Why good investors should invest in bad companies

Social/impact investors are always looking for what we call the triple bottom line: financially viable, socially responsible, and environmentally conscious companies. The idea is that these companies are good long-term investments because they’re sustainable and they allow one’s money to do good for humanity and the environment.

But is there a role for bad companies in the socially conscious investor?

I found myself doing some soul-searching about the idea after some African loans in our portfolio had gone bad in 2014. As loan portfolio manager in charge of Uganda, the Democratic Republican of Congo, and northwestern Tanzania for Root Capital, a US-based nonprofit social lender, I had encountered challenges working with social entrepreneurs whose heart was in the right place but who were not necessarily astute business people. They focused on the operations, volumes, and farmer suppliers with the blind hope that the numbers would automatically add up at the end of the season, which in agriculture is not a safe assumption. When coffee prices plunged in 2014/15, their financial results were disastrous.

I realized that it is more difficult to teach a social entrepreneur to become a good businessperson than it is to teach a good businessperson to see the business case for embracing social and environmental concerns. If I could reach well-run, established, and profitable companies and show them what Root Capital could offer them in terms of financing and advisory services to strengthen their business, I could convince them to modify their business model to engage with social and environmental concerns.

Soon enough, I encountered Shiramsetti Shravan, the CEO of a cocoa-exporting company in Uganda. An astute businessman, he was taken aback when I took him through our lending model. His business couldn’t plausibly demonstrate a social impact on the small farmers who grew his cocoa, because he used middle men. At best, these aggregators had no social impact on the farmers; at worst, they were exploiting them with very high-interest loans, tampered weighing scales, and other tactics to drive purchase prices down. They were prioritizing short-term gains over future considerations. 

On the environmental front, Mr. Shravan had no awareness of environmental considerations, let alone any activities that directly related to environmental conservation. At least, the company’s activities didn’t affect the environment negatively, so this issue did not disqualify it.

When I explained that an agribusiness’s sustainability is based on the consistency of quality and supply and that farmers needed positive interactions with the enterprise to ensure that consistency, Shravan immediately bought the argument. We agreed that the easiest way to qualify for Root Capital’s loans would be to change their sourcing model to a local cooperative. With time, the business would also consider supporting some environmental conservation initiatives with the same co-op.

Root Capital approved a $600,000 loan in September 2014, which Uganda Cocoa and Commodities Ltd. fully paid back in June 2015, two months ahead of schedule. It applied for another working capital loan of $1.2 million in July 2015, which it also fully paid by June 2016. It now has a third working capital loan of $2.8 million that it is on schedule to fully pay back by this June.

I set about searching for a philosophy in support of my idea and found these references in the English Standard Version of the Bible:

“And when Jesus heard it, he said to them, ‘Those who are well have no need of a physician, but those who are sick. I came not to call the righteous, but sinners.” (Mark 2:17)

“I tell you, there will be more joy in heaven over one sinner who repents than over ninety-nine righteous persons who need no repentance.” (Luke 15:7)

Jesus went on to tell the parable of the lost sheep (Matt. 18: 12-13): “If a man has a hundred sheep, and one of them has gone astray, does he not leave the ninety-nine on the mountains and go in search of the one that went astray? And if he finds it, truly, I say to you, he rejoices over it more than over the ninety-nine that never went astray.”

I am inspired by these parables not only to lend to those businesses that are already doing good, but to reach out to those that are not, in hopes of changing how they think of social and environmental impact. Had I assessed this cocoa-exporter as unworthy to qualify for our financing, we would have left them to continue doing “bad.” In fact, the rapid growth of the business would have meant a growing negative impact.

If impact investors adopted this approach more broadly, they would:

• Improve the social and environmental practices of a large swath of mainstream businesses;
• Diversify their portfolio;
• Boost their portfolio quality with companies that are already economically viable;
• Differentiate themselves from traditional investors and position impact investors as innovators and thought leaders.

It is a blessing to work with clients that are already involved in strong environmental, social and governance practices. But in my view, to work with those that are not and to help them improve is an even greater thing. It represents perhaps the greatest opportunity for impact investors to exponentially expand the benefit of their work for society.

– Mr. Tugume is a Uganda-based loan portfolio manager for Root Capital, a US-based social lender.