How Big Is the Legacy Investor Market?

The nature of a pyramid is that what is at the top is always smaller than what is at the base. Socially responsible investments (SRIs) are estimated to represent approximately 8 to 10 percent of all American investments, or far more than $2 trillion. That's a big number, but it only represents the percentage of funds under professional management by investment firms. It doesn't count the Larry and Ann Wheats of the world. And that $2 trillion probably doesn't include the Omidyar Network, a $400 million mission-based private investment group created by Pierre and Pam Omidyar (who founded eBay) to invest in for-profit (and some nonprofit) ventures that are meant to make a difference in the world.

Baby Boomers control the wealth in America today, and many of these bourgeois bohemians want to make a difference with their investing. Bob Buford, who has written many popular books on the transitions of midlife, including Halftime, suggests, “Our first half is about how to make a living, and our second half has the promise of being about how to make a life.”² Author Ken Blanchard echoes this when he says, “Success is all about getting; significance is about giving back.”³ Those with the means are looking for a way to create meaning in their lives by how they invest. SRI research shows that the growing prosperity of people younger than 40 is quickly skewing investment activity into more legacy-driven directions, as there's a renewed idealism and sense of choice that these computer-savvy younger investors bring to their investment philosophy. More and more, individual investors are moving up the alignment hierarchy from transactional alignment to relationship alignment to mission alignment (legacy). It should be no surprise that SRIs are a natural extension of a phenomenon that's already well established in consumer markets, especially among Gen Xers and Millennials: the idea that consumers make buying choices aligned with their worldview.

There's a history of legacy investing in this country. Religious investors have long married morals with money. In the American colonies, Quakers and Methodists often refused to make investments that might have benefited the slave trade, and other religious orders chose not to invest in sin stocks that had anything to do with alcohol, tobacco, or gambling. Indeed, the first fund to incorporate such sin-stock screening was the Pioneer Fund, which was opened in 1928 and started screening out sinful investments in the 1950s to meet the needs of Christian investors. More recently, Tom Monaghan, a born-again Catholic, grew Domino's Pizza from a single shop to a company he sold for an estimated $1 billion. Since selling Domino's, Monaghan has pursued a number of legacy-driven avenues, including helping to set up the Ave Maria Mutual Funds in 2001, targeted toward clients who want to make sure their investing is aligned with the principles of the Roman Catholic Church.

Changing one little letter makes a world of difference, as Domini Social Investment Funds is to the left what Ave Maria Funds is to the right. In 2005, Amy Domini was featured in Time magazine's cover story as one of the “most influential people” in the world because her company brought ethical investing to the masses. Most importantly, she's also proved that SRIs can be financially beneficial, as the company's Domini 400 Social Index generated almost a 15 percent higher return than Standard & Poor's 500 between 1990 and 2005. Similarly, the Dow Jones Sustainability Index outperformed the S&P 500 in the 1990s by about 15 percent. So, investing with your heart doesn't necessarily lighten your pocketbook.

This SRI trend doesn't show any sign of slowing down, as mainstream investment banks like Goldman Sachs and Smith Barney are now offering legacy-driven investment vehicles. According to Nelson Information's Directory of Investment Managers, more than 600 money managers now provide some form of socially screened investment offerings. And in 2006, the United Nations launched the “Principles of Responsible Investment” campaign with more than 70 institutional investors from 16 countries, representing over $4.5 trillion in assets, joining together to pledge a growing commitment to a core set of environmental, social, and governance principles that legitimize sustainable and responsible investment. Maybe what Dr. Timothy Leary whispered to me all those years ago was spot on: The business world can be the most powerful institution for change that we've ever seen.

Purpose Drives Profit

Before I get too carried away, let me reiterate that the vast majority of investors don't fit this transformational model of investing. But one fact that's hard to argue is that all investors appreciate a company that makes a healthy profit. Numerous studies have shown that the companies most likely to create sustained profits are those that have an enduring purpose that balances the various needs of stakeholders. Collins and Porras demonstrated this in Built to Last. A recent Harvard University study found that “stakeholder-balanced” companies showed four times the growth rate of companies that focus only on shareholders. And a sensational new book, Firms of Endearment: How World-Class Companies Profit from Passion and Purpose, showed even greater investment performance for these stakeholder-centered companies (an eight-times better return on investment over a 10-year period!). These authors suggest that stakeholder-centered companies are following a successful business model more than a moral code.

Orin Smith, who took over the CEO duties from founder Howard Schultz at Starbucks many years ago, has said that having a purpose, while adding more complexity to their business model, has been one of the primary reasons for their success. He told Business Ethics Magazine, “When you have social commitments like making a difference for the environment and for farmers, that builds loyalty, it builds passion for this company.” Because Starbucks considers corporate social responsibility (CSR) integral to its success, the company has become a leader in institutionalizing it, like creating an audited social report in 2002 of Starbucks' activities. Smith continued, “It's such an inherent part of the business model, our company can't work without it.”

Professional investor George McCown says that while most investors aren't necessarily interested in the legacy of their investments, they are interested in finding companies that have an enduring ability to create great returns. Ironically, many of those companies also have a noble vision and strong values. He explains, “The companies we were most proud of had a quality about them that just made us feel energized when we thought about them. We realized it was because they made a difference in people's lives. They made differences in the industry they were in. They were companies that attracted the best employees. They were companies that the communities wanted to have in their town. They were companies that vendors fought over to have their business. They were the companies that customers wanted to do business with. They were companies where the shareholders loved being shareholders.” McCown is a self-actualized investor who has pride of ownership when he invests in private companies.

But McCown isn't your garden-variety investor. Most dyed-in-the-wool institutional investors couldn't tell the difference between a legacy investment and a head of lettuce. Yet, many old-school investors are coming to realize that investing in a company with an aspirational purpose can generate great results. So, the idea of legacy investing is gaining currency in groups far beyond just the Social Venture Network and Business for Social Responsibility crowd.

Investing in Community Pays Off

Back in Chapter Four, I talked about Joie de Vivre's purchase of what used to be called the Kabuki Hot Springs (now called Kabuki Springs & Spa), motivated in part because we wanted to provide our employees with a unique perk. But there was a deeper reason for our purchase 10 years ago of America's largest Japanese communal bathhouse and San Francisco's biggest spa.

When it opened in 1971, Kabuki was the crowning glory of San Francisco's Japantown district. Fashioned after the traditional bathhouses found in Japanese cities, Kabuki was founded by a collection of massage practitioners who wanted to introduce shiatsu massage and traditional community bathing into the American lifestyle. Given San Francisco's taste for the exotic and the city's populist roots, the business quickly turned into a well-loved city institution—long before the idea of pampering spas was even a glimmer in some health-minded entrepreneur's dream.

Fifteen years after it opened, the original ownership team sold the business to Kansas City–based AMC Theatres because this mega-multiplex movie company planned to build the city's largest theater next door and call it the AMC Kabuki Theater. So now Kabuki Hot Springs was going to be operated via remote control by a company in Kansas City that had no clue how to run a Japanese bathhouse. This was a classic wrong-owner syndrome, as McCown suggested in Chapter Ten.

I happened to be a regular at Kabuki, as it had become a favorite way to take the edge off at the end of a long workday. While the atmosphere was a little spartan, I appreciated the sense that for an hour or two I could feel like I'd taken a short vacation to Osaka. But AMC's lack of entrepreneurial focus on this business started to become apparent to me and others, especially as a whole new brand of sparkling spas started to open in the 1990s. I began to notice fewer and fewer customers, and there was even talk in Japantown that this community institution, now almost a quarter-century old, might have to close. For nearly five years, I tried to convince the local AMC representatives that owning a large San Francisco communal bath and spa wasn't a good fit for their company, and I asked how I could send that message to their decision makers in Kansas City.

Just when it looked like Kabuki was on its last legs, I got a call from my closest contact at AMC telling me that, given the challenges in the movie theater business at that time, the company decided it was time to shed its nonstrategic assets. After a short negotiation period, AMC sold the Kabuki business to Joie de Vivre and gave us a 20-year tenant commitment (as they still owned the real estate) at a fire-sale price.

So, it was now a matter of raising the few hundred thousand dollars we needed to buy the business and turn around both the aesthetics and the services. In considering investors for this project, I wanted to make sure we had transactional alignment. For example, I wanted them to know this investment could last 20 years, as we had no interest in a short turnaround and flipping of the business. I wanted to make sure we had relationship alignment, which came in many ways, including the fact that two of our largest investors were the interior designer and the contractor for the project who chose to receive much of the compensation for their services in ownership interests.

Finally, I also wanted my investors to realize that we were investing in a community asset with the Kabuki. Although we intended to make a number of changes to improve the guest experience and expand the offering of services, at its core Kabuki Springs & Spa (we chose the new name to clarify there are no mineral hot springs on site) needed to both continue its legacy as the largest Japanese communal bath in the United States and be priced affordably in the Japanese bathhouse tradition. We weren't going to become some kind of exclusive, glamorous, pampering spa. We were going to recreate this local forgotten treasure into a serene respite from our crazy, overmerchandized world.

If you believe that what's scarce is what's valuable, you had to know that in the late 1990s Bay Area dot-com era, serenity was scarce. Whereas most spas peddled product (all kinds of facial creams and the like), we were packaging serenity and an authentic Japanese bathhouse experience (or at least as authentic as one can be in America). That may sound a little ephemeral, which is all the more reason we needed to find the right investors.

As I considered partners for this project, many were enamored with the spa industry, given American demographics and trends toward holistic health. The investors liked the idea of spending a ton of money on this first investment to prove it as a prototype that could then be rolled out across the country. Many of these investors wanted to change our marketing focus to a more upscale clientele (which is typical of most day spas). In fact, the amount of money they wanted to spend on renovation almost necessitated that we go after a high-end customer base, which meant we would have to abandon the democratic principles on which Kabuki had been founded. Many of the prospective investors were more focused on short-term returns than a long-term investment. They were more interested in how they were going to get their money out than how they were going to invest in a legacy.

Fortunately, I had a collection of friends and associates who appreciated my unconventional perspective on this troubled little business. These are the people I chose to be my investors. The net result is that Kabuki Springs & Spa now attracts more than 70,000 customers annually, which is substantially more people than any other day spa in San Francisco. We are doing four times the revenue AMC was doing in exactly the same 10,000 square feet of space, yet with upfront renovation costs of less than $500,000. The collateral benefit for these investors: Kabuki has earned them more than seven times their original investment in cash distributions. Giving back to the community has given back to our investors. Our Kabuki investors have considerable pride of ownership. The only argument they've ever had with me is why we haven't gone out and replicated this successful business model. From my perspective, you can't replicate a legacy.

Developing this Investor Pyramid has completely changed how I view our prospective investors. I know that if we're looking for a long-term investor on a project, we need to look for Legacy Investors. In fact, our senior executives now try to categorize each of our investor or owner groups by which of the three levels of the Investor Pyramid best describes them. But I've come to recognize that some investors can't be easily categorized. We had one investor group that was clearly transactionally minded on one hotel yet viewed another investment as a legacy project. The key lesson here is making sure that the relationships with your investors are properly aligned because if you aren't able to first do this, it could wreak havoc on you and the employees in your business.

Investor pride of ownership. Customer evangelism. Employee inspiration. This is what is created at the transformative peak of the pyramid. Few companies ever scale to the peak of any one of these pyramids, but there is a rare breed that can scale the peak of all three. In the next chapter, I'll illustrate what's ticking at the center of the Relationship Truths for those rare companies.