By the end of the year, Time Partners chairman Mark Florman will have taken a significant step forward with his initiative to develop what he terms an external rate of return (ERR) metric.
Florman, who was head of the British Private Equity and Venture Capital Association from 2011 to 2013, is working with academics at the London School of Economics and King’s College London to build the ERR model. Its 25 weighted components will gauge the impact of a business, be it public or private, on its immediate environment and the wider world. He expects to unveil a paper outlining a version of the ERR model by the end of the year.
The model goes further than environmental, social and governance (ESG) reporting, Florman tells Private Equity International.
“It is a disciplined method of tracking impact through subsidiary categories that have no obvious correlation with IRR [internal rate of return]. ESG is too basic. This is more fundamental.”
The idea springs from Florman’s days at Doughty Hanson, where he helped develop the value enhancement team to demonstrate the social impact of its investments. It has carried through his work at Africa-focused private equity fund 8 Miles and his chairmanship of B Corporation UK.
“Retail and sophisticated institutional investors want to know companies are behaving better. In a more informed and principled world, there is pressure,” Florman says, noting that in the social media age companies are more mindful of their reputation of contributing to society. “You could argue that you may attract more capital if you develop your ERR credentials.”
Critically, the ERR metric aims through annual reporting to allow business owners to chart any change in impact over time, which will show where they fall short and give credit where typically their contribution is unseen, Florman says.
The components will be weighted on the business’s location and the economic environment in which it operates and the risk. An unnamed company is already testing the idea.
There are five categories, with the key metric being the value the company builds within itself for its stakeholders. This is not return on equity or IRR, Florman points out, but what the company provides in terms of jobs, including the quality of those roles, training, skills development and the treatment of its employees. It will measure the social value of the product or services offered, and the contribution of new ideas, intellectual property and research and development, he says.
A second category is a company’s impact on suppliers, a third on its customers, including the number of beneficiaries of the goods and services it makes, affordability and access.
“For example, customers. Suppose you build a small bank in a rural town in Africa and when you open, people queue to deposit and borrow. It’s a good thing. You have brought them the ability to engage with financial services. It’s providing something to someone who didn’t have it before. If you did the same in the UK, the impact is going to be less,” Florman says.
The fourth key component is social impact, which includes wages and taxes, the multiplier effect of a business on related industries and infrastructure. The fifth is the environment, and includes the use of renewables, exploitation of raw materials, carbon emissions, waste and impact on air quality.
Speaking about the metrics overall, Florman notes “these impacts can and should be measured and reported”.