#02, September 2019


Financing the Economies of the Future

Around the world, financial innovation labs such as SecondMuse are working to build resilient future economies able to give back to the people and the planet. This radical and groundbreaking experiment has been yielding its fruits for the last ten years.

Raccords #02 - Financer les économies de l’avenir

Todd Khozein (Managing Partner at SecondMuse)

Throughout the entire recorded history of human civilization, we have had economic activity. Sometimes with currency, sometimes without it, sometimes expanding, sometimes not—but always evidence of some sort of management of resources within a community.

With this economic activity, and particularly in the larger, more modern-day growth-focused economies, we also see negative externalities. Whether anticipated and intentional or accidental and unintentional, economic growth has a tendency to produce negative outcomes, either to the natural environment or to some of the humans who participate in those economies. This can look like the destruction of forests, the extinction of species, plastic in our water, and a changing climate. It also can look like crushing poverty and unbalanced economic opportunity based on gender, geography, race, culture, or caste.

Is it necessary, then, for economic activity to exist at the expense of human dignity and environmental well-being?

Scaling Hurt Won’t Make It Go Away

After a couple of decades studying and working in economic modelling, complex systems, investment, and market creation, I would not only propose that negative externalities are a design flaw, but that negative externalities are an enormous vulnerability in some of our largest economies today. While we have clearly developed an understanding of the substantial environmental consequences of greenhouse gases, for instance, it was ignorance of this scientific reality that contributed to a global economy largely dependent on them. Similarly in the social sphere, it was basic ignorance of the inherent value of diversity of people, and beliefs of racial and gender-based superiority, that led to power structures that continue to oppress large swaths of humanity to this day. The challenge with these negative externalities, and one that plays into our central investment thesis at SecondMuse Capital (2MC), is that the larger these economies get, the more entrenched and intractable their externalities become and the more substantial their impacts.

According to a recent study of the US $69.1 trillion in global financial assets under management, published by my colleagues at Illumen Capital and Stanford, fewer than 1.3 per cent are managed by women and people of colour.1 The study further goes on to describe experiments which showed substantial bias in fund activities. Similarly, according to a New York Times analysis pursued in 2018, there were fewer women among CEOs of Fortune 500 companies than there were CEOs of Fortune 500 companies named “James.”2 

Beyond the Moral Dilemma

The primary reason that diversity is good is because it uncovers and challenges bias. While there is plenty of evidence that diversity leads to teams that value facts,3 generate superior innovation,4 and generate better financial corporate outcomes,5 it is the risk of homogeneity in the face of complex challenges that is potentially the scariest of them all. Bias is not an ethical judgment, it is an evolutionary and neurological reality. Just imagine the impact it has on an entire social system with the power to reshape the planet and those that inhabit it. This is not just a moral problem; this presents a fundamental vulnerability in the fabric of our economy. 

There is often a false dichotomy that occurs within more traditional frameworks of economic thought, namely that of profit versus good. In the era of the global economies in which we live, we simply cannot afford to design and finance future economies based on the assumptions of neoclassical economics that have long outlived any value they once possessed. We need to populate economies with diversity and we need to embed that which we value in their hearts, otherwise we are designing for a past whose problems are rapidly catching up to us. It is not just about building “gooder” economies, it is about building better economies. 

It is incredibly difficult to change a multi-trillion-dollar industry. Think of a trillion-dollar industry today, imagine who populates the leadership of that industry, and imagine what it would take to make that industry more representative, more inclusive, more aware of the negative externalities it is producing. Many of you won’t hold your breath. But if you want to influence a human, do you influence them when they are old or when they are young? If you want to influence the growth of a tree, do you do it when it’s a mature oak or when it’s a sapling? If you want to influence an economic system, it is substantially easier to do it when it is young than when it is established. 

This is precisely why at SecondMuse we have spent the last decade developing the entrepreneurial ecosystems of today. When supporting an entrepreneurial ecosystem, we are able to influence its culture and composition. As it grows, this curated culture and composition will form the fabric of a future economy, surely with its own blind spots, but hopefully not the same ones that are present today. The problem early-stage entrepreneurial ecosystems present for investment and finance, however, is precisely that they are not yet ready for investment. Venture capital, for instance, tends to wait for the most part until a venture is ready to intelligently use that capital for rapid growth. Unfortunately, by that time the ecosystem is largely formed, and influencing the culture becomes more difficult.

At 2MC we are actively investing in early-stage entrepreneurial ecosystems using models of blended capital that allow different types of investors with different return needs to co-invest over a large period of time. By stacking these various capital allocations, we are finding ways to get capital in earlier, where we can build lasting and thriving economies, in large part by ensuring that the humans and planet touched by this economy will not be hurt.

Sharing the Risks While Keeping the Return

Six years ago we partnered with the Economic Development Corporation (EDC) of New York City to build and support an advanced manufacturing economy—think 3-D and robotic printing as well as the software, the design, and the support institutions surrounding it. There really wasn’t that much activity in the space early on, as testified by our inability to find many more than five or six enterprises that we felt were mature enough to be accelerated. The EDC, with a mandate to create new markets, provided funding to build this ecosystem. Last year our cohort had 85 entrepreneurs, with over half of them identifying as women or people of colour, compared to national averages in the very low single digits. Get in early, and you can influence the culture and the composition of an economy.

In Fort Myers, Florida, 2MC is General Partner in SW Florida Impact Partners LLP, a community impact fund focused on reducing inequalities in southwest Florida by raising the profile and capacity of female, minority, and traditionally marginalized entrepreneurs. Total fund capitalization will stand at $30.0M on closing and deploy capital to real estate for anchor institutions—schools, groceries, banks, and health-care facilities—and small businesses. 

2MC, through its partnership in the SWFL Impact Partners fund and the SecondMuse incubator in Fort Myers, stands as an example of a new model for community redevelopment, one that engages and builds upon the knowledge and experience of local stakeholders, identifying immediate needs and opportunities as well as more complex challenges. The Fort Myers Community Redevelopment Agency and Southwest Florida Community Foundation are partners in this effort.

In Southeast Asia, via The Incubator Network by Circulate Capital and SecondMuse, we are actively developing an entire regional entrepreneurial ecosystem focused on the elimination of ocean plastics in some of the highest-leakage countries in the world. But women also face substantial abuse in the waste supply chain; thus instead of just addressing a tragic environmental problem we are simultaneously positioning women entrepreneurs to be the beating heart of a new economy. This has allowed us to introduce multilateral funding, government grants, and non-profit donations alongside a US $100M investment fund backed by multinational corporations eager to find a solution to the 8 million metric tons of plastic entering the ocean each year. 

In all three of these examples the investment would not be able to enter early enough without the participation of foundations and governments, and without the backing of capital, the non-dilutive equity would not have been able to influence the formation of a new economic system. A foundation, an investor, a multinational corporation, and a city’s economic development institution can align their capital such that by co-investing they not only can all get what they want, but they can de-risk the investment of their uncommon partners.

In a largely capitalistic world, capital tends to have a voice that is larger than the value it brings to the table. We need to continue to find creative ways to align investment capital with other forms of capital to allow it to enter earlier. We simultaneously need to be very clear about what we consider a viable economy, namely one that is resilient and inclusive.

  1. «Race influences professional investors’ financial judgments», Sarah Lyons-Padilla, Hazel Rose Markus, Ashby Monk, Sid Radhakrishna, Radhika Shah, Norris A. “Daryn” Dodson IV, et Jennifer L. Eberhardt, Proceedings of the National Academy of Sciences, 12 août 2019.
  2. «The Top Jobs Where Women Are Outnumbered by Men Named John», Claire Cain Miller, Kevin Quealy et Margot Sanger-Katz, The New York Times, 24 avril 2018.
  3. «Ethnic diversity deflates price bubbles», Sheen S. Levine, Evan P. Apfelbaum, Mark Bernard, Valerie L. Bartelt, Edward J. Zajac, et David Stark, Proceedings of the National Academy of Sciences, 17 novembre 2014.
  4. «Gender diversity within R&D Teams: Its impact on radicalness of Innovation», Cristina Diaz-Garcia, Angela Gonzales-Moreno, Francisco José Saez-Martinez, Innovation, 17 décembre 2014.
  5. «Why diversity matters», Vivian Hunt, Dennis Layton et Sara Prince, janvier 2015.

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