Verge Capital

VERGE CAPITAL: INVESTING FOR SOCIAL IMPACT 

Sandy Chen, Sarangen Sathasivam, and Andrew Newton wrote this case under the supervision of Diane-Laure Arjaliès solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized, or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Our goal is to publish materials of the highest quality; submit any errata to publishcases@ivey.ca. Copyright © 2020, Ivey Business School Foundation Version: 2020-07-14 

It was September 2019, and it had been a particularly long day for the committee from Verge Capital, an impact investing firm based in London, Ontario, whose mission was to help social entrepreneurs from the community. The committee had just reviewed proposals from two social enterprises, Sri Lankan Foods and Material Impact, that were seeking financing to grow. Andre Vashist, Verge Capital’s social finance manager, had to decide which social enterprise should be offered a loan of CA$30,000.1 Traditional banks had generally been unwilling to provide financing to social enterprises, which were usually deemed high- risk ventures. Although both businesses had their strengths, determining whether their respective owners had the expertise needed to sustain the businesses in the long term was challenging. Vashist sat back in his chair and closed his eyes. He knew that deciding which organization Verge Capital should lend money to was significant. He sat up to review his notes on both business plans.

SOCIAL ENTERPRISES AND IMPACT INVESTING
Social enterprises and impact investing had emerged as innovative ways to tackle societal problems while simultaneously providing a financial return for investors. Social enterprises were businesses that leveraged business strategies and practices to achieve measurable impacts on their triple bottom lines: financial, social, and environmental. They could be either non- or for-profit enterprises, and they balanced social impacts with financial sustainability (see Exhibit 1). While some investments in social enterprises still came in the form of grants and donations, impact investing—where investors sought financial returns as well as social returns inherent in the activities of the financed organization—was becoming a significant source of capital. The ultimate goal of impact investing was to make a meaningful difference in some of the world’s daunting social and environmental problems while generating financial returns (see Exhibit 2). Impact investing had been growing rapidly in Canada, increasing 81 per cent between 2016 and 2018, to over $14.75 billion. The challenge for most impact investors was determining how the impact of these investments should be quantified. There were various investment models within the broader category of impact investing—from global to more localized models. For example, a global impact investing model included business support to enterprises that supported and uplifted people at the bottom of the wealth pyramid around the world. Alternatively, a localized, “place-based” impact investing pool provided a means for allocating local investment, which in turn generated positive effects in the community that was home to both investors and the enterprise in which they invested.

EXHIBIT 2: IMPACT INVESTING ECOSYSTEM AND MARKET SEGMENTS
Supply: Investment providers, with terms 
Products: Channels for matching capital with investment opportunities
Intermediaries: Means of matching supply with demand 
Demand: Investment seekers, with unique purposes
Impact Measurements: What impact is created?
Government Engagement: How can government enable the marketplace?
Leadership: Who is providing leadership to the nascent field?

LONDON, ONTARIO, CANADA
London, a city in southwestern Ontario with a population of 404,699,6 was halfway between Detroit, Michigan, and Toronto, Ontario. It was known as a regional epicentre for medical research, education, insurance, manufacturing, and information technology and was home to 3M Canada, Goodlife Fitness Centres Inc., Western University, Fanshawe College, London Life Insurance Company, Libro Credit Union Limited, and Labatt Brewing Company Limited. In 2016, London’s unemployment rate was 7.9 per cent, and 9.7 per cent of workers were self-employed.7 The top three occupation categories for Londoners were sales and service (25.6 per cent); business, finance, and administration (14.7 per cent); and education, law, social, community, and government services (13.5 per cent). The city had more than 1,800 non-profit organizations and charities, and 45.3 per cent of its citizens volunteered, contributing more than $600 million in value every year. Because of the renowned universities and colleges in the city, London was a transient city—a college town that was bustling during the school year but quiet during the summer and winter holidays. Canada’s education system was ranked as one of the best in the world, and education was critically important to London’s character. Canada was home to many migrant students, and children of new Canadians integrated quickly into the Canadian school system and performed at the same high level as their classmates. In 2016, one in five people in the London region was foreign born, with the largest numbers coming from Europe, Asia, the Middle East, and Africa. As a result, London had a diverse population, with 16 per cent of its inhabitants self-identifying as members of visible minorities and almost half of these people identifying as South Asian, Chinese, Black, or Arab.

VERGE CAPITAL
Based in London, Ontario, Canada, Verge Capital was a place-based impact investing organization created in 2015 to connect aspiring local entrepreneurs with funding to support initiatives with social or environmental missions that benefited local communities. Verge Capital operated a social enterprise loan fund that provided social enterprises with loans up to $100,000. The organization provided access to potential investors and expert business advice to early-stage businesses, specifically those with high growth potential. Its interest rates were lower than those offered by traditional banks, which typically did not lend to these types of businesses because they were considered high risk. Although Verge Capital considered all applicants, its review panel determined which applicants were eligible to be shortlisted for funding according to Verge Capital’s lending process (see Exhibit 3). Verge Capital leveraged the support and input of local stakeholders to address two core issues for the community: (1) improving access to capital and (2) building momentum to support the increasing cultural preference for social impact investments (see Exhibit 4). Addressing these two core issues ensured that the Verge Capital portfolio contributed to achieving the United Nations (UN) Sustainable Development Goals— the 17 goals adopted by all UN member states in 2015—which offered common strategies and goals for countries to build peaceful and prosperous futures for both their people and the planet (see Exhibit 5).11 Access to capital was critical to enabling social entrepreneurs to turn their business ideas into reality. It was also essential to continue to build momentum to allow more investors to see the value of impact investing in the communities in which they lived. By leveraging these changes, Verge Capital would be able to make a lasting difference in the community through social impact investing. On the investors’ end, Verge Capital worked to enable investors to easily locate, review, and invest in initiatives that provided both financial and social returns. By acting as an intermediary between investors and social entrepreneurs, Verge Capital was building a social finance ecosystem that fostered the growth of local ventures seeking to create social and environmental change. At the same time, Verge Capital engaged with business professionals who could serve as volunteer mentors and coaches, providing them with opportunities to tackle some of the community’s toughest social and environmental challenges. This increased community awareness about the value of impact investing. Verge Capital had already distributed capital to various social enterprises within the London community. The firm worked with entrepreneurs to provide flexible repayment terms and interest rates. It had provided For the Love of Laundry with a three-year $10,000 loan at 4.7 per cent interest, which required interest- only payments over the first year, providing cash flow to support the establishment of the business during that period. For the Love of Laundry used the proceeds from its sales of environmentally friendly laundry products to support laundry services for low-income individuals. Verge Capital had also provided Old East Village Grocer with a five-year loan of $100,000 at 4.7 per cent. Old East Village Grocer was a not-for- profit grocery store that employed adults with disabilities while offering economically accessible fresh products to impoverished populations. Finally, it had provided Cyber Smart Canada, which taught students about digital safety and technology, with a two-year loan of $12,500 at 4.7 per cent. Verge Capital was not currently generating enough returns from its investments to sustain and grow its operations. The program hoped to refine its mechanisms to make the vetting process for investors easier and provide more substantial financial and social returns. Another goal was to have a team of business consultants who could provide social enterprises with expertise and help them more quickly become ready to work with investors.

EXHIBIT 3: VERGE CAPITAL’S LENDING PROCESS
Step 1: Inquire. Enterprise submits an expression of interest to Verge Capital.
Step 2: Meet. Enterprise personnel meet with Verge Capital staff to explore fit and expectations.
Step 3: Apply. Selected enterprises apply, with Verge Capital coaching. 
Step 4: Pitch. Selected enterprises are invited to pitch to the review panel. 
Step 5: Finance. Approved enterprises receive capital and ongoing support.
Step 6: Report. Enterprises report on social and financial results.

EXHIBIT 4: PARTNERS AND COMMUNITY STAKEHOLDERS ENGAGED WITH VERGE CAPITAL
- Lina Bowden, lead volunteer consultant
- Andre Vashist, social finance manager
- Lead/Governing Group  Pillar Nonprofit Network (program manager and backbone organization)  London Community Foundation  United Way Elgin Middlesex  Sisters of St. Joseph  Libro Credit Union
- Supporters and Engaged Community Organizations and Individuals:  London Small Business Centre  Ivey Business School  Emerging Leaders  Business Help Centre/Community Futures Development Corporation of Middlesex County  City of London  Westminster College Foundation  Good Foundation Inc.  Westany Holdings  Pathways Skills Development  Johnny Fansher Financial  Jens Stickling  Goodwill Industries  The Old East Village Business Improvement Area  Habitat for Humanity  Devonshire Financial (London) Inc.
- Funders:  Pillar Nonprofit Network (in kind)  United Way Elgin Middlesex  Sisters of St. Joseph  London Community Foundation  Libro Credit Union (in-kind administration and 25 per cent investment in each approved loan)  Ursuline Sisters of Chatham  Government of Ontario, Ministry of Economic Development, Employment and Infrastructure  Lina Bowden and Lynn Davis (Material Impact investors)

EXHIBIT 5: THE 17 UNITED NATIONS SUSTAINABLE DEVELOPMENT GOALS
 No Poverty  Zero Hunger  Good Health and Well-Being  Quality Education  Gender Equality  Clean Water and Sanitation  Affordable and Clean Energy  Decent Work and Economic Growth  Industry, Innovation, and Infrastructure  Reduced Inequalities  Sustainable Cities and Communities  Responsible Consumption and Production  Climate Action  Life below Water  Life on Land  Peace, Justice, and Strong Institutions  Partners for the Goal

IMPACT ASSESSMENT METRICS
The biggest challenge for impact investors was measuring and comparing the positive social and environmental effects or impacts of the investments. There were no universally accepted metrics because of variations between sectors and regions. Many social enterprises used their own success metrics to measure impact, which not only made it challenging to compare ventures but also created ambiguity regarding the credibility of the metrics. Furthermore, metrics continuously needed to be adapted based on the stage of each individual investment. Lastly, measuring impact was a costly process that required extensive data collection and analysis. Many social entrepreneurs simply did not have the resources to invest in such activities. Although no industry standards existed, the Impact Reporting and Investment Standards (IRIS) rating system, implemented by rating agencies such as the Global Impact Investing Rating System, was commonly used (see Exhibit 6). IRIS metrics were typically incorporated into other measurements, including social return on investment (SROI). One weakness of these metrics was that they accounted only for outputs, while investors were more interested in monetization.

EXHIBIT 6: GLOBAL IMPACT INVESTING RATING SYSTEM RATINGS INPUTS
The Global Impact Investing Rating System is an agency that reviews the following topics when rating a company’s impact, assigning weightings for each topic as noted below. The total points are added up to a maximum of 200 points.
 Governance (7.5%)  Workers (25.0%)  Community (27.5%)  Environment (10.0%)  Socially and Environmentally Focused Business Models (30.0%)

Impact Reporting Investment Standards
IRIS, created by the Global Impact Investing Network, was widely accepted to provide accurate and reliable impact investing assessments that avoided “impact washing.” Verge Capital currently used IRIS.

Social Return on Investment
SROI attributed a financial value to environmental, social, and governance factors that might not typically be considered or reflected under traditional financial statements and valuations. SROI considerations could lead to improved corporate stewardship, planning, and project decisions. Although SROI assigned monetary value to social impact, at its core, its main driver was not financial gain but the positive output from business operations. SROI calculations could include outcomes such as improved labour skills for employees; new jobs in economically ignored communities; environmental restoration, which might improve insurance companies’ bottom lines; carbon footprint offset initiatives; and wildlife protection and rehabilitation.

Verge Capital Investment Decision Matrix
When considering the viability and scalability of a business venture, Verge Capital’s review panel used an investment decision matrix that included the following sections: character, capacity or risk analysis, market conditions, and financial and social impact (see Exhibit 7). Each member of the panel provided a score for each category, and the combined scores were used to assess whether the loan was approved. Assessments of character examined the background profile of the management to ensure that the entrepreneur had the skills or support from advisers to be able to execute the business plan successfully. Assessments of capacity examined whether the operational and legal considerations were realistic. The review panel also completed a risk analysis to determine whether the entrepreneur had conducted an adequate risk analysis of their own and whether there were contingency plans in place. The panel also reviewed the market conditions to see if the business plan was achievable. It considered competitors and barriers that might prevent the business from being successful. The panel expected that the plan would identify ways to mitigate these threats or convert them into opportunities. The financial review examined whether the capital was adequate for the business. It also studied default risk and reviewed historical capital usage to see whether Verge Capital should provide further financing. Finally, the panel reviewed the social and environmental impact to see if this was incorporated into the plan in a meaningful way that would address gaps or needs within the community.

EXHIBIT 7: INVESTMENT DECISION MATRIX USED BY VERGE CAPITAL
1. Character (Management Profile) /13
2. Capacity (Business Plan Summary) /20
3. Conditions (Risk Analysis/Market Overview) /14
4. Capital (Financial Overview) /13
5. Impact (Social/Environmental) /35
6. The Ask /5
Total Score: /100
(Minimum (50%) = 50/100 Average (70%) = 70/100 Above Average (80%) = 80/100)

POTENTIAL INVESTMENTS
1. Sri Lankan Foods
Sri Lankan Foods operated three related businesses: a Sri Lankan restaurant, a catering business, and a granola production facility. There were currently no other Sri Lankan restaurants in the city of London offering food selections like those offered by Sri Lankan Foods. Dhriti Tamang, the business owner, was a hands-on operator who worked hard to ensure her business stayed true to its intention to sell authentic Sri Lankan food and healthy meal options. She had over 12 years’ experience working in the restaurant industry in London and had been cooking for more than 23 years, creating Western and Sri Lankan cuisine as well as dishes from many other cultures. Tamang had been operating the first location of Sri Lankan Foods since November 2008 and was interested in adding a social impact element to the business. She wanted to provide opportunities for newcomers who had been in Canada for less than five years and were not proficient in English. She would offer these people employment for periods of six to 12 months. The business would pay these employees minimum wage during this time. While Tamang had connections with members of the Sri Lankan community who could work at her establishment, she had neither experience in executing a social impact strategy nor experience in running a large business. Currently, she had one permanent employee, who assisted with administration. The restaurant, in a busy marketplace in the heart of downtown London, was open to customers only on Saturdays. During the week, the space was used for granola production. The total available space was relatively small (about 14 square metres) and did not provide adequate space for serving customers. The funds would be used to retrofit a new location in London that would function as a restaurant and a distribution outlet for the granola. The newly opened site would have more room to serve customers (about 63 square metres). The business had requested $30,000 from Verge Capital; the owner would provide an additional $20,000 for a total capital investment of $50,000 (see Exhibit 8). 

EXHIBIT 8: SRI LANKAN FOODS
Envisioned Use of Funds (CA$):
a. Kitchen Equipment 39,300
b. Customer Seating Furniture 2,500
c. Electrical and Plumbing Work 6,000
d. Miscellaneous Work 2,200
Total: 50,000

Sri Lankan Foods Income Statement (CA$):
Here are revenue from 2017, 2018, 2019, 2020 (projected), 2021 (projected)

Catering 13,096; 20,738; 26,192; 26,192; 26,192.

Food Sales (Market) 97,927; 82,713; 71,856; 71,856; 71,856.

Food Sales (New Location) ... 101,190; 273,600; 328,500; 328,500.

Total Restaurant Sales 111,023; 204,641; 371,648; 426,548; 426,548.

Granola (Wholesale) 25,730; 25,730; 38,595; 51,460; 64,325.

Granola (Retail) 25,730; 44,095; 57,200; 57,200; 57,200.

Total Granola Sales 51,460; 69,824; 95,795; 108,660; 121,525.

Total Revenue 162,483; 274,466; 467,443; 535,208; 548,073.

Restaurant COGS 48,274; 89,402; 163,785; 188,459; 188,459.

Granola Costs 50,326; 51,705; 69,361; 79,240; 89,119.

Administrative Expenses 60,936; 155,031; 221,789; 221,789; 215,687.

Total Expenses 159,537; 296,138; 454,935; 489,488; 493,265.

Net Income/(Loss) 2,946; (loss 21,673); 12,508; 45,720; 54,807.

2. Material Impact
In 2011, Paulina Moran started to collect used textbooks from her classmates at Western University’s Ivey Business School in London and to resell the books to raise funds for the Canadian Cancer Society. Shortly after, when Moran was teaching in Chile and Guyana, she realized the students did not have access to the educational resources that were essential for academic success. She applied her previous program of selling used textbooks to raise funds to address the social need for improving South American students’ access to academic resources; thus, Material Impact was born. Material Impact collected used textbooks and case study books from students on campuses and from Goodwill and Red Cross donation centres. It then sold 30 per cent of the books through Amazon.com Inc. (Amazon) and donated 60 per cent of the books to South American universities and the remaining 10 per cent to other non-profits. The books were sorted based on their condition and market value. The textbooks sent to South American universities had to have been published within the past 10 years and be in good condition. The books that did not meet the criteria for either online sales or donations to South America were sent for recycling. The organization leveraged a partnership with the southwestern Ontario organization Recycle with Purpose to pick up textbooks in the Greater Toronto Area. To move beyond southern Ontario, Material Impact would need to find a national partner that could help grow the organization’s reach. Material Impact shipped books out of Burlington, Ontario, completing 80–85 per cent of its sales through Amazon by using the Fulfillment by Amazon service. This reduced the need to invest in warehousing and inventory storage facilities. Its books were listed online at a minimum value of $7.50. The organization was able to provide competitive pricing to consumers by utilizing software that checked comparable listings every 25 minutes. It was considering expanding into renting textbooks to students and using third-party logistics companies to handle international sales. Material Impact had no existing direct competitor in the Canadian marketplace with a similar social impact. Its closest competitor was the US-based company Reading with Purpose. Like Material Impact, this organization collected textbooks and novels that had been donated to non-profit organizations, and any books that the organization did not sell were donated to Books for Africa. A percentage of Reading with Purpose’s profits was donated to literacy causes. In its first year of operations, Material Impact, which was located on 12 campuses across Ontario and worked with three different Goodwill and Red Cross partners, had collected 55,000 textbooks and generated revenues of $260,000. The business had donated 40,000 textbooks to two South American universities and $30,000 to student-led impact initiatives, invested $39,000 in microfinance loans, and reused and recycled 50,000 textbooks. The organization directed 60 per cent of the revenue from textbook sales toward textbook or monetary donations to a student-led charity. The organization was seeking $50,000 in debt financing from Verge Capital as well as additional funding from other sources to help finance their ambitious goals of making a positive impact. These funds would go toward recruiting staff for the core leadership team, developing logistic systems for use across the province, managing two warehouse operations, and recruiting essential warehouse employees. The team had achieved impressive growth in its first years of operations. However, the Verge Capital review panel was concerned about its sustainability and the feasibility of its aggressive future growth targets and annual objectives (see Exhibits 9 and 10).

EXHIBIT 9: MATERIAL IMPACT—FINANCIAL AND OPERATIONAL GOALS
- 2020 Goals :  Sales target: $1.2 million.  Number of textbooks collected: 250,000.  Textbook donations: 120,000.  Expand to every major school in Ontario; have a total of 200 drop boxes.  Review renting/selling textbooks through multiple platforms in the US market.  Review selling e-textbooks on website.  Donate tablets to students in South America.  Create a sharing platform to enable students to share notes with students in developing countries.
- 2021 Goals:  Sales target: $3.6 million.  Number of textbooks collected: 750,000.  Textbook donations: 360,000.  Expand into the United States; set up two to three regional US hubs.  Monetize content-sharing platform.  Target 20,000–30,000 digital notes from North American students.
- 2022 Goals  Sales target: $11.6 million.  Number of textbooks collected: 2,225,000.  Textbook donations: 1,080,000.  Become the leading social impact provider of affordable physical and digital educational material for students around the world.  Develop a top-quality international team while developing Canada’s social impact and start-up environment.  Achieve sustainability of the content-sharing platform.  Target 100,000 digital notes from North American students.
Note: All dollar amounts are in Canadian dollars.

EXHIBIT 10: MATERIAL IMPACT—FINANCIAL AND OPERATIONAL SUPPORTING DOCUMENTS (CA$)
1. Five-Year Projected Balance Sheet (data 2020, 2021, 2022, 2023, 2024)

Assets (2020, 2021, 2022, 2023, 2024):

Cash and Equivalents 105,466; 388,592; 1,165,777; 2,331,554; 4,663,107.

Accounts Receivable 2,500; 7,500; 15,000; 30,000; 60,000.

Furniture and Equipment 5,000; 15,000; 30,000; 60,000; 120,000.

Vehicles 35,000; 75,000; 150,000; 300,000; 600,000.

Total Assets 147,966; 486,092; 1,360,777; 2,721,554; 5,443,107.

Liabilities (2020, 2021, 2022, 2023, 2024):

Accounts Payable 2,000; 6,000; 12,000; 24,000; 48,000.

Loans Outstanding 196,250; 182,500; 168,750; 155,000; 105,000.

Equity (2020, 2021, 2022, 2023, 2024):

Owners' Equity 50,284; 297,592; 1,180,027; 2,542,554; 5,290,107.

Total Liabilities and Equity (2020, 2021, 2022, 2023, 2024): 147,966; 486,092; 1,360,777; 2,721,554; 5,443,107.

2. Five-Year Projected Income Statement (data 2020, 2021, 2022, 2023, 2024)

Textbook Revenue 1,203,258; 3,891,554; 7,783,108; 15,566,217; 31,132,433.

Marketplace and Shipping Fees 452,591; 1,453,947; 2,907,895; 5,815,789; 11,631,579.

Gross Profit 750,667; 2,437,607; 4,875,214; 9,750,427; 19,500,855.

Collection Partner Payments 77,280; 151,020; 302,039; 604,079; 1,208,158.

Advertising and Promotion 52,850; 132,300; 396,900; 1,190,700; 3,572,100.

Salaries and Wages 510,413; 1,346,971; 2,424,548; 4,364,187; 7,855,536.

Vehicle Operating Costs 29,200; 53,400; 80,100; 120,150; 180,225.

Rent 63,360; 117,100; 210,780; 379,404; 682,927.

Freight 25,600; 129,600; 259,200; 518,400; 1,036,800.

Office and Warehouse Supplies 18,000; 31,600; 56,880; 102,384; 184,291.

Administrative and Professional Fees 12,000; 37,350; 93,375; 233,438; 583,594.

Miscellaneous 18,000; 37,600; 75,200; 150,400; 300,800.

Total Operating Expenses 806,703; 2,036,941; 3,899,022; 7,663,141; 15,604,431.

Net Ordinary Income 56,036; 400,666; 976,191; 2,087,287; 3,896,424.

Other Income 17,349; 0; 0; 0; 0.

EBIT 38,687; 400,666; 976,191; 2,087,287; 3,896,424.

Interest Expense 9,208; 13,463; 13,238; 13,013; 11,100.

Tax Expense 0; 58,080; 144,443; 311,141; 582,799.

Net Income 47,895; 329,123; 818,510; 1,763,133; 3,302,526.

3. Loan Interest Schedule (data 2020, 2021, 2022, 2023, 2024)

London Lenders (15,000): 788; 563; 338; 113; 0.

Lisa & Quinn (40,000): 2,400; 2,400; 2,400; 2,400; 600.

Lisa & Quinn (50,000): 1,875; 3,000; 3,000; 3,000; 3,000.

LSY Investment Fund (50,000): 2,700; 5,000; 5,000; 5,000; 5,000.

Verge Capital (50,000): 1,445; 2,500; 2,500; 2,500; 2,500.

Total Interest Expense: 9,208; 13,463; 13,238; 13,013; 11,100.