On Tuesday, April 8th, the Impact Investing NYC Meetup group had a special guest—Bruce Usher, Director of the Social Enterprise Program at Columbia Business School, presented us with a case study of E+Co, a well-respected, pioneer impact investing organization. E+Co's Initial Success
In 2010, Bruce joined the board of E+Co, an impact investing leader with a clear mission. Established in 1994, the nonprofit had been borrowing long term fixed rate debt and investing it in almost 200 clean energy entrepreneurs across the developing world, in six main types of energy tech (solar, bio-gas, energy efficiency, etc). They'd had a big impact: the loans had affected hundreds of thousands of households, and the organization had won all of the big awards, from the Financial Times to the Ashden Awards. E+Co was the first and largest clean energy impact investing success story.
In the spring of 2011, the board started to get concerned about the health of E+Co. Repayment rates were declining, there was not much data available, and there was staff turnover. In late 2011 the board brought in new management, who discovered that the portfolio was worth half as much as previously thought.
Where had E+Co gone wrong? In order to determine the problem, Bruce put together a simple model of their business surrounding the following points:
- Principal investing model: E+Co borrowed money at a rate of 5.6%, then invested it over a period of 5-10 years in the form of $100,000 average loan size and at a rate of 12%.
- Significant operating expenses: Due to the large staff required to conduct due diligence and provide technical assistance to entrepreneurs, operating expenses were equivalent to about 10% of loans.
- Grants were used to cover the majority of expenses, and some additional revenue was raised through consulting contracts.
- Loan loss reserves, a measure of risk, were used to account for the amount of money E+Co was losing when entrepreneurs failed to repay their loans.
Using this model, Bruce demonstrated how rapid growth made the quality of the portfolio less visible—unintentionally—and because E+Co had been growing so quickly from 2006-2010, with new money coming in and loans going out, weaknesses in the loan portfolio were not recognized. Once growth slowed, in 2010, problem loans in the portfolio became apparent. By 2011, the organization was stuck in a liquidity trap. They were forced to cut staff, but it’s much harder to cut one's way out of poor investments, and their portfolio began to deteriorate in what became a downward spiral.
What went wrong? E+Co started out as a small nonprofit organization dependent on grants. They offered low salaries, which made it very difficult to recruit employees with financial experience. They were overextended both geographically and functionally. E+Co was mission-driven, and their mission was not to make money investing, creating an absence of financial analysis and rigor due to both lack of data and an unwillingness to enforce payment obligations. But E+Co also did a lot of things right, and well: they demonstrated the high demand for energy and a willingness to pay by the poor, supported talented local entrepreneurs, and supported the demand for growth capital. Unfortunately, there was no solution to their model, and E+Co is now disbanded.
The E+Co case study teaches us several important lessons:
- Donors are attracted to unproven business models with the potential to scale (catalytic),
- Commercial investors are attracted to proven business models at scale (avoid risk),
- And nonprofit board members are attracted to the reputation of nonprofits.
E+Co could not raise more grants once they reached a plateau of around 5 million dollars per year, because donors thought that their model was proven after seventeen years and was no longer catalytic to change. At the same time, the commercial side viewed an investment in E+Co as too high-risk. This left E+Co in a gap between the two funders—a problem that a lot of social enterprises find themselves facing. Board members need to learn to ask the right questions when they join a nonprofit, thinking about the organization as an investment instead of going in on an assumption of reputation.
Many thanks to Bruce for sharing with us! To view photos from the event, please visit the Inspiring Capital Facebook page.
See you next month!