Industry-Focused.
Mission-Focused.
Community-Focused.

Relative Weight of Triple Bottom Line Components.
Level of Investment Involvement.
Level of Company Involvement.
Investment Strategy/Stage of Company/Time Horizon.
Size of Company/Company’s Markets.
Size of Investment Per Portfolio Company.
Industry Focus.
Geographic Focus.

Private equity is any privately negotiated investment in the equity of an enterprise. Typically, it is a common or preferred equity interest in a privately-held company. It can also include privately negotiated investments in public companies.

From an asset allocation perspective, private equity investments are considered a subset of the alternative investment asset class, which is broadly defined to include all investments other than traditional public equity and fixed income securities. Private equity may be further classified by strategy or investment type, such as venture capital or leveraged buyouts (see Investment Strategy/Stage of Company/Time Horizon under Useful Classifications below).

Private equity investors expect returns above public equity returns to compensate for additional risks, principally liquidity risk and in some cases increased risks due to financial leverage, unproven technology, and/or unseasoned business models. Traditional private equity investors have historically targeted internal rates of return (the most commonly used performance measure for private equity) of at least 20 percent, compared to long-term average annual public equity returns of about ten percent. The historical advantages of private equity include higher returns that are not fully correlated with returns on public equities or other asset classes, reducing the overall volatility of an investment portfolio.

Investors may invest directly in operating companies or in professionally managed funds, typically structured as limited partnerships that invest in diversified portfolios of companies. When investing through private equity funds, net returns to investors reflect fund expenses and manager’s compensation, which usually includes an annual management fee (typically between one and two percent of committed capital or net assets) and a percentage of the portfolio’s capital gains (“carried interest,” typically 20 percent).

Sustainable private equity targets companies that advance environmental sustainability – that is, meeting today’s needs without compromising the ability of future generations to meet their own needs. Sustainable companies may offer products and services that are greener or more environmentally benign than existing alternatives (such as renewable energy, organic agriculture, green building materials), or that solve environmental problems (recycling and resource recovery technologies, brownfield remediation, pollution control), or that help conventional businesses and governments operate in a more environmentally friendly way (energy efficiency, waste reduction, healthier facilities).

Sustainable investing is attracting increased attention from the investment and academic communities. Global business school INSEAD and the United Nations Environment Programme (UNEP) co-sponsored an expert workshop on sustainable venture finance in June 2002 that attracted over 70 investment professionals, the majority from Europe (presentations and background papers are online at www.unepfi.net). Investors' Circle (www.investorscircle.net) is a non-profit U.S. network of forward-thinking angel and institutional investors, foundation officers and entrepreneurs who seek to balance financial, social and environmental returns. The sustainable investment marketplace has benefited from the growth and increased acceptance of socially responsible investing in general. It is important to emphasize, however, that neither sustainability nor social responsibility require accepting lower financial returns. Investments in technologies designed to solve environmental problems can be expected to have a risk/return profile similar to that of traditional venture capital investments. Designing business models and investment opportunities to maximize environmental and social returns may also have synergistic effects on the financial bottom line -- e.g., competitive advantages in attracting customers, improved employee recruitment, retention and productivity, and reduction in other operating costs, such as energy, waste disposal, and regulatory compliance.

Industry specialization gives investment firms competitive advantages over generalist firms in technical expertise and deeper networks of industry managers, experts and personnel. Industry-focused sustainable private equity firms specialize in industries such as renewable energy, sustainable/organic agriculture, recycling and resource recovery technologies, and pollution control and remediation.

Most of these funds target competitive financial returns, and on that basis appeal to financial investors. Because of their industry specialization, these funds may also appeal to strategic investors with other business interests in those industries.

A good example of this strategy is Sustainable Asset Management’s (SAM) private equity group (www.sam-group.com), which focuses on emerging energy (distributed and micro-scale power generation (including heating and cooling), renewable energy, electricity storage and uninterruptible power supply, power quality electronics, and demand side energy management), resource productivity (water related technologies, biocompatible materials, and high value materials recovery technologies), and healthy nutrition (natural foods, food quality analysis, biopesticides, and alternative medicine). SAM targets traditional private equity returns, investing in portfolio companies with the potential for returning three to ten times the capital invested within a three- to five-year time frame.

Some traditional private equity funds specializing in certain industries, such as energy and industrial technology, will also invest in sustainable portfolio companies. For these funds, however, the financial return is paramount and environmental returns are not a factor in the investment process.

Mission-related investing rejects the premise that endowments, foundations and other mission-based organizations must manage their investment assets based on detached, purely financial criteria. This strategy seeks competitive financial returns through investments in companies that further the organization’s mission.

Steven Viederman and Woody Tasch, champions of mission-related investing formerly with the Jesse Smith Noyes Foundation (www.noyes.org), have argued that fiduciaries may and should manage their assets in accordance with the organization’s mission, including making competitive venture capital investments in companies whose activities further that mission. Thus, the Noyes Foundation has made venture capital investments in companies pursuing commercial solutions to the same problems the foundation addresses through its grantmaking – e.g., a manufacturer of innovative leak detection systems for underground storage tanks (addressing the foundation’s concerns about toxins in underground water supplies) and a yogurt company that sources its ingredients from organic and sustainably managed family farms (addressing the foundation’s interest in environmentally and economically sound agriculture).

Some funds apply a triple bottom line approach – a combination of financial, social and environmental returns.

Community development venture capital (CDVC) places most emphasis on social returns, typically job creation and economic development in low-income and distressed communities. Some CDVC funds also consider environmental returns, sometimes by funding environmentally-oriented businesses but more often by seeking to reduce negative environmental impacts from portfolio company operations.

CDVC funds can be non-profit or for-profit, with for-profit funds typically targeting net internal rates of return to investors of ten to fifteen percent. Their investment activities are usually locally or regionally focused. Particularly in geographic areas underserved by traditional private equity investors, competitive private market returns are possible.

Significant funding for CDVC in the U.S. comes from banking institutions as a result of the federal Community Reinvestment Act (CRA). More recently the federal New Markets Venture Capital Program and New Markets Tax Credit Program have created additional opportunities for CDVC funds. The National Community Capital Association (NCCA) (www.communitycapital.org) is a membership organization of community development financial institutions, including CDVC funds. The Community Development Venture Capital Alliance (CDVCA) (www.cdvca.org), a trade organization of CDVC funds, reports that there are more than 60 CDVC funds operating in the U.S. and more than 20 outside the U.S., with aggregate assets under management of $400 million.

Examples of for-profit CDVC funds include CEI Ventures (CEI) and Sustainable Jobs Fund (SJF). CEI (www.ceimaine.org) is a leading community development corporation serving the state of Maine since 1979, with venture operations since 1984. SJF (www.sjfund.com) grew out of its founders’ economic development efforts supporting sustainable businesses and invests throughout the eastern U.S. Both CEI and SJF place most emphasis on social and financial returns but also seek investments with an environmental focus.

Economically targeted investment (ETI) programs of public pensions and government agencies also typically apply double and triple bottom line approaches.

The following factors are useful in classifying both traditional and sustainable private equity investment strategies.

All private equity investment strategies can be classified according to their emphasis on financial, environmental, and social returns. If traditional private equity is the maximization of financial returns without regard to social or environmental impacts, sustainable private equity strategies encompass a wide variety of weightings along these three dimensions.

Industry-focused firms emphasize financial and environmental returns, with social benefits incidental. Mission-related investing seeks financial returns through investments that further the organization’s mission, which in many cases has social and/or environmental components. Community-focused strategies emphasize social and financial returns, with environmental considerations often included within social returns.

Different forms of private equity investment offer a range of levels of involvement in investment decisions. Toward the more passive and least resource-intensive end of the spectrum is investment in private equity funds. Fund investors’ responsibilities are limited to selecting a fund and/or fund manager, negotiating terms of the fund at its inception, and monitoring the fund’s performance over its life of approximately ten years. Fund investors are not involved in investment decisions at the portfolio company level, which are the responsibility of the fund manager. Funds-of-funds, in which investors can invest in several private equity funds through a single vehicle with a single manager, take this more passive investment approach one step further.

Investing at the company level requires more resources than investing in funds – e.g., conducting due diligence on each potential company, structuring and negotiating each investment, developing the company, making valuation decisions, and ultimately exiting the investment. Here too there is a range of involvement, from less active – co-investing (investing only in transactions led by others) or investing only in follow-on rounds where another institutional investor has previously backed the company – to more active – being the first institutional investor in a company or even helping to create the company.

Investors at the portfolio company level also have different ranges of involvement in the company post-investment. On the more passive side, investors rely upon the company’s management team or on other larger or lead investors and have little involvement in the company at either the strategic or operational level. At the more active end, investors may provide substantial assistance to company management, common in venture capital and community development investing, and/or may have potential or actual control of the company.

Investment strategy and stage of portfolio company development also determine the nature and extent of investor involvement. Venture capital investors specialize in emerging companies that may or may not have a complete management team, revenue, or positive cashflow, and often involve technology risk. Firms commonly referred to as buyout investors apply one or more of several strategies, including growth or expansion financing, management buyouts (MBOs), recapitalizations of family- or founder-owned companies, leveraged buyouts (LBOs), corporate spinouts, and taking public companies private. Turnaround specialists seek to reposition troubled companies. Typical investment horizons can range from one to several years, depending on the strategy, the company, and market conditions.

Investors may define target companies by size, with enterprise value or annual revenues being the most common metrics. They may also define preferences by the type or size of the portfolio company’s target markets – local to global, niche or mass markets, consumer or business customers – or by the potential size of an emerging industry.

Preferred investment size is stated in a range, and a function of several factors including fund size, investment strategy, and company size.

Firms may be generalists or may specialize in certain industries. Specialists offer greater in-house expertise, certain efficiencies in evaluating transactions and developing portfolio companies, and advantages in originating investments. Generalists offer greater portfolio diversification and relative protection from market cycles.

Firms may focus their activities locally, regionally, nationally or globally. Intensity and quality of coverage are a function of geographic scope and number of investment personnel.