The firm has always invested in line with its list of values, including transparency and trust; success measured by factors beyond financial returns; an appreciation for innovation, invention and entrepreneurship; and the desire to extend the opportunity to invest and borrow to everyone interested in aligning their values with their money.
But when investing through Wall Street products and firms, investors lack a personal connection to their holdings. For RSF, the issue drills down to where the firm conducts its banking business—it carefully vets the community banks it engages with, but laments that most Americans aren’t paying attention to the investment practices of their own banks.
“If someone deposits their money with Bank of America, there’s nothing wrong with them, but they don’t know where their money goes,” Shaffer says. “It could go into a community loan in their area, or into a big hedge fund that works with companies clear-cutting rain forests or operating sweatshops. People are demanding higher standards from their investment products.”
The first move was to change the firm’s $100 million flagship loan fund, which lends to social enterprises directly, so that it no longer used the LIBOR as a benchmark interest rate. Instead, RSF has created a committee of investors, borrowers and staff members that meet quarterly to determine each borrower’s rate moving forward.
“In 2009, we stepped back and asked, ‘Why are we using LIBOR as a benchmark for setting interest rates on our loans?’” Shaffer says. “We opted for a community-based approach where representatives for investors, borrowers and RSF would work together to determine a rate of return and a rate of interest.”
For the most part, the committee sets rates comparable to those being offered in the macroeconomy, says Shaffer, but also allows RSF the flexibility to adjust to borrower needs. The loan fund includes work-through teams, committees of investors and borrowers who can shift the expectations and covenants of loans to head off defaults and other potential issues.
“The key principle is that the different parties in an investment transaction can be more visible to each other and understand each other’s intentions,” Shaffer says. “Then you have a shot at having a level of creativity if things don’t work out as planned, a level of patience. The intuitive thing is for investors to want higher rates and for borrowers to want lower rates, but we actually see the opposite occurring. One of the borrowers will say, without prompting, that they can afford to pay a little more if it might help their fellow borrowers or attract more investment into the fund. Then one of the investors will tell us that they’re really inspired by a borrower, and would be happy to take less return. That happens spontaneously.”
RSF does not permit institutional investors to participate in its loan fund because it wants to make sure that borrowers and investors can meet each other. Currently, 1,600 investors participate in the fund, and can invest as little of $1,000 or hold multi-million-dollar positions. All these investors are found through direct contact. Potency, not scale, is the fund’s aim, says Shaffer.
The opportunity for investors and borrowers to meet and work in cooperation impacts both sides of the financial relationship, says Shaffer. “To be inspired by the missions of these social entrepreneurs is an experience that these investors aren’t used to. Vice versa, entrepreneurs see where they are getting their money from rather than a black box. To be able to meet the people on the other side of the transaction is a radical act of transparency.”
At any given time, RSF has 100 or more active loans in play, and thus far has a 100% repayment rate to its investors. One of those loans went to Revolution Foods, an Oakland, Calif., company that sources local and organic food to create meals for school lunches in areas where children don’t have exposure to fresh produce.
“They now have over $100 million in revenue and have moved on to a larger financial institution for their financing, but we were the ones who helped them begin,” Shaffer says. “When we met with them, their idea was difficult to understand and they were very early in the process. No big bank was going to give them a loan.”
Many of RSF’s borrowers share traits with Revolution Foods in that they create impact in several ways, fostering improvements in the environment, education and nutrition. Another recipient, RecycleForce, is an Indianapolis-based e-waste recycler that doubles as a job-training program to rehabilitate formerly incarcerated individuals.
“Their activity provides e-waste recycling services to a community that they did not have before,” Shaffer says. “They provide an added benefit in that the recidivism of program participants is about 20%, compared to a national average between 70% and 80%.”
RSF also offers access to grants, loan guarantees and subordinated debts, providing borrowers with integrated capital opportunities to help them grow. RSF’s financing offers investors lower returns than other debt, says Shaffer, but also poses lower risk than many other fixed-income investments, offering 90-day liquidity.
“Direct investments are lower risk from a fundamental standpoint and they come with lower volatility,” Shaffer says. “We have a 2% loss rate over 32 years in the portfolio, and we have some longtime clients supporting that.”
Shaffer and RSF did have to reconsider some investments. For example, the firm had been a major early investor in Generation Investment Management, the firm founded by former U.S. Vice President Al Gore and David Blood, and had pumped $5 million into the organization, but decided to sell its stake because it wanted a more direct relationship with its investments.
“We decided categorically that we needed to exit any position where we can’t and don’t know what’s going on,” Shaffer says. “This is not to judge people at publicly traded companies or on Wall Street. It really isn’t a ‘holier than thou’ thing, but we wanted to model and reimagine how we could use the financial system to change the world.”
Even so, RSF still has legacy private equity holdings, and is experimenting with green bonds, including issuances by SolarCity, the solar power system provider slated for a potential merger with Tesla Motors. Stepping back, Shaffer is elated with the rise of impact, green and socially responsible investing in recent years.
“There’s certainly a move towards socially responsible behavior in general, not just investing,” Shaffer says. “Look at the local food movement: Now it’s not just people in artisanal or boutique communities like Berkeley who want to know where their food comes from and want to connect with the people who are producing their food. I see what’s going on with capital right now in a similar way.”