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Appropriate Capital refers to the goal of finding the right capital structure to balance the needs of the investor and entrepreneur.
Many traditional financing methods are not Appropriate Capital. For example, debt forces a company to pay at a specific schedule but would not be appropriate for a company that can not predict if their business performance will match the debt schedule.
Contingent Payment Structures are the most common form of Alternative Exits. Unlike a traditional note or loan, the time and/or payment amounts made by these structures are contingent on some other factor like company revenues.
Royalties are a special case of contingent payments as the payment of royalty is contingent on events that trigger a royalty payment, typically the use of intellectually properly. While Royalties are contingent payments the converse is not true and not all contingent payments are royalties. This distinction is important in countries like the United States that have different tax treatment for royalties than other forms of contingent payment.
Collective Investment Vehicles aggregate capital from multiple investors into a single investment entity. Generally, the purpose of Collective Investment Vehicles is to invest in a portfolio of companies or projects, although, in some instances, special purpose vehicles are created for a single investment whose capital requirements exceed the available capital that a single investor is willing to commit.
Collective Investment Vehicles are managed by professional investment managers in order to leverage their professional experience, full time dedication, and comprehensive risk management practices.
The aggregation of capital in a single vehicle also improves economies of scale by spreading transaction costs (such as due diligence costs) over a larger pool of capital, as well as the risk return profile by diversifying the assets of the vehicle through a portfolio of investments.
Collective Investment Vehicles are managed by professional asset managers, who are the agents of the firm. The managers take investment decisions on behalf of the collective investment vehicle, and are remunerated for the management of the vehicle as well as for the performance of the investments.
In the impact investing industry, impact fund managers often have relevant industry investment and thematic experience, ability to operate in frontier or undercapitalized markets, and relevant professional networks which they can make available to investors in an investment vehicle.
Among the most important factors for managers are that the Collective Investment Vehicle be adequately capitalized and that the managers have the time and flexibility to execute their investment strategy.
For the investors in the Collective Investment Vehicles, it is important that the investment thesis implemented by the manager delivers the expected financial returns and social and environmental impact, while maintaining adequate risk mitigation practices.
The benefits of pooling capital into a single Collective Investment Vehicle include:
The most common structure for Collective Investment Vehicles in venture and private equity is the limited partnership. This structure separates the fund managers, the General Partners (GPs), who manage the fund and take investment decisions. The GPs bear unlimited liability for the obligations of the fund. They raise capital from investors in the fund known as Limited Partners (LPs), who are not involved in the investment decisions and have limited liability (for the amount the invested in the fund?). The limited partnership is a closed ended fund with a fixed life, and standard provisions that regulate the distribution of capital to protect the invested capital of Limited Partners before capital distributions are made to the General Partners.
“A Limited Partnership Agreement regulates the relationship between the General Partners and the Limited Partners, covering terms, fees, investment structures, and other items that require mutual agreement before investment.
A limited partnership model usually also includes an advisory committee and an investment committee.”
(Source: GIIN Developing a Private Equity Fund Foundation and Structure)
Carried interest, also known as “carry” or “profit participation,” is the share in the profits generated through the investments that the general partner receives from the fund. The terms of the Carried Interest vary, and may or may not be payable to the GP only after achieving a Hurdle Rate.
The management fee is the fee charged by the General Partner to the fund for running the day-to-day operation of the fund, and is paid from the paid in capital annually.
Even though Limited Partnerships are the most common vehicle to structure funds in impact investing (GIIN), alternative terms or collective investment vehicles structures have emerged In impact investing to overcome intrinsic features of the Limited Partnership model.
In a conventional limited partnership, the Limited Partners handle all the investment decisions and management of the investment portfolio over to the General Partners. As a result of this delegation, the Limited Partners have no control over the impact management of the portfolio investment.
In order to better align the financial incentives of the General Partners to the impact expectations of the Limited Partners, innovative structures to align the financial remuneration of the General Partners to the impact results have emerged.
The Carried Interest is the profit participation of the General Partner in the fund, which is calculated on the returns of the fund that exceed the invested capital. The Carried Interest can be tiered or unlocked based on the achievement of specific social impact metrics.
Holding Companies (HoldCos, or permanent capital vehicles, or evergreen investment structures) are deployed to extend the lifetime of an investment vehicle beyond the traditional 10 years plus extension of a close ended fund (limited partnership investment fund).
The longer lifetime of the investment vehicle gives additional flexibility to the fund manager in investing patiently in a social enterprise, and does not require exiting the investment within the closed ended lifetime of a traditional limited partnership structure. Patient capital and a longer investment period can facilitate a mission aligned exit of the investment in social enterprises when the company has fewer prospective target buyers and chances of an initial public offering.
While limited partnerships operate through the yearly management fee calculated on committed or invested capital, holding companies typically are managed on an operating budget. Innovative approaches to determine a cost based fee calculation have emerged, which limit the operational expenses to the actual operational expense and is capped to the invested capital.
If entrepreneurs and investors choose to measure and report on impact metrics specific to the company, they need to consider whether to develop completely customized metrics or to use standardized frameworks including IRIS and Toniic SDG Impact Theme Framework. The parties may also want to think about whether an independent audit of impact performance would be desirable. In addition to, or in lieu of, measuring and reporting on company-specific impact metrics, the parties may choose to evaluate and/or certify general social and environmental performance against third party standards.
Parties will need to agree on the set of metrics to measure the company’s impact performance, and a schedule for reporting actual results. Measuring impact can be difficult, so the parties should be careful to ensure that the metrics they choose to track accurately reflect the outcomes they’re seeking to achieve.
Metrics may be completely customized or based on publicly available frameworks. The most widely used public framework is IRIS, an online catalog of social, environmental, and financial performance metrics managed by the Global Impact Investing Network (GIIN).
Sample language: The Company and the Investors have defined a set of metrics to assess the Company’s performance in [describe impact goals], which metrics are described in [Exhibit X]. [As long as the Investors hold at least X percent of the Shares purchased] OR [During the term of the Loan], the Company shall deliver to the Investors, within X days following the end of each [reporting period], a report setting forth [the metrics] OR [the Company’s progress toward each impact milestone] described in Exhibit X.
Similar to a financial audit, an impact audit uses a third party to verify a company’s reported performance against its agreed-upon impact metrics. This sample language assumes that impact metrics and reporting requirements are defined elsewhere in the term sheet.
Sample language: [As long as the Investors hold at least X percent of the Shares purchased] OR [During the term of the Loan], each Impact Report described in the preceding paragraph shall be audited by a third party organization with relevant expertise, [selected by the Investors and reasonably acceptable to the Company] OR [agreed upon by the Investors and the Company]. Costs of the audit shall be borne by the Company. If mutually agreed, the findings of the audit may be publicized by the Investors and the Company.
Sample language: [As long as the Investors hold at least X percent of the Shares purchased] OR [During the term of the Loan], the Investors may require that the Impact Report described in the preceding paragraph be audited by a third party organization with relevant expertise, [selected by the Investors and reasonably acceptable to the Company] OR [agreed upon by the Investors and the Company]. If an audit is requested more frequently than once every [three] years, then the investors shall pay for the audit, unless the audit reveals substantial reporting errors. If mutually agreed, the findings of the audit may be publicized by the Investors and the Company.
In addition to or in lieu of company-specific impact metrics, the parties may agree to assess social and environmental performance against standards set by a third party organization such as GIIRS (Global Impact Investing Rating Service), a ratings tool that assesses overall social and environmental performance. Other standards for overall social and environmental performance include the Ceres Roadmap to Sustainability and the Global Reporting Initiative
Sample language: [As long as the Investors hold at least X percent of the Shares purchased] OR [During the term of the Loan], the Company shall [annually complete the GIIRS Ratings Process] OR [describe the time period and define the standard for overall social and environmental performance measurement].
Entrepreneurs and investors may agree that a Company’s overall social and environmental performance be assessed and certified according to a recognized third-party standard. Companies with a B Corp certification, for example, must measure their performance against a set of standards set by the nonprofit B Lab.
If the company has not yet been certified by a third-party at the time of investment, investors and entrepreneurs may agree that the company will certify within a certain period of time after investment. If the company is certified at the time of investment, the founders may ask that investors commit to supporting the certification over time.
Sample language: The Company shall seek to achieve certified B Corporation status within [time period] after the Closing, and shall maintain that status for as long as the Investors hold at least X percent of the Shares purchased during the term of the Loan.
Sample language: The Investors acknowledge that the Company is a certified B Corporation, and to the extent possible under law, shall act in conformity with the Term Sheet for Certified B Corporations that the Company has entered into with B Lab. The Investors shall agree to take any actions reasonably proposed by the Board in order to meet the requirements of and to continue to operate as a B Corporation.
Notice – We are currently revising the content and layout of this section – it will be updated soon
These term sheets, like other impactterms.org content, are intended to help inform investors and entrepreneurs. It is not legal advice, and none of the content should be used verbatim or in any way without help from a lawyer. Our goal is to be comprehensive, so not all of the innovations we document are useful, and no innovation is always appropriate. You assume responsibility for the consequences of using documents or information found on our website.
Unlike traditional corporate structures, in the US, a benefit corporation obligates the board to consider the interests of all stakeholders in its decision making, not just shareholders. The company must pursue a public benefit purpose, and must report on its impact performance to shareholders and potentially to the general public (depending on the state). The definition of public benefit varies by state, but it is most often expressed as a purpose of creating a positive impact on society and the environment as a whole, or of operating in a responsible and sustainable manner. The statutes also allow (or in some states require) the company to specify one or more specific public benefit purposes that it will pursue, each of which must fall within statutory definitions. For example, Delaware requires the specific public benefit purpose to be stated in the certificate of incorporation, and allows it to include positive effects of “an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific or technological nature.”
Some states, including New York, also allow the company to specify which purposes have priority. Practitioners should keep in mind that provisions prioritizing one purpose over others run the risk of limiting the board’s discretion.
Benefit corporations are often conflated with certified B Corporations (or B Lab certifications or B Corp certifications). Benefit corporation is a legal status conferred by state law in the US; whereas B Lab certification is issued by a private organization and has no legislative framework. B Lab certification is not needed to obtain benefit corporation status.
Non-profit B Lab, which issues B Corporation Certifications to organizations that commit to a set of impact “best practices”, also advocates for the adoption and improvement of benefit corporation.
Term sheet language specific to benefit corporations may be useful in the following situations:
With some of the sample language, we identify a state or states for which the language is designed. Adjustments may be required to this language for corporations formed in other states.
Sample language: The [Certificate][Articles] of Incorporation of the Company shall identify as the Company’s specific public benefit purpose(s) [definition of specific public benefit purpose(s)].
Sample language: The Company shall provide to its shareholders its benefit report [insert time period, which is more frequent than statutorily required].
Sample language: The Company’s benefit report shall be posted on the Company’s website. The Company may omit from the posted reports any financial or proprietary information included in the reports.
Sample language: The Company’s benefit report shall include an assessment of the overall social and environmental performance of the Company against a credible, independent third party standard].
(Sample language – Delaware Debt): During the term of the Loan, the consent of the Investor shall be required to (1) change the Company’s specific public benefit purpose(s), (2) adopt or change the objectives the Board is required to establish to promote its public benefit purpose(s) and the interests of those materially affected by the Company’s conduct, or (3) adopt or change the standards the Board is required to adopt to measure progress in promoting such public benefit purpose(s) and interests.
Sample language (Delaware equity): As long as the Investors hold at least [X percent] of the Shares purchased, [the vote of at least X percent of the Shares, voting as a separate class] OR [the approval of the Board, including the approval of the Series X Director(s)], shall be required to (1) change the Company’s specific public benefit purpose(s), (2) adopt or change the objectives the Board is required to establish to promote its public benefit purpose(s) and the interests of those materially affected by the Company’s conduct, or (3) adopt or change the standards the Board is required to adopt to measure progress in promoting such public benefit purpose(s) and interests.
Sample language – NY/CA debt): During the term of the Loan, the consent of the Investor shall be required to (1) change the Company’s specific public benefit purpose(s), or (2) adopt or change the third-party standard used to assess the Company’s social and environmental performance.
Sample language (NY/CA equity): As long as the Investors hold at least X percent of the Shares purchased, [the vote of at least X percentage of the Shares, voting as a separate class] OR [the approval of the Board, including the approval of the Series X Director(s)], shall be required to (1) change the Company’s specific public benefit purpose(s), or (2) adopt or change the third-party standard used to assess the Company’s social and environmental performance.
Sample language: The [Certificate][Articles] of Incorporation of the Company shall identify as the Company’s specific public benefit purpose(s) [definition of the specific public benefit purpose], and shall state the Company’s intention to give priority to [definition of the priority purpose].