I have spent the last few weeks thinking about zombies—and not just because of Halloween. Why, you may ask?
The Rockefeller Foundation is an impact investor through our portfolio of program-related investments (PRIs). Over the past twenty years, we have invested in a number of impact-focused private equity funds, most of which invest in companies that are creating products, services, or jobs for low-income people. The hypothesis is that with greater access to capital and engaged investors, portfolio companies will grow and better serve low-income customers. With growth, the portfolio companies will also become more valuable and upon a liquidity event—like the sale of the company or an IPO—generate favorable rates of return for their investors.
Unfortunately, things don’t always play out as expected.
“A zombie fund is one that still holds some or all of its assets beyond its intended holding period—usually because the fund is struggling to sell its investments for a profit.”
Some of the funds we have invested in have become “zombie funds.” A zombie fund is one that still holds some or all of its assets beyond its intended holding period—usually because the fund is struggling to sell its investments for a profit. This can happen for a number of reasons, including a downturn in the market or because managers have failed to aggressively seek exit opportunities. Managers in these circumstances will frequently extend the life of a fund beyond what investors expected. This can depress the fund’s internal rate of return (IRR) since it takes longer for investors to be paid. Additionally, the manager of a zombie fund will still receive a management fee on the assets held, creating a misalignment of interests with investors.
Zombie funds aren’t unique to impact investing—in fact, research shows that the number of zombie funds are increasing in the mainstream private equity world as well. However, our experience raises the question about whether or not the traditional private equity structure of a ten-year, closed-end fund works for the impact investing space. In other words, do impact-focused fund managers deserve more time than traditional investors? After all, we ask a lot of our impact-focused fund managers. They are: trying to deliver on social impact and financial return; working with early stage companies, many of whom are innovating; perhaps operating in countries with weak capital markets that do not present frequent liquidity events; and trying to build the nascent ecosystem for impact investing.
Is all of that even possible within a ten-year timeframe?
Comfortingly, I am not alone in my musings about the appropriateness of the traditional private equity model for impact investing—many smart people in this space are thinking about possible alternative structures. The one I am most intrigued by is the holding company, which is an open vehicle with the ability to add deals as they manifest. The holding company structure has many benefits, including on-going capital raising, flexibility with fees, investments and exits are not forced due to a fixed time horizon, and the ability to accommodate different types of investors. Holding companies are frequently criticized, however, for their inability to provide investors with a clear exit. So while promising, it’s clear that there isn’t yet one, clean-cut answer to the question of what is the best intermediary structure for impact investing.
As the impact investing space continues to grow, The Rockefeller Foundation is committed to testing different early-stage investing structures through our program-related investments and beyond—while trying to avoid any zombies that may come our way!