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Foundations

Building Venture Capital from Within

Five lessons on creating a venture capital fund inside a foundation—a look at the Knight Enterprise Fund.

Over the last year the Knight Enterprise Fund, a $10M fund that is part of the Knight Foundation, has invested in more than a dozen early-stage, for-profit companies. They include crowd-sourced news networks such as PolicyMic, revenue tools for existing publishers such as OwnLocal and Umbel, and open government services such as PublicStuff and Captricity. Collectively, these companies help hundreds of cities, thousands of publishers, and millions of people to create, share, and consume information.

The Enterprise Fund is separate from Knight Foundation’s grantmaking budget. It is carved out from Knight Foundation’s $2.2 billion endowment, a venture fund that seeks to directly drive social impact while generating a financial return. Though it is too soon to tell whether the fund will succeed in both goals, we’d like to share some lessons that highlight what we’ve learned to date, at a time when the field of impact investing is generally struggling with a dearth of early-stage funding.

We feel that this focused venture capital approach is particularly appropriate for Knight because it augments its programmatic mission while still managing the associated risks. At the same time, it keeps Knight connected to media innovators—no matter what their business model—in a way that can inform its nonprofit work.

Lesson 1: Ensure that there is a strong mission fit.

Early-stage investments are highly risky, and all but the top-tier venture capitalists generate terrible returns. The potential of media-innovation companies, both nonprofit and for-profit, to promote Knight’s mission of informed and engaged communities explains Knight’s willingness to take on this risk.

Because the companies we target are mission-aligned, we are able to recruit prospects organically and take more concentrated positions in companies with stronger potential for social impact. For example, several Enterprise Fund companies have been recruited through the Knight News Challenge, and these have received larger investments. We are also able to foment collaboration across Knight-funded organizations and communities.

A strong mission bias also helps us in culling potential deals that don’t fit Knight’s mission or expertise (see Lesson 2). It is roughly 200 times cheaper to start a tech company than it was during the dot-com boom, meaning that there are more opportunities than ever before. Being able to say no quickly is a necessity.

Lesson 2: Have a keen understanding of the problem you are trying to solve.

A Ford Foundation assessment of its pioneering efforts in impact investing remarked that successful investments “were most often in fields we knew very well—we knew the people and the players from our grantmaking experiences. Many of our early losses were with types of ventures that, in retrospect, we probably had no business being in because we didn’t know the field.”

Knight intensively studied the information gap that exists around government, education, healthcare, and civic news at the local level, and contributed more than $200 million in charitable funding to hundreds of media innovation projects that intended to address this gap. In the process, we developed a knowledgeable network of people who care about this issue and identified six areas where for-profit solutions are likely to emerge.

All of this means that when we invest in companies, Knight has an informed perspective and is viewed as a knowledgeable investor, helping to attract additional capital to the companies we favor.

Lesson 3: Develop a structure that mitigates risk.

The biggest barrier for us in launching the fund was developing a structure that adequately guarded against our own inexperience in making these types of investments. After some trial and error, we adopted four principal ways to mitigate this risk:

  • We invest no more than 10 percent of any round that we participate in—typically $50,000-$150,000 at the seed stage.
  • We use the track record of other committed investors to inform our investment decisions.
  • Staff does our own assessment of the business risks and rewards.
  • We have an advisory committee of experienced investors and entrepreneurs (Joi Ito, Chris Hughes, and John Palfrey) who provide council and approve larger investments.

This strategy mitigates risk while ensuring that the companies we invest in benefit from the strong entrepreneurial operating experience and private-sector partnership opportunities that traditional venture capitalists can provide.

Lesson 4: Add value beyond dollars.

If Knight can’t add value beyond capital, we don’t make the investment, because it is a strong indicator to us that the mission fit is not very good. Moreover, because Knight is not a traditional investor, we are often able to open unique doors for Enterprise Fund companies across Knight’s large network of media, educational, community, and nonprofit partners.
For example, introducing PhillyMedia (which owns several newspapers in Philadelphia) to OwnLocal (which provides digital advertising services to newspapers) helped OwnLocal to close PhillyMedia as its biggest customer. Similarly, PublicStuff, which provides 311 services for cities, presented at a Knight sponsored conference on community foundations and made inroads among a number of stakeholders in new cities.

Lesson 5: Measure results (both dollars and mission).

We expect successful early-stage venture investments to take 4-5 years, while failures can be spotted much sooner than that. To gird our organization for the long road ahead, we have adopted a quarterly reporting system that tracks both mission and financial metrics for portfolio companies. We hope this, along with discipline in our investment approach, makes it easier to sustain our commitment to these companies and to the fund.

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COMMENTS

  • Stephen Viederman's avatar

    BY Stephen Viederman

    ON March 20, 2013 03:24 PM

    An historical note. Beginning in 1994 the Jessie Smith Noyes Foundation, as part of its mission-related investing program, had about 10 percent of its assets in venture capital investments related to mission managed by the foundation in-house.. This program continued throughout the rest of the decade. By that time there were commercial investment managers who shared our values and concerns so we invested through them.

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