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 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. 3 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