Acumen Fund and Embrace: from the Leading Edge of Social Venture Investing

CASE: SM-191 DATE: 04/14/11

ACUMEN FUND AND EMBRACE: FROM THE LEADING EDGE OF SOCIAL VENTURE INVESTING

INTRODUCTION

Jane Chen (GSB 08) and Brian Trelstad (GSB 99) had known one another for years. Trelstad, the chief investment officer of the nonprofit global venture fund Acumen Fund, had been a mentor to Chen and her colleagues as they worked to develop a low cost infant warmer to meet the needs of low birth-weight babies, their mothers, and healthcare providers in developing countries. Chen, who became the chief executive officer of Embrace Global, the nonprofit founded to achieve this objective, had come to value Trelstad’s guidance and trust his advice.

In late 2010, as she and her team were on the cusp getting their innovative new product to market, Chen and Trelstad’s relationship took on a new dimension. Embrace was seeking an infusion of funds to support its product launch and help the company rapidly achieve scale. In parallel, Acumen Fund was continuing to look for organizations with game-changing products and services in need of patient capital on their way to becoming self-sustaining businesses that effectively serve the poor. Suddenly, Trelstad was a potential investor and Chen was a prospective investee. As they explored the possibilities of a financial partnership, one of the key questions facing Embrace was whether or not it should consider adopting a for-profit or hybrid organization structure so it could raise more substantial funding by taking on equity investors. Acumen Fund had to think about whether or not it was interested in investing in Embrace, how to value the company, and how large a stake it might be willing to take if a deal moved forward.

Lyn Denend and Professor William Meehan prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. To request disguised financials for Embrace, please send an email to [email protected].

Copyright © 2011 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. To order copies or request permission to reproduce materials, e-mail the Case Writing Office at: [email protected] or write: Case Writing Office, Stanford Graduate School of Business, 518 Memorial Way, Stanford University, Stanford, CA 94305-5015. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means––electronic, mechanical, photocopying, recording, or Dootherwise––without Not the permission of the StanfordCopy Graduate School of Business. or Every effort Posthas been made to respect copyright and to contact copyright holders as appropriate. If you are a copyright holder and have concerns about any material appearing in this case study, please contact the Case Writing Office at [email protected].

This document is authorized for use only by William Allen until July 2011. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860. Acumen Fund and Embrace: From the Leading Edge of Social Venture Investing SM-191 p. 2

PHILANTHROPY IN THE U.S.

Charitable giving in America dates back to colonial times. Early philanthropists were mostly individuals from modest backgrounds who contributed what they could to private, not-for-profit associations in their local communities.1 During the late nineteenth and early twentieth centuries, as the country experienced rapid economic growth, a new form of philanthropy emerged. Newly wealthy “captains of industry,” such as John D. Rockefeller, Andrew Carnegie, and Henry Ford, used their personal and corporate fortunes to create philanthropic foundations— permanent endowments managed by independent (nongovernmental) organizations for charitable purposes.2 The primary focus of these foundations was to make large, often ongoing grants to charitable organizations rather than to directly operate charitable programs on their own.3 By the beginning of the 2000s, the United States had more than 50,000 philanthropic foundations.4

The Emergence of Venture Philanthropy

The next important trend in U.S. philanthropy corresponded to the bull market of the 1990s. As a new generation of successful entrepreneurs amassed personal wealth they, too, began to turn their attention from wealth creation to wealth distribution. According to research by the Boston College Social Research Institute, a $41 trillion wealth transfer was expected between 1998 and 2052 with an estimated $6 trillion going to charity. The study concluded that “a golden age of philanthropy is dawning, especially among wealth holders and the upper affluent.” 5

Rather than creating their own traditional foundations, these new philanthropists sought to apply practices from their business backgrounds to charitable giving to ensure that they were having a meaningful social impact. This desire led to the creation of a type of giving known as high- engagement or venture philanthropy. Venture philanthropy involved traditional grantmaking to nonprofit organizations, but donors modeled their involvement on certain proven principles from the venture capital sector. Specifically, while traditional foundations often published their grantmaking criteria and waited for qualified nonprofits to apply, venture philanthropists actively researched and pursued organizations that were aligned with their interests and could benefit from their involvement. Just as venture capitalists targeted business start-ups, venture philanthropists targeted philanthropic start-ups and sought to build relatively small portfolios of complementary grantees. They also took a highly engaged, active role in helping these nonprofits set and achieve strategic objectives (e.g., often taking a seat on their boards of directors and offering hands-on guidance). Finally, they focused heavily on the need to define clear measures of performance to ensure that a “social return on investment” was realized in lieu of the financial returns expected by traditional VCs.6 According one estimate, 40 to 50 high- engagement philanthropies existed by 2006,7 which managed roughly $100 million in investment funds.8

Critics of venture philanthropy claimed that the movement was little more than a fad initiated by those “who got rich in the stock bubble of the 1990s and blithely assumed that they could transfer their skills to a field in which they had no experience.”9 They complained that these new leaders could be too aggressive, crossing the line between engagement and control. Others argued that the “bigger, faster, cheaper” philosophy of business clashed with the traditional Dononprofit culture, Not creating resentme Copynt and tension—not productivity. or More Postspecifically, some

asserted that venture philanthropy was “just a fancy name for practices that well-run charities and foundations have always employed.”10

High-engagement philanthropists countered that applying the rigorous due diligence and reporting standards of Wall Street to charitable entities helped address public skepticism of nonprofits and their effectiveness. After the September 11th terrorist attacks and subsequent natural disasters like Hurricane Katrina, Americans responded with an outpouring of financial support intended for those affected by the tragedies. But media coverage of scandals at charitable foundations and reports about the diversion of funds dampened public enthusiasm and fueled U.S. Congressional calls for greater regulation of the field. Venture philanthropists’ emphasis on accountability was meant to help addressed concerns such as these. Moreover, the new generation of philanthropists argued that most charitable organizations could benefit in concrete and measurable ways from the professional managerial skills and mentoring that comes with venture-style investment. Some even went as far as to argue that the rigor and discipline brought to the field had made all traditional foundations more performance-oriented.11

Challenges with International Development

Despite significant progress in the sector, venture philanthropists and traditional foundations alike continued to face obstacles when it came to international development. Typically, charitable funding was channeled to developing countries by governments, multilateral organizations, and private nongovernmental organizations (NGOs). Donors had access to plenty of information about NGOs in the U.S., but had difficulty identifying partners and entrepreneurs with whom to work in remote, overseas locations.

Additionally, philanthropists wrestled with logistical issues when working abroad, including Internal Revenue Service (IRS) regulations, Patriot Act safeguards, and local regulations and government statutes that varied widely by geography.12 Managing fluctuating exchange rates and establishing fund transfer arrangements also required considerable expertise. Corruption was also endemic in many developing countries. Analysts estimated that only a small percentage of the $2.3 trillion the Western world had poured into foreign aid over the last 50 years reached the people it was intended to help and made a significant and enduring impact on their lives.13 Instead of translating into results on the ground, one economist suggested that foreign aid money tended to “disappear into government bureaucracies, sometimes into outright corruption” as it was absorbed by ineffective aid agencies.14

As a result, philanthropists found that investments in the global nonprofit sector were difficult without the assistance of a trusted intermediary who was familiar with a particular geography, understood local requirements, had shrewd financial skills, and could anticipate and address key risks in distributing valuable funds.

ACUMEN FUND

Acumen Fund was established against the backdrop of the venture philanthropy movement and the need for more effective, efficient ways to provide philanthropic support in developing Docountries. The Not organization was foundedCopy in 2001 by Jacqueline orNovogratz. NovogratzPost began a

career in international banking with Chase Manhattan Bank, but was intrinsically drawn to opportunities to help make the world a better place. After several years she left Chase and began to travel and work throughout Africa as a consultant to the World Bank and UNICEF. On a project for UNICEF in Rwanda in the late 1980s, she helped launch the country’s first microfinance institution. When a group of Rwandan women approached her for a small business loan for their struggling bakery, Novogratz decided to work with them to turn around the operation. Within six months, she helped transform the bakery into a profitable enterprise and, in the process, boosted the women’s income, confidence, and self-respect. In doing so, said Novogratz, “I saw the power that markets can have to help bring people out of poverty, the discipline that running a business provides, and the pride that results from ownership.”15

To enhance her own business acumen, Novogratz completed an MBA at Stanford in 1991. Her next move was to increase her experience in the philanthropy sector by working with the Rockefeller Foundation. There, among other accomplishments, she created and managed The Philanthropy Workshop to train donors in strategic approaches to charitable giving. By the start of the new millennium, Novogratz was ready to combine her experience in banking, microfinance, and traditional philanthropy to create a new approach to addressing global poverty.

The Acumen Approach: Patient Capital

Acumen Fund was a nonprofit global venture fund that set out “to create a blueprint for alleviating poverty using market-oriented approaches.”16 The organization was built on a principle that Novogratz, who became Acumen’s CEO, called patient capital. The concept was simple: market forces alone would not solve the problems of global poverty; yet traditional charity was inadequate to address the challenges faced by the world’s poor. Patient capital provided a third method for assisting those at the “bottom of the pyramid.”17 Specifically, it was intended to bridge the gap between traditional venture capital and traditional philanthropy (as shown in Figure 1) to bring life-changing goods and services to the poor in innovative ways.18

Figure 1 Patient Capital Traditional venture capital Maximize financial return

Maximize Patient Capital Blending social and financial returns for long-term social impact

Financial return 0% objective

Traditional philanthropy Maximize social impact No return None Maximize Social impact objective DoSource: Not Courtesy of Acumen Fund.Copy or Post

Patient capital was different from venture philanthropy, as Trelstad explained:19

Venture philanthropy, from my perspective, is philanthropy dressed up in venture capital clothing. But it’s still philanthropy, where you take exempt dollars and you give them to exempt institutions. Acumen Fund is really part of a new kind of hybrid approach to development investing through which we raise philanthropic funding and then lend or make equity investments in businesses that meet our investment criteria.

Figure 2 illustrates how the organization’s business model worked.

Figure 2 – How Acumen Fund Works

Source: Courtesy of Acumen Fund.

At the most basic level, Acumen raised donations from foundations and individuals. These donors did not expect a financial return on their money but were typically looking for ways to maximize the social impact realized through their financial support.

Acumen then sought to identify businesses in targeted geographic markets that were finding innovative ways to address core problems affecting the poor in one of five key areas: agriculture, energy, health, housing, and water. These enterprises could be nonprofit, for-profit, or hybrid organizations. Hybrids involved both a for-profit and a nonprofit entity that shared the same or similar purpose, were controlled by a common group, and had an interest in leveraging commercial investments, as well as charitable contributions.20 Regardless of their structure, they had to be focused on providing essential goods or services to the poor. Moreover, Acumen looked for prospective investees that could rapidly scale to reach hundreds of thousands (or even millions) of people and that had the potential to become self-sustaining.

Once promising enterprises were identified and evaluated (see the next section for more information about the due diligence process), Acumen made investments by providing loans or taking an equity position in exchange for capital. In some circumstances, it also made guarantees to third-party lenders to facilitate access to local sources of capital, set up licensing or Doroyalty agreements Not when assisting Copywith the creation or registration or of intellectual Post property (IP),

or provided lab investments to fund innovative but high-risk experiments expected to generate important near-term lessons.21 Equity investments represented the most common form of capital provided to for-profit and hybrid organizations, while nonprofits most often received loans.22 Importantly, nonprofits were not legally authorized to grant equity or pay returns to investors. Acumen originally provided grants to targeted nonprofit organizations but stopped doing so in 2003 when the team decided that its grant-making model did not promote the financial discipline needed for these companies to eventually be able to attract capital from traditional financial sources instead of philanthropic ones. Access to capital markets was considered essential if the fund’s portfolio companies were going to become sustainable in the long run. “What we do,” explained Yasmina Zaidman (GSB 03), director of communications, “is act as a bridge to help institutions that aren’t quite there yet become more financially sustainable so they can ultimately appeal to private investors.”

With all of its investees, Acumen’s staff members established relationships that allowed them to work closely with the company for the duration of Acumen’s investment. The Acumen team provided managerial support in the form of specialized business expertise, networks of relevant contacts, and a wealth of accumulated experience to help the enterprises grow and achieve their goals.

Over time, Acumen expected to realize a return on its investments, for example, through the repayment of loans or “exit” opportunities that would allow it to liquidate its equity position (e.g., through an acquisition, an initial public offering, or the redemption of Acumen’s shares by the company). Given Acumen’s nonprofit status, any returns were not shared with its employees or funders. Instead, all proceeds were reinvested into other promising businesses targeted at helping the poor. According to Trelstad, Acumen anticipated that approximately half of its investments would succeed and half would fail. For this reason, it hoped to realize a 200 percent return on its successful investments so that 100 percent of all capital raised from Acumen’s donors could be reinvested multiple times.

According to the organization, several core characteristics were at the heart of the patient capital model:23

 Long time horizons for the investment  A relatively high tolerance for risk  A goal of maximizing social, rather than financial, returns  Providing management support and business acumen to help pioneering new business models succeed  The flexibility to seek partnerships with governments and corporations through subsidies or co-investment when it was beneficial to low-income customers.

This allowed Acumen to support ventures with high financial risk and low expected financial returns in the short term, but high social returns over time.

Even more importantly, the model promoted “dignity, not dependence; choice, not charity.”24 By supporting enterprises with sound business models that could become self-sustaining, the Doorganization enabledNot good ideas toCopy reach many more people orthan they wouldPost if they were

dependent on grant funding to survive. It also created jobs that allowed the poor to support themselves. “People don't want handouts,” Novogratz said at the TEDGlobal 2005 conference. “They want to make their own decisions, to solve their own problems.”25 Accordingly, Acumen also believed in investing in solutions that were developed by entrepreneurs from within their own communities whenever possible rather than those that were imposed from the outside.26

Acumen Fund’s initial philanthropic capital came from the Rockefeller Foundation, Cisco Systems Foundation, and a core group of individuals. Its first-year goals included assembling a team, investing in at least two enterprises in health services or housing, and raising $2 million. By 2010, it had raised more than $100 million in capital, invested over $50 million in 50 companies in three primary geographies (East Africa, India, and Pakistan), touched 40 million lives, and helped create 35,000 jobs27 (see Exhibits 1 through 3). It had also grown to a team of 60 staff members. Roughly half of these employees were based in the U.S., with the remainder working from offices in the countries where Acumen invested. The non-U.S. offices helped Acumen get closer to the communities it was targeting and the entrepreneurs it supported. Additionally, Acumen launched a fellowship program to train highly skilled and motivated leaders and then deploy them to tackle specific challenges that portfolio companies needed to meet their targeted objectives.

Acumen’s long-term goal was to continuing using patient capital to “catalyze game-changing enterprises, companies that are so significant that they transform industries.”28 Just as microfinance had fundamentally altered the delivery of financial services to the poor, Acumen intended to invest in organizations with the potential to enact changes of a similar magnitude in the areas of water, health care, agriculture, housing, and energy. Although it would be no easy feat, the team hoped to have the $100 million invested in these types of organizations in the next few years.

Acumen’s continued growth depended on its ability to identify, fund, and support high-quality entrepreneurs, as well as to learn from its experiences by listening to the individuals with whom it worked and responding quickly to the emerging needs of those serving low-income markets. Novogratz also underscored the importance of continuing to attract prospective donors to the organization’s model:29

It never fails to amaze me how people seem so comfortable with making grants for purely charitable purposes so that they experience a 100 percent loss of their money, and are equally comfortable investing in hopes of seeing financial returns of 10-20 percent (or more), even if they risk losing a large portion of principal. Yet these same individuals will often not consider investment that results in negative returns of 10-20 percent but that also creates outsized social impact. Between pure charity and pure financial return, there is an unexplored space with tremendous opportunities for innovation, social impact, and lasting change.

Managing and Expanding the Acumen Fund Portfolio

Approximately forty five percent of Acumen’s employees were dedicated to managing and Doexpanding theNot organization’s inve Copystments, led by Trelstad; theor remainder Post of the team was

focused on the fellowship program, communications, business development, and various functional responsibilities such as finance and human resources. Acumen maintained separate portfolios for its five sectors of operation, each of which was led by portfolio managers and cross-country coverage teams. Portfolio team members brought extensive field experience in their sector, as well as strong technical knowledge. According to Omer Imtiazuddin, the health portfolio manager, the individuals on these team—from associates through managers and directors—were responsible for sourcing investments that aligned with Acumen’s mission, building a pipeline of opportunities, evaluating specific companies, conducting formal due diligence, making recommendations to the investment committee, and then structuring deal terms for approved investments. Portfolio managers also worked with their teams and resources from outside the organization to provide management and technical assistance to companies after they were funded by Acumen. “They do this by drawing upon their personal experience, as well as the advisory panels Acumen has in each sector and our broad network of entrepreneurs, funding institutions, individual philanthropists, and corporate connections. They also transferred knowledge between portfolio investments,” explained Zaidman, who formerly worked as a portfolio manager in the water sector before taking over the communications department in 2006.

As of year-end 2010, the health portfolio represented the largest percentage of Acumen’s total investments (44 percent), followed by agriculture (21 percent), energy (14 percent), water (13 percent), and housing (8 percent). Across these sectors, the team used four broad, but clearly defined investment criteria to evaluate its opportunities:

 Quality and Integrity of the Entrepreneur – At the very beginning of the diligence process, the portfolio team carefully considered the caliber of a company’s management team. As Imtiazuddin explained, “We’re really investing in the entrepreneurs. An ‘A’ management team can take a ‘B’ business plan and make it a success. But it’s much harder to do it the other way around.” Acumen also looked for a good fit between its own values and the values of the entrepreneurs it funded, as well as general openness toward working together to achieve mutually beneficial results.  Social Impact – “Social impact is another key driver of every investment decision we make,” said Zaidman. “At the end of the day, we want to understand how many people at the bottom of the socioeconomic pyramid have the potential to benefit from a company’s product or service, as well as how quickly the business can achieve adequate scale to reach large numbers of people within a relatively short period of time.” As a rough guideline, Acumen sought companies whose products and services had the potential to positively affect at least 1 million end users within five to seven years. Importantly, Acumen did not require a business to be focused exclusively on serving the poor. However, portfolio teams had to be convinced that addressing the needs of this market was a significant, lasting part of the business model. They also needed to be certain that the product or service being offered to the poor compared favorably to alternatives already on the market and/or those being offered by charitable sources in terms of cost and quality.30  Financial Sustainability – Acumen also looked for companies with the potential to become self-supporting within five to seven years. This required a company to have a clear, realistic, growth-oriented business model that would lead to sufficient operating Dorevenues Not to cover operating Copy expenses.31 The ability to becomeor self-sustaining Post not only

improved a business’s prospects for long-term success by reducing its dependence on donation or high interest short-term financing, but by increasing its ability to access commercial capital as its funding needs expanded  Demonstration Effect – Finally, Acumen looked for businesses capable of producing a demonstration effect—that is, providing a successful example of an innovative idea or approach in action to teach the development sector about new ways of delivering goods and services.

Health Strategy In addition to these overarching investment criteria, each sector had its own strategy that the portfolio managers used to further guide investment decisions. In the health sector, Acumen believed that the private sector had a critical role to play in improving health systems and increasing the poor’s access to critical health-related goods and services in developing countries. Imtiazuddin and his team were particularly interested in identifying businesses that were pursuing:

 Reduced Cost Structures – Companies modifying existing health products or developing new technologies to allow production at substantially lower cost.  New Pricing Models – Companies developing sustainable pricing schemes that use innovations such as cross-subsidies and microfinance to make health products and services more affordable.  Novel Distribution Systems – Companies using creative marketing and distribution mechanisms—including public-private partnerships and grassroots efforts—to bring critical goods and services to underserved areas.

To date, the health team had made 17 investments totaling more than $17 million.32 The majority of these companies provided health services (primary and emergency care, information management, financing/insurance, training); only a small number produced products. “When you start looking at products—diagnostics or devices, for example—the total capital required is traditionally very high. So these opportunities are just not suitable for an organization like Acumen that tends to invest in the $1-1.5 million range,” noted Imtiazuddin. Moreover, he said, “Most of the product companies we see are U.S.-based companies that have come up with products that are suitable for low-income populations in developing markets. On the services side, there are more local, homegrown opportunities that are easier to find since we know the hospital/clinic space in those countries.” However, as more social enterprises emerged with innovative cost and pricing structures, business models, and distributions concepts, he expected to see more product concepts that could be promising targets for Acumen’s portfolio. “But they’ll have to be products where the financing need is within the ballpark where Acumen operates, and where the products themselves are appropriate for our target populations.”

Due Diligence When Acumen conducted due diligence, anywhere from two to four team members typically worked together to assess the opportunity. Most importantly, the portfolio manager was involved to provide deep sector experience, in addition to an associate on the ground in the country who could provide in-depth knowledge of the local area and people. Do Not Copy or Post

Imtiazuddin provided an overview of Acumen’s due diligence process from the health sector perspective: “The starting point is getting a business plan from the entrepreneurs. We have a template that we share with them, which I always advise them to use. It’s often a useful way for the entrepreneurs to look at their own business models. Once they’ve done that, we review it internally as a team and engage in what we call the SKW.” SKW was an acronym for “Shaitan ka Wakil,” loosely translated from the Urdu as “advocate of the devil.” During the SKW process, the Acumen portfolio associate or manager advocating for a given deal stated his/her case, then a non-affiliated portfolio team member stated the reasons why Acumen should not do the deal. This promoted creative tension and a healthy debate, two factors that were critical to Acumen’s investment process. “Based on that conversation,” continued Imtiazuddin, “we either move a company into formal due diligence, advise them that the timing isn’t right but we should keep in touch, or in some cases reject the opportunity as not appropriate.”

Once Acumen moved a company into formal due diligence, the process was similar to how diligence was conducted by venture capitalists. Imtiazuddin and the other portfolio managers evaluated the company’s business model, finances, management team, marketing strategy, competitive landscape, and sector dynamics. They also assessed its performance (or potential) against Acumen’s unique overall and sector-specific criteria. Additionally, the team looked at whether or not there were any impending changes in global health that could positively or negatively affect the company (e.g., widespread government or NGO subsidies for products or services in the field).

After a company had been thoroughly researched, the team made a call on whether it would bring the opportunity to the investment committee (called the IC). “We can sometimes get pretty far in the due diligence process and then uncover some information which, in our mind, would make the business model unviable,” said Imtiazuddin. “In these cases, we try to work with the company to see if there’s a solution. If not, we usually won’t move them forward to the IC.” For instance, the team sometimes determined that a company’s competition was so far ahead that it would never be able to catch up. In other cases, Acumen asked people in the field to test a product or service and the feedback from those trials was negative.

The conclusion of an investment committee meeting is either the rejection or approval of the investment. At that point, the team shifted its focus and played a central role in negotiating the terms of the deal and seeing it through to closing. When it came to equity investments, “Our standard position is not to take a majority stake. So we’re bounded by 49 percent at the top,” said Trelstad. “But we want to be an activist minority shareholder—owning less than 10 percent would put us in the passive minority bucket. Our sweet spot is to target 20-35 percent equity ownership in exchange for our investment.”

Performance Management After the deal was completed, the portfolio team’s next responsibility was to provide management support to the new portfolio company (as described). They also worked with company contacts to establish financial and social measures of success, as well as reporting requirements. The use of sound metrics offered proof of concept, helping to attract further investments in Acumen and more local backing of its portfolio companies. However, calculating Doa quantitative Notsocial return on investmentCopy could be difficult. Acumen’sor approachPost was not to

strain its portfolio companies’ management resources by requesting financial reports that measured information that was not fundamentally significant to the supervision of their businesses, or that Acumen would not be capable of measuring itself. Instead, Acumen developed simple portfolio investment scorecards that were tracked quarterly. These quarterly scorecards consisted of roughly seven measures that applied to all investments, such as revenue, cost of goods, operating expenses, net income, and profitability. As a quarterly communication mechanism, the scorecards provided Acumen Fund with a synopsis of the investment’s status, as well as information on its financial sustainability, social impact in the target market, and growth toward scale and cost-effectiveness relative to alternative solutions to the same problem. These data were used primarily to help identify and address major management challenges, as well as to gauge their ongoing effectiveness.

EMBRACE

The idea for the Embrace Infant Warmer was developed as part of Professor Jim Patell’s Entrepreneurial Design for Extreme Affordability class—a course hosted by the Stanford Institute of Design (also known as the d-school), which involved graduate students and faculty from multiple schools across the university. During this two-quarter, project-based class, cross- disciplinary teams of students worked to create innovations that “lie at the intersection of business, technology, and human values.”33 The idea was to pioneer effective, creative products and services designed to meet the unique needs of the world’s poor at affordable prices.

In 2007, a number of student teams were asked to look at the problem of infant mortality for premature and low birth-weight babies. According to the World Health Organization (WHO), 20 million infants weighing less than 5.5 pounds are born each year. More than 95 percent of them are in developing countries, and approximately 4 million die within the first four weeks of life.34 Low birth-weight is a leading cause of neonatal death because the babies do not have enough body fat to help them stay warm (so they experience hypothermia). The problem can become fatal when complications develop, such as infections, the inability to eat, and organ shutdown. Those who survive often have lasting health problems or low IQ. In Western health systems, incubators that could cost as much as $20,000 each were used to treat these infants until they gained enough weight to self-regulate their body temperature. Lower-cost incubators and baby warmers, which ranged from $3,000 to as little at $1,000, had been designed for developing countries, but this price was still cost prohibitive in many areas.

Patell and his co-instructors challenged students to address this problem by designing a better incubator for the developing world that cost $200 or less. Chen and Linus Liang, who were business students, teamed up with engineering students Rahul Panicker and Naganand Murty, to tackle the assignment. To better understand the need and the conditions in which a solution would have to work, students from the class took a trip to Nepal. As one article described:35

[They] began their need finding in Kathmandu, the capital city of Nepal. After spending several days observing the neonatal unit of the Kathmandu hospital, the team asked to be taken outside the city to see how premature infants were cared for in rural areas. They learned two alarming things: First, the overwhelming Domajority Not of all premature NepaleseCopy infants were born inor these rural areas.Post And

second, most of these infants would never make it to a hospital. They realized that no matter how good their design for a new incubator was, it would never help these babies if [the technology] stayed in a hospital. To save the maximum number of lives, their design would have to function in a rural environment. It would have to work without electricity and be transportable, intuitive, sanitizable, culturally appropriate, and perhaps most importantly—inexpensive.

At the end of the course, the team had developed an early prototype of a low-cost infant warmer that looked a great deal like a sleeping bag for babies. The breakthrough was a pouch of phase- change material (PCM) that could be heated to 98-degrees Fahrenheit and inserted into the sleeping bag to keep the baby warm. The PCM would maintain that temperature for up to four hours and then could be reheated. The design was small and light, easily transportable, and more intuitive to use than traditional incubators. Moreover, the entire sleeping bag could be sanitized in boiling water and complemented the popular concept of “Kangaroo Mother Care” (KMC), through which mothers warmed their babies by holding or wrapping them against their skin.36 Importantly, the solution also had the potential to be produced at a fraction of the cost of traditional incubators. (See Exhibits 4 and 5 for more information about the product.)

Buoyed by the possibility of helping millions of low birth-weight babies with their innovative solution, Chen, Liang, Panicker, and Murty decided to pursue their idea. Over the next several years, they incorporated as a nonprofit (taking the name Embrace), refined their business plan, added team members, and continued to iterate their design. They also moved their operations to India to immerse themselves in an important market. According to Chen, one out of every three babies born in India has a low birth-weight and more than 1 million of them die every year.37 Being on the ground in the country also kept their costs low and allowed them to begin forging relationships in target communities.

Defining a Product Development Strategy and a Preliminary Target Market

In India, the team used its in-country relationships to bring prototypes to prospective users to gather their feedback. “We ended up speaking to more than 150 stakeholders across a lot of different geographies in India. After collecting all of that information and doing co-creation with doctors in the field, we ended up redefining our product point of view,” recalled Murty. “In India, there are hundreds of thousands of primary health clinics all over the country,” explained Liang. “They’re not the traditional clinics we think of in the U.S. They’re mostly one-room offices with one doctor who treats the whole village. But they do have intermittent electricity.” More often than not, when a low birth-weight baby was born in one of these clinics, the doctor recommended transferring the baby to a city hospital for more specialized care. However, given the distances between the clinics and the hospitals, as well as the condition of the roads, these journeys could take hours and further jeopardize the baby’s health.

This inspired the team to develop a product with an electric heat source that could be used for transport purposes, as well as to meet other needs in these clinics and in the urban hospitals that received the babies they transferred. Designing a product with an electric heater would be somewhat easier because there were fewer variables to control. For example, it would be easier Doto heat the pouchNot to a precise temperature Copy using an electric heater or that could Post be more carefully

regulated than boiling water. This would allow Embrace to directly resolve safety-related concerns raised by parents and physicians about the possibility of overheating the PCM and, as a result, they could get to market sooner. Hannah Wright (GSB 11), who interned with Embrace in the summer of 2010, described another benefit of this shift in strategy: “People in India revere and respect their doctors. So if Embrace wants its product to be successful in homes with mothers and community health workers in rural areas, it needs to be used and recommended by the professional medical community. Going after the clinical and urban markets first will actually help them build the rural market once they finish developing a non-electric version.” The clinical/urban market could also afford a slightly higher price, which would relieve a bit of the cost pressure on the product development team in completing the first market-ready version.

Ultimately, Embrace decided to divide its product development resources into two teams. Murty, who became president of urban products, would lead development of the electric version. Panicker, who became the president of rural products, would stay focused on the original goal of creating a version for areas without access to power. The urban product, which was known as the clinical version, was scheduled to launch in March 2011. The rural product would follow approximately 6 to 12 months later. “It’s like taking a baby step toward our ultimate goal,” commented Liang, who assumed the role of the company’s COO.

Preparing for Launch

Before they could launch the urban product, Liang recalled that, “People wanted evidence that it worked.” “We did a lot of testing,” added Chen. “We started at Lund University doing what’s called mannequin testing. In India, we first tested the product on full-term babies. Then, we conducted a randomized, controlled trial on low birth-weight babies who were experiencing cold stress.” While only 20 low birth-weight babies were included in the randomized study, “The results were very positive,” Chen noted. “They showed that Embrace is doing exactly what we promised, which is keeping babies at a constant temperature over an extended period of time. We also demonstrated that we’re able to bring babies who are experiencing cold stress back up to normal body temperature, and that our device works better than the current standards of care in the hospital.” “More importantly,” noted Murty, “the trial showed that there aren’t any safety concerns.” In early 2011, Embrace was in the process of conducting a multi-center trial of its clinical product at four hospitals in India to validate these results.

The sale and distribution of the clinical product was another essential hurdle to overcome prior to launch. Due to resource constraints and the desire to concentrate its efforts, Embrace had decided to focus its initial launch in India rather than tackling multiple geographies at the same time. Within the country, the team eventually hoped to penetrate the both the public and private sectors. However, it would take significantly more time to develop the government relationships needed to get into public hospitals and clinics. For this reason, according to Liang, its immediate focus was on private hospitals and clinics in India’s tier one and tier two cities (as measured by population size). To reach physicians in these facilities, said Chen, “We’re basically looking at three sales models.” First, Embrace was conducting a pilot study with a pharmaceutical company to have their sales representatives promote the product to physicians when they made sales calls for their pharmaceutical products. While the infant warmer was a device rather than a Dodrug, one pharmaceutical Not company Copy had agreed to the pilot to orhelp advance Post Embrace’s social

mission. Embrace was also working with a nonprofit distribution organization in India. This organization would build and maintain a dedicated sales force on behalf of Embrace, which Embrace would fund. Finally, the company had signed a memo of understanding with GE Healthcare, which included a minimum purchase order. Although the agreement gave GE global sales and distribution rights, GE would focus its preliminary efforts in India just as Embrace and its other partners intended to do.

In addition, Embrace had to develop a network of stockists—independent entities that distributed medicines and simple medical and surgical devices to doctors and pharmacies. A small town might have one stockist, while a large city would have dozens, all of whom were supplied by a larger “super stockist” with a warehouse in a central location. A local stockist would order the Embrace product and carry it in inventory based on recent demand. Doctors could buy the product directly from the stockist or would have their sales representative place an order for them that they could then pick up or have delivered.

The Embrace Business Model

Embrace planned to manufacture and package the infant warmer itself. The team estimated that it would be able to sell its first product units to clinics and hospital in tier one and tier two cities in India for approximately $150 to $200. The company would share a portion of its margin with its sales partners and its network of stockists.

At the heart of the Embrace business model was the idea that serving customers at the bottom of the global socioeconomic pyramid could be profitable. As Esha Tiwary, the company’s head of business development put it, “It should not be that any technology or product that’s developed for low income groups is a charity product.” Embrace considered itself a social enterprise and planned to become self-sustaining by generating sufficient earned income to cover its operating expenses and to support the company’s expansion (see Exhibit 6). “We intend to reinvest that into the company so we can adequately scale and grow,” said Liang. “This is a worldwide problem. It’s not just limited to India, so we want to be sure we have the resources to reach other countries.” The company’s overarching goal for its infant warmer products was to save the lives of more than 100,000 babies and prevent illness in as many as 800,000 more by 2013.

The company also had ambitions that extended beyond the infant warmer. According to Tiwary, “We look at ourselves as a company with a strong innovation competency and a deep knowledge of the communities we’re focused on serving. We’ve invested heavily in research for the past two-plus years and we understand the communities—how people live in these areas and what their needs are. And so we hope to develop a whole line of affordable technologies for developing countries.” Murty added: “Our focus over the next three to five years is going to be on healthcare products primarily because we have some expertise in this space. Having gone through the trials and tribulations of putting the first product out, we feel that we have developed the knowledge and leverage to push out other products in a similar space.”

Do Not Copy or Post

Funding Strategy and Implications on the Company’s Structure

Looking forward, the Embrace team estimated that it needed to raise $5 million in the first part of 2011 to support its operations over the next three to five years. This capital would be used to get the complete infant warmer product line to market, establish a successful commercial track record in India, begin expanding to other developing markets, and become fully self-sustaining.

Given the magnitude of the required investment, the team wondered if donations represented the best available capital source to meet its needs. As Liang put it:

We’ve found that donor money only gets you so far. Jane’s been fundraising almost every day for the last two years and so far our largest donation is in the six figures range. This definitely worked when we were a start-up. But to actually get to market and grow a company, you need seven figures. Foundation money and grant money just isn’t enough. It’s not that it can’t be done, but it will take a long time. Being as ambitious as we all are, it makes sense to start thinking about whether we should consider becoming a for-profit or a for-profit/nonprofit hybrid so we can get access to the level of investment appropriate to our growth and scale ambitions.

Chen explained the team’s original rationale for starting the business as a nonprofit:

We decided to structure ourselves as a nonprofit for a couple of different reasons. One was we wanted to adhere to the social mission of the organization. As we did our research in India, the other thing was that we noticed people were more willing to work with us as a nonprofit organization, especially other NGOs, the government, and a lot of the hospitals we were talking to about doing our clinical studies. In fact, some hospitals said very explicitly, “We do not want to work with you if you’re doing this as a for-profit venture.’ So for these reasons, and because we felt at that time that our distribution channels were going to be dependent on NGOs and the government, we thought it was wisest to start as a nonprofit.

However, the team now had concerns that it was outgrowing this original approach.

Becoming a for-profit or hybrid organization had some potential downsides (see Exhibit 7). As a company with private investors seeking a financial return on their invested capital, it might be more difficult to justify research into areas that were considered small or otherwise unattractive by commercial standards. For example, said Wright, “The neonatal hypothermia market in India would not strike most commercial investors as a great business opportunity until someone develops a $200 infant warmer that doesn’t need electricity. If Embrace goes fully private, it could be harder to take these kinds of risks and develop technologies specifically designed to serve needy or poor populations.” The team also worried about decisions on how these technologies would be commercialized. “They’re thinking about things like price,” Wright said. “So you might be able to make more money selling to fewer people at a higher price point, but Dothe founders wouldNot like the product Copy to be as accessible to as maorny people asPost possible, and they

would love to be able to have the flexibility to give some of it away or give it away at a subsidized price point for folks who really can’t afford it at all.”

Chen called out a few other benefits to being a nonprofit, as well: “You get a lot of publicity. You get volunteers, pro bono services, people who are willing to do clinical testing for free, and so on.” However, she acknowledged that fundraising at higher and higher levels was “really difficult.” Moreover, Chen said, “There’s a lot of reluctance from foundations to pump money into product development. They really want to fund the scaling and the execution of solutions, not the product development piece.” As a product company (rather than a service), Embrace also required more capital than many typical organizations that were funded by donations. “It’s hard to fund long-term product development, manufacturing, inventory management, and distribution agreements with small bits and pieces of donor money,” noted Murty.

Finally, Chen explained, “We’ll eventually have to be able to offer competitive salaries, and we want to be able to attract the best talent to the organization. I don’t want people to come work for Embrace and think it’s a one- or two-year gig, almost like a Peace Corps type of thing. I want this to be a real career option for the people who are involved, and that includes being able to offer them some financial upside.” By 2011, Embrace had grown to 18 employees who were passionate about its mission, but had all made substantial sacrifices to work with the organization.

After spending an extensive amount of time researching and evaluating its option, the Embrace team was leaning toward a for-profit/nonprofit hybrid structure that would potentially allow it access investment capital while maintaining some of the benefits of being a nonprofit entity. The most challenging part of considering a shift to a hybrid organization was that there were few precedents of companies that had done this successfully in the past. As Tiwary described:

This is just unchartered territory. We’ve done a lot of research and we haven’t come across many successful hybrid structures. We’ve come across a lot of poorly implemented ones. And so this is a new space. One concern is how to efficiently and transparently implement such a structure, because it has a lot of ramifications. It shouldn’t be the reason that the company is not able to succeed or achieve its objectives. And there are perception issues with international organizations such as UNICEF and WHO. The structure we choose has a lot of repercussions. So we would have to make sure that we have a very, very clear distinction between the roles of the for-profit and nonprofit arms and that we make that clear to the outside world.

Beyond this, said Chen, “There’s the challenge of operating two separate organizations. It’s difficult enough to operate one organization. With two entities, we would have to be sure we have the manpower and processes in place to keep them as seamlessly integrated as possible, while at the same time having an onsite agreement to make sure there isn’t a conflict of interest. There are a lot of issues to figure out.”

One hybrid model that appealed to the team was shown in Figure 3. Using this structure, the Dononprofit arm Notwould manage all needsCopy finding, research, product or development, Post and early-stage

prototyping, as well as education and awareness-raising for existing and new products. The for- profit arm would be responsible for all commercial activities, including product refinement, manufacturing, sales, distribution, and customer service. The nonprofit’s activities would be funded by grants, in addition to royalties or dividends paid to it by the for-profit in exchange for licensing the nonprofit’s IP. The nonprofit would also have an ownership stake in the for-profit entity.

Figure 3 Royalty/Dividend Hybrid Model

Shareholders Grantors Equity Grants Capital Dividends Licenses IP

India For-profit India Nonprofit IP Royalties OR Dividends

X% ownership Commercial Activities: R&D: Manufacturing, Sales, IP development (current Distribution, etc. and new products)

Source: Courtesy of Embrace.

As it considered its options, Embrace sought the input of its nonprofit board of directors, which included a professor of pediatrics, a serial innovator/entrepreneur, and several healthcare investors. The board was generally supportive as long as adequate controls were put into place to ensure that both entities were independently viable and that the nonprofit was not just a shell organization. For instance, the nonprofit would need a separate board and its own CEO to give it equal weight in making important joint decisions.

Another critical issue to address was how to communicate with Embrace’s donors about any changes to the organization’s legal structure. “We’ll have to figure out how to manage people who have supported us as a nonprofit so far, and how to make sure they’re comfortable coming along for the ride,” said Tiwary. As a first step in this process, the management team had begun seeking input from its largest donors about the possible benefits of a transition.

INTERACTIONS BETWEEN ACUMEN AND EMBRACE

Chen met Trelstad at the Stanford GSB when she was a student. He presented in a course she was taking on the strategic management of nonprofits and she talked with him after class. As Embrace progressed, Chen kept in touch with Trelstad who became an informal advisor to the team. When Embrace began to consider a more sophisticated funding strategy that could include Dothe transition toNot a for-profit or hybridCopy entity, Trelstad helped themor think throughPost the pros and

cons of the different alternatives. They also started talking about the possibility of Acumen becoming an investor in Embrace.

Acumen could only provide Embrace with debt capital as a nonprofit. As a hybrid, Embrace could offer Acumen an equity stake in the business in exchange for a significantly larger capital infusion. Acumen’s debt investments typically averaged about $500,000, while its equity investments averaged approximately $750,000 (the organization considered equity investments in the range of $500,000 to $1.5 million to be its “sweet spot”). Embrace would require additional investment to meet its total financing needs, but a company like Acumen could play a lead role in the investment round. As Trelstad explained, “We are not in a position to syndicate investments. However, we know a number of impact investors with similar investment criteria in our growing social impact ecosystem, and we have enjoyed working with many of them in the past. The entrepreneurs would be welcome to consider their co-investment, although any of these other organizations would, of course, have to do their own due diligence to determine the advisability of the investment.”

Embrace was excited about the prospect of bringing Acumen on as an investor. According to Chen:

Acumen is a good fit for us. They are a nonprofit VC, so their incentives are different than a traditional for-profit VC, and even a for-profit social VC. On top of that, we’ve had really positive interactions with Brian, in particular, and the other people there. That’s something really important to us. We’d very much like someone like Brian to sit on our board. And then there’s Acumen’s experience. They invest in companies like LifeSpring Hospitals, which is a chain of private maternity hospitals in India that deal with birthing. So they have domain experience, as well as India-specific experience. We’ve talked with a lot of the companies Acumen has invested in, and they’ve all had very positive experiences.

“They can bring a lot of people and resources to the table,” added Liang. And, said Tiwary, “They are one of the bigger well-known players in the field—pioneers of the social fund concept. I think that really carries a lot of weight in terms of attracting other investors and even other potential partners.”

From the Acumen Fund perspective, Embrace also seemed to be a promising opportunity. “The need is compelling and the product is cutting-edge,” said Trelstad. “Just looking at the problem they’re trying to tackle, the potential for social impact is huge,” Imtiazuddin agreed. “In the health sector, we’re looking for companies that come up with a product or a service that can be offered at a substantially lower cost and thereby enable affordability,” he added. “Making low- cost infant warmers fits nicely with that objective.” Both Trelstad and Imtiazuddin were also impressed with the management team and what they had accomplished to date.

In terms of risks, “Embrace is a little atypical from an Acumen perspective,” said Imtiazuddin. “Our preference is to invest when companies need expansion capital. By that I mean that they already have an existing business that’s been running for at least a couple of years, but we feel Dothat our mix Notof financial capital Copyand management support canor really helpPost them scale up.

Embrace is still very much a start-up.” With no established customer base, proven distribution channels, or track record of generating revenue, the key question was whether the Embrace solution would gain traction in the marketplace. “It’s a completely new way of incubating low birth-weight babies. Will clinicians and parents be comfortable with it?” asked Trelstad. Some of the other product opportunities Acumen had investigated in the health sector had a hard time making sales because of the extensive customer education that was required to convince users to make a change.

There was also the question of whether the relatively young, inexperienced Embrace team would be able to successfully transition “from being graduate school students to a real medical device company,” Trelstad said. “We’ve seen in similar situations that it can be hard to get the founders to take a company past the first million dollars in revenue.” If Embrace decided to transition to a hybrid structure, this risk would be amplified by the complexities associated with implementing and managing the new legal structure. “In certain cases, you can face mission drift, if you’re too hard on the business model, or you can affect the financial sustainability of the business, if you’re too hardcore on the mission,” Imtiazuddin pointed out. Even the most experienced executives struggled to strike an appropriate balance.

Despite these potential risks, Acumen initiated formal due diligence with Embrace. “We provided them with all the information they need—the overview presentation, the business plan, and our financial projections,” said Tiwary. Now the ball was in Acumen’s court to decide whether to offer Embrace debt funding or an equity investment (see Exhibit 8 and Appendix 1), or to pass on the investment opportunity at this time.

DISCUSSION QUESTIONS

From the Acumen Fund perspective:

 If Embrace becomes a for-profit or hybrid organization, should Acumen invest in the company? Why or why not?

 If it invests, in what range should Acumen negotiate the equity percentage and value (i.e., what is the most it should pay and what is the least)?

From the Embrace perspective:

 Should the company convert to a for-profit or hybrid organization structure? Why or why not?

 Is Acumen an attractive investor? Why or why not?

 If it does a deal with Acumen, in what range should Embrace negotiate the equity percentage and value?

 What other initial investors—by name or type—should Embrace also consider? Do Not Copy or Post

Exhibit 1 Acumen Fund Financial Highlights Years Ended December 31, 2007, 2008, and 2009

STATEMENT OF POSITION 2007 2008 2009 Assets Cash and investments 26,753,543 38,415,447 43,100,299 Pledges receivable 32,467,711 28,165,035 21,632,046 Other assets 1,104,121 880,157 991,543 Program Investments Loans receivable 4,148,303 6,769,221 6,506,372 Equity investments 7,284,655 13,092,237 16,743,854 Loan guarantees 294,000 1,663,000 1,663,000 Total Assets $72,052,333 $88,985,097 $90,637,114

Liabilities and Net Assets Capital contributions received in advance 3,312,361 Notes payable 2,585,125 Short-term liabilities 628,601 592,037 779,582 Net assets 71,423,732 88,393,060 83,960,046 Total Liabilities and Net Assets $72,052,333 $88,985,097 $90,637,114

STATEMENT OF ACTIVITIES Revenues Contributions and support 45,520,394 33,971,301 8,452,569 Prior years’ contributions write-off (8,412,965) (2,100,000) Investment income 861,295 638,753 222,096 Interest income – Program loans 156,707 435,988 533,114 Change in value of charitable remainder trust 25,098 (92,948) 45,612 Other income 22,063 35,123 94,505 Revenue Before Donated Legal Services, Space and $46,585,557 $26,575,252 $7,247,896 Investment Losses Donated legal services and space 1,264,730 2,714,314 2,208,000 Portfolio investment loss (40,060) (2,221,970) (1,994,688) Total Revenue $47,810,227 $27,067,596 $7,461,208

Program Expenses Portfolio expenses 3,044,295 2,939,637 3,914,471 Outreach, knowledge, and communications 679,203 1,431,087 3,542,448 Fellows 667,881 721,345 684,231 Management and general administration 836,508 1,227,484 964,830 Fundraising 593,192 749,505 1,002,547 Total Expenses Before Donated Legal Services and Space $5,821,079 $7,069,058 $10,108,527 Donated legal services and space 1,264,730 2,714,314 2,208,000 Total Expenses $7,085,809 $9,783,372 $12,316,527 Foreign currency exchange gain (loss) 7,123 (698,544) (151,910) Change in Net Assets $40,731,541 $16,585,680 ($5,007,229)

PORTFOLIO INVESTMENT DISBURSEMENTS $5,359,665 $12,031,020 $6,164,681

Source: “On the Ground: 2009/2010 Annual Report,” Acumen Fund, p. 20. Reprinted with permission of Acumen Fund. Do Not Copy or Post

Exhibit 2 Investment Overview

Cumulative Invested and Approved $50.3 million Current Active and Approved Investments $39.2 million  Debt/Loan Guarantees  $11.8 million  Equity  $27.3 million  Grants  $0.1 million Cumulative Number of Companies 50 Number of Active Companies 32 Leverage on Capital $140 million (non-Acumen follow-on or co-investment) People Reached 40+ million Jobs Created 35,000

Active and Approved Investments by Sector in millions (as of 9/30/10)

Agriculture, $8.2

Health, $17.4

Energy, $5.3

Housing, $3.3

Water, $5.0

Active and Approved Investments by Geographies (as of 9/30/10)

Pakistan, $9.9

India, $15.7

East Africa, $13.6

Source: “On the Ground: 2009/2010 Annual Report,” Acumen Fund, p. 19. Reprinted with permission of Acumen DoFund. Not Copy or Post

Exhibit 3 Acumen Fund’s Cumulative Approved Investment (2004-2010)

$50.3 M $50 INVESTMENTS APPROVED

Source: Courtesy of Acumen Fund.

Do Not Copy or Post

Exhibit 4 The Embrace Product (as of late 2010)

Electric or hot water heater

phase change pouch

how it works 1. Heated pouch is placed into the ‘sleeping bag’ 2. Infant is placed on the lining that covers the pouch 3. Temperature indicator shows when pouch needs to be reheated

Source: Embrace Global. Reprinted with permission. Do Not Copy or Post

Exhibit 5 Embrace Performance Relative to Potential Substitutes

Cost Thermoregul- Ease of Use Mother/Child Safety Ability to work Effectiveness ation Efficacy Interaction w/o Electricity

Embrace

Traditional Incubator

Kangaroo Care

Home Remedies

High High/Medium Medium Medium / Low Low Note: This matrix refers to the non-electric version of the Embrace product.

Source: Embrace Global. Reprinted with permission.

Do Not Copy or Post

Exhibit 6 Spectrum of Social and Financial Returns

Nonprofit structure

For-profit structure

Business with Nonprofit with strong Emphasis on Emphasis on Conventional Social Conventional some earned emphasis on financial social returns nonprofit enterprise business income social returns responsibility

Philanthropic capital

Commercial capital

Source: Source: As presented by Michael Chertok, Jeff Hamaoui, and Eliot Jamison in “The Funding Gap,” Stanford Social Innovation Review, Spring 2008. Copyright © 2007 by Leland Stanford Jr. University. All rights reserved. Reprinted with permission.

Do Not Copy or Post

Exhibit 7 Overview of Embrace’s Legal Structure Options

For-profit Nonprofit Hybrid

• Enterprise operates as a bottom of • Organization operates completely • A nonprofit and for-profit the pyramid for-profit organization on nonprofit basis, earning no organization exists in parallel, Description earning minimal profit per unit profits many a times leveraging each others expertise

• Simple structure with low • Simple organization structure with • Potentially easy to get grants from overheads low overheads corporate & funding from PE firms • Funding from conventional • Easy to get grants from corporate • Can retain social focus and offer sources like VC / PE firms etc. philanthropy and foundations economic incentives to employees Pros • Economic incentives for • Easier to work with some partners employees as a nonprofit • More rigorous decision-making

• Access to grants can be limited • Challenge to make the • Complicated organizational • May lose social focus organization self sustainable structure with higher overheads Cons • More difficult to work with some • Difficult to offer economic • Ethical concerns over using grant partners incentives to employees money to generate profit

• D. Light • PATH • IDE-I Comparable • Husk Power • World of Good Organizations • 1298 Ambulances

Source: Embrace Global. Reprinted with permission.

Do Not Copy or Post

Exhibit 8 Abridged Preference Share Term Sheet (Sample)

This “Term Sheet” relates to Investor’s proposed Investment in Company. This Term Sheet is nonbinding and for discussion purposes only among the Company and Investor(s). Investor is not obligated to make this Investment or any other investment in Company. Investor will only provide the Investment upon approval of the Investment by Investor’s Investment Committee and execution of the Transaction Documents. This Term Sheet may change for any reason, including the results of Investor’s diligence. This Term Sheet should not be shared with anyone other than Company and its representatives without Investor’s prior written consent and is subject to the terms of the Non-Disclosure Agreement between Investor and the Company and the Exclusivity Agreement between Investor and the Company. THE PROPOSED INVESTMENT Company: “Company” is Embrace Global. Investor[(s)]: “Investor” is Acumen Fund, Inc. Amount of Investment: $______, subject to the satisfaction of the Conditions Precedent (described below). Number of Shares to be Issued: Investor(s) will purchase ______shares, sometimes called “Preference Shares” or “Investor Shares.” Share Price: $______per share; referred to as the “Purchase Price.” Closing/Disbursement(s): One disbursement of the total investment amount will occur on the “Closing Date,” subject to the satisfaction of the Conditions Precedent. The target Closing Date is ______. Use of Proceeds Proceeds from the Investment must be used to support the company’s mission. TERMS OF THE INVESTOR SHARES

Voting Rights: The Investor Shares will be entitled to that number of votes on all matters presented to holders of Ordinary Shares as if the Investor Shares had already been converted to Ordinary Shares according to the “Conversion Rate.” INVESTOR RIGHTS Redemption: If a liquidation, winding up, dissolution or IPO does not occur within five years from the Closing, then the Investor Shares will be redeemable at the election of Investor(s) for an amount in cash equal to the Purchase Price plus all accrued but unpaid dividends. [All redemptions will be made pro rata among all eligible shareholders, until all redemption requests have been satisfied.] Right of First Refusal: If any of the Company’s shareholders other than Investor(s) propose to transfer any of their Company shares to a third party, then Investor(s) will have a right of first refusal to purchase those shares on the same terms as the proposed transferee. DoManagement Lock-in:Not CopyFor five years following Closing, or Founder(s) andPost other key

employees will not be permitted to transfer any of their Company shares without the permission of Investor(s). Board of Directors: Investor(s) will have the right to elect ______members of the Board. The Company will provide standard directors’ and officers’ insurance, satisfactory to Investor(s). Board Observer Rights: Investor(s) will be entitled to Board observer rights and will be entitled to participate as an observer at all Board meetings and to receive copies of all materials distributed to the Board. Information and Inspection Investor(s) will be provided with standard audited annual and Rights: unaudited quarterly financial statements, unaudited monthly financial statements, annual business plans and budgets of the Company, and any other information, including a series of measures of social impact as agreed by the Company and Investor(s), as Investor(s) may reasonably request. Investor(s) will be entitled to inspection rights of the books and registers maintained by the Company. OTHER TERMS Conditions Precedent to Closing: The Investment will be subject to customary “Conditions Precedent”, including, but not limited to:  completion of due diligence to the satisfaction of Investor(s);  negotiation and execution of definitive agreements;  receipt of all required authorizations, approvals and consents;  delivery of a final share certificate for the Investor Shares;  delivery of an opinion of counsel for the Company;  the absence of material adverse changes of the Company; and  undertaking by the Company of its commitment to the philanthropic mission of Acumen Fund’s Investment. Non-Competition and Non- Each Founder will enter into a ______year non-competition and Solicitation and Agreements: non-solicitation agreement in a form acceptable to Investor(s).

Source: This exhibit is based on a standard term sheet provided by Acumen Fund. The authors modified it significantly to simplify and shorten it for the purposes of class discussion. The terms listed above represent some of the most important financial and nonfinancial terms for students to consider. However, they do not provide a complete picture of all the terms that would normally be addressed as part of a deal of this nature. Do Not Copy or Post

Appendix 1 Glossary of Venture Financing Terms

Common Stock Common stock is the basic equity interest in a company. It is typically the type of stock held by founders and employees.

Preferred Stock Preferred stock has various "preferences" over common stock. These preferences can include liquidation preferences, dividend rights, redemption rights, conversion rights and voting rights, as described in more detail below. Venture capitalists and other investors in private companies typically receive preferred stock for their investment.

“Series” of Preferred Stock When a company raises venture capital in a preferred stock financing, it typically designates the shares of preferred stock sold in that financing with a letter. The shares sold in the first financing are usually designated "Series A", the second "Series B", the third "Series C" and so forth. Shares of the same series all have the same rights, but shares of different series can have very different rights.

Liquidation Preference “Liquidation preference” refers to the dollar amount that a holder of a series of preferred stock will receive prior to holders of common stock in the event that the company is sold (or the company is otherwise liquidated and its assets distributed to stockholders). For example, if holders of preferred stock have a liquidation preference equal to $30 million and the company is sold, they will receive the first $30 million before common stockholders receive any amounts. The liquidation preference amount can be paid in cash or stock of an acquirer.

Senior Liquidation Preference A series of preferred stock has a "senior" liquidation preference when it is entitled to receive its liquidation preference before another series of preferred stock. (All series of preferred stock will, of course, be "senior" to the common stock simply by virtue of having a liquidation preference.) For example, if the Series B has a $30 million senior liquidation preference and the Series A has a $25 million liquidation preference and the company is sold for $40 million, the Series B will receive $30 million and the Series A will receive $10 million.

Multiple Liquidation Preference The amount of liquidation preference that a given series of preferred stock has is usually equal to the amount paid for the stock. However, in certain financings new investors may require that their liquidation preference amount be equal to more than the amount they originally invested (often referred to as a "multiple" liquidation preference). Multiples tend to be one and one-half to three times the purchase price. A multiple liquidation preference will almost always also be a senior liquidation preference as well. For example, if the Series B was purchased for $30 million, but has a senior liquidation preference equal to two times the purchase price, then the Series B investors will receive the first $60 million on any sale of the company before the Series A or Docommon stockholders Not receive any amounts.Copy or Post

Participation Preferred stock is said to "participate" or to have “participation” rights when, after the holders of preferred stock receive their full liquidation preference amount, they are then entitled to share with the holders of common stock in the remaining amount being paid for the company (or otherwise distributed to stockholders).

For example, if the company is sold for $200 million, the preferred stock has a liquidation preference of $30 million and the preferred stock represents 40% of the total number of outstanding shares of the company, then the $200 million would be distributed among stockholders as follows:

(1) First $30 million - Paid to holders of preferred stock per their liquidation

preference. (2) Remaining $170 million:

• Preferred stock holders receive their 40% pro rata share ($68 million)

per their participation rights. • Common stock holders receive remaining 60% ($102 million).

Totals: Preferred stock holders - $98 million Common stock holders - $102 million

Capped Participation Participation rights are described as "capped" when the participation rights of the preferred stock are limited so that the preferred stock stops participating in the proceeds of a sale (or other distribution) after it has received back a pre-determined dollar amount (caps typically range from three to five times the original amount invested). Building on the previous example, if the participation rights of the preferred stock were capped at a 3x multiple of their liquidation preference amount (which 3x includes the amount of liquidation preference), then the result would be that the preferred stock would receive only an additional $60 million in participation in step (2) above. Thus, the total amount received by the holders of preferred stock would be $90 million (down from $98 million without a cap) and the amount received by the holders of common stock would increase to $110 million (up from $102 million).

Note: If the price paid for the company in this example were substantially higher (e.g., $275 million) then the holders of preferred stock would convert to common stock (thereby giving up their liquidation preference) in order to eliminate the 3x cap, because 40% of $275 million equals $110 million, which is $12 million more than the preferred would receive if they did not convert and were subject to the 3x cap.

Cumulative Dividends Holders of preferred stock having a cumulative dividend right are entitled to be paid, in addition to a liquidation preference, an amount equal to a certain percentage per year of the purchase Doprice for the preferredNot stock (typically Copy five to eight percent). Foror example, if Postthe preferred stock

purchase price was $20 million, and the stock had a 1x liquidation preference and a six percent cumulative dividend, and if the company was sold after three years, then the preferred stock holders would be entitled to $23.6 million before anything was paid on the common stock. In some circumstances cumulative dividends must be paid annually, but this is unusual in venture financed companies.

Conversion Rate Almost all preferred stock issued in venture financings can be converted into common stock at the option of the holder of preferred stock. The typical initial conversion rate is one share of preferred stock converts into one share of common stock. However, the conversion rate can change for a number of reasons, such as stock splits or antidilution adjustments.

Antidilution Provisions Antidilution provisions retroactively reduce the per share purchase price of preferred stock if the company sells stock in the future at a lower prices. This is effected by increasing the conversion rate of the preferred and accordingly increasing the number of shares of common stock into which a share of preferred stock converts. There are two main types of antidilution protection: weighted average antidilution protection and ratchet antidilution protection.

Weighted Average Antidilution Weighted average antidilution provisions, which are the milder form of antidilution protection, increase the conversion rate of the preferred stock based on a formula that is intended to take into account the overall economic effect of the sale of new stock by the company. The formula includes variables for the price at which new stock is sold, the price at which the old preferred stock was sold, the total number of new shares issued and the total number of shares outstanding.

Ratchet Antidilution Ratchet antidilution provisions, which are the tougher form of antidilution protection, increase the conversion rate of the preferred stock based on the price per share at which the company sells its stock in a future down round, regardless of how few or how many new shares are sold at the lower price. This has the effect of retroactively reducing the price per share which the preferred was sold in the current round to the new, lower valuation of a future down round.

Pay to Play Pay to play provisions impose penalties on investors for not investing their full pro rata share in the next round (typically only if the next round is a down round). The more severe version of these penalties is to provide that investors who do not invest their full pro rata amount will have their existing preferred stock converted into common stock, resulting in the loss of their liquidation preference and antidilution protection, among other rights. A less severe version is to convert the preferred stock into a different series of preferred (often referred to as "shadow preferred") that retains some or all of its liquidation preference, but loses anti-dilution protection, both for the subject financing, and going forward.

Do Not Copy or Post

Redemption Redemption provisions allow investors to require the company to repurchase their preferred stock under certain circumstances, typically for the price originally paid. Redemption rights usually cannot be exercised unless the holders of at least a majority (sometimes more) of the preferred stock so request and usually cannot be exercised for four to five years after the financing. In certain circumstances, redemption provisions may provide for a right of exercise more quickly or for a repurchase at more than the original purchase price.

Corporate Reorganization Corporate reorganizations typically refer to either (a) the conversion of existing preferred stock into common stock, or into a new series of preferred stock with a substantially reduced liquidation preference amount and/or (b) a reverse stock split of outstanding stock. Corporate reorganizations are usually implemented to reset the economic interests of existing stockholders to current economic realities so as to facilitate the company's ability to attract additional investment and to provide appropriate incentive to the management team. The conversion of existing preferred stock into common or a new series of preferred stock has a significant economic effect, as those stockholders will often lose substantial liquidation preferences and other rights. A reverse stock split has no economic effect in and of itself, but is usually undertaken when a company's stock price has fallen significantly and the company wants to raise it to a more typical range.

Source: Barry Kramer and Michael Patrick, “Explanation of Certain Terms Used in Venture Financing Terms Survey,” Fenwick & West LLP, 2010. Reprinted with permission.

Do Not Copy or Post

Endnotes

1 Paul S. Boyer, “Philanthropy and Philanthropic Foundations,” The Oxford Companion to United States History, 2001, Encyclopedia.com, http://www.encyclopedia.com/doc/1O119-PhlnthrpyndPhlnthrpcFndtn.html (January 3, 2011). 2 Ibid. 3 “Philanthropic Foundation,” New World Encyclopedia, http://www.newworldencyclopedia.org/entry/Philanthropic_foundation (January 3, 2011). 4 “Does Venture Philanthropy Work?” CNETNews, May 8, 2004, http://news.cnet.com/2030-1030_3-5206330.html (December 16, 2010). 5 John J. Havens and Paul G. Schervish, “Millionaires and the Millennium: New Estimates of Forthcoming Wealth Transfer and the Prospects for a Golden Age of Philanthropy,” Social Welfare Research Institute, Boston College, October 1999. 6 “Does Venture Philanthropy Work?” op. cit. 7 Paola Grenier, “Venture Philanthropy in Europe: Obstacles and Opportunities,” European Venture Philanthropy Association, January 2006, http://www.evpa.eu.com/downloads/EVPA_Research_Report_January_2006_Summary.pdf (January 27, 2011). 8 Dahlia Fahmy, “Adventures in Philanthropy,” Institutional Investor, December 2004, p. 60. 9 “Does Venture Philanthropy Work?” op. cit. 10 Ibid. 11 Ibid. 12 The Council on Foundations publishes texts like Beyond Our Borders (2nd ed. 2006), a 66-page guide explaining terms, rules, and models. 13 Bill Easterly, “Mind Over Money,” In the Money, CNN, Dec. 24, 2006. 14 Ibid. 15 Anne Fields, “Investor in the World’s Poor,” Stanford Business, May 2007, http://www.gsb.stanford.edu/NEWS/bmag/sbsm0705/feature_novogratz.html (December 15, 2010). 16 “Jacqueline Novogratz: Philanthropist,” TED, http://www.ted.com/speakers/jacqueline_novogratz.html (December 15, 2010). 17 “Five Year Report,” Acumen Fund, 2006, p. 4. 18 “What Is Patient Capital?” Acumen Fund, http://www.acumenfund.org/about-us/what-is-patient-capital.html (December 15, 2010). 19 All quotations and data included in the case are from interviews conducted by the authors unless otherwise cited. 20 Kent Seaton, “‘Hybrid’ Organization: The What and the Why,” Philanthropy Journal, January 16, 2009, http://www.philanthropyjournal.org/resources/managementleadership/%E2%80%98hybrid%E2%80%99- organizations-what-and-why (December 15, 2010). 21 “Our Investments,” Acumen Fund, http://www.acumenfund.org/investments/investment-discipline.html (December 15, 2010). 22 “Five Year Report,” op. cit., p. 16. 23 “What Is Patient Capital?” op. cit. 24 Acumen Fund, http://www.acumenfund.org/ (December 15, 2010). 25 “Jacqueline Novogratz: Philanthropist,” op. cit. 26 Ibid. 27 “On the Ground: 2009/2010 Annual Report,” Acumen Fund, http://www.acumenfund.org/uploads/assets/documents/Acumen%20Fund%20Annual%20Report%202009%20FIN AL%20FOR%20WEB_tf99CSHN.pdf (December 15, 2010), p. 5 and p. 7. 28 Ibid., p. 18. 29 Ibid., p. 5. 30 Alnoor Ebrahim and V. Kasturi Rangan, “Acumen Fund: Measurement in Impact Investing (A),” Harvard Business School No. 9-310-011, May 4, 2010, p. 3. 31 Ibid. 32 “On the Ground: 2009/2010 Annual Report,” op. cit., p. 19. 33 “Our Class,” Entrepreneurial Design for Extreme Affordability, Dohttp://extreme.stanford.edu/big_picture/our_class.html Not Copy (January 11, 2011). or Post

34 “Prematurity and Low Birth Weight: Background Report,” Global Health Watch, PBS Newshour, March 19, 2009, http://www.pbs.org/newshour/globalhealth/diseases/premature.html (January 11, 2011). 35 “Continuing Projects: Embrace,” Entrepreneurial Design for Extreme Affordability, http://extreme.stanford.edu/projects/embrace.html (January 11, 2011). 36 Ibid. 37 Jane Chen, “Embrace Infant Warmer: Saving Babies the World Over,” August 16, 2010, http://www.chickfriendly.net/jane-chen/embrace-infant-warmer-saving-babies-the-world-over/ (January 11, 2011).

Do Not Copy or Post

This document is authorized for use only by William Allen until July 2011. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860.