes social investments from traditional investments. There are risky and safe investments in both social and traditional sectors. To emphasize my point, with the benefit of hindsight it’s clear that owning a share of Citigroup was much riskier than a share of Compartamos Banco of Mexico, where the average size loan is still under US$ 500.

My criteria for a good social investment is an enterprise that is capable of generating high social return (e.g. providing access to primary healthcare for low income populations) together with the creation of outstanding financial return (e.g. IRRs (1) in the 30s%). IGNIA’s investment in Primedic fulfils exactly those characteristics.

FS: As a manager of a social investment fund, how are you able to find the balance between social impact and financial returns when making your decisions? Doesn’t one of these variables eventually end up taking precedence over the other?

MC: At IGNIA, finding that only one of the two considerations is met is precisely a reason why we would decline a deal. For us, it makes no sense to just generate financial returns. My partner Alvaro Rodriguez and I could have done that by just sticking to what we were doing after we graduated from business school. On the other hand, if we find something of high social potential, we believe that meaningful impact can only be obtained through massive scale, which requires not only one firm but a whole industry, for which outstanding financial returns are essential. So for us, high financial returns is not a “nice-to-have” but an integral component to our theory of change and social impact.

FS: How will the current crisis impact the access to capital for social entrepreneurs? Do you think that following this crisis, people will invest a bigger part of their money in socially responsible institutions such as Ignia fund? Might the current events represent an opportunity for social entrepreneurs to gain influence in the public debate over the fundamentals of a more sustainable economic model?

MC: The current crisis will make access to capital difficult for everybody. Having said that, the latest two rounds of investment of the three we have had in IGNIA have been subsequent to the meltdown of global capital markets. We hope to continue with more investment rounds in the near future until we complete our fundraising goal.

While I would like to think that the current crisis will end up redirecting capital markets towards alternatives like IGNIA, at the end of the day this will be determined really by the actual results delivered by IGNIA.

FS: The debate you had in Geneva with Muhammad Yunus has been widely commented on the Internet…Your view is that market-based approaches and commercials means should be applied to organisations addressing the Base of the Pyramid. Could you please tell us more about this?

MC: Winning over poverty requires four conditions: massive scale, sustainability across generations, continuous efficacy (a model that gets better every day) and continuous efficiency (a model that gets cheaper every day). NGOs, philanthropy, developmental agencies can start initiatives but cannot on their own deliver scale or permanence. On the other hand, Governments cannot deliver continuous efficacy and efficiency. Business, i.e, market-based solutions, is the only way humans have known how to deliver all four of the necessary conditions simultaneously and consistently. But this is accomplished not through one individual enterprise. Business delivers this through the creation of whole industries. And I know of only one way to create an industry: an economic activity and above average returns.

One caveat, though. If you use market mechanisms to address social issues, you must also understand that the only way to ensure through time that the benefits of the additional value created do not remain solely with investors and managers but continue to flow to those being helped is through competition — open, transparent and intense. Then prices will drop, product variety will increase and customer service will excel. This is the enduring lesson of successful commercial microfinance.

(1) IRR: The Internal Rate of Return is a capital budgeting metric indicating the quality of an investment. It is the discount rate that makes the Net Present Value of the investment’s cash flow equal to zero. As any discount rate inferior to the IRR will provide a positive Net Present Value, the higher the IRR is, the better the investment will probably be.

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