Can Investors Make Money and Do Good in Education?

For many investors, education technology has long been a field with great potential and not-so-great returns. But it seems that Matt Greenfield has figured out how to pick companies he likes and achieve enviable financial success. His secret: seek out pioneers, not those who focus on honing a familiar approach.

Greenfield is a partner with Rethink Education, a New York City-based firm that started investing in edtech in 2012. His cofounders include long-time investor Rick Segal, and two other partners, Michael Walden and Brandon Avrutin. And although Rethink isn’t releasing exact returns, here’s one statistic that hints at the record Rethink is building: gains from three of the fund’s 16 investments equal the entire $60 million raised for the fund.

Even better, Rethink may not be losing as much money as many other investment firms do. Only 20% of Greenfield and his partners’ edtech investments have failed in a decade of activity, he says. He hastens to add that he can’t promise any specific performance. Even so that’s a first-in-class result for venture capitalists who often admit that half their investments don’t pan out. Actual investor returns may even be worse: Harvard Business School senior lecturer, Shikhar Ghosh, who combed through results from venture investments between 2004 and 2010, concluded that as many as 75% of those investments didn’t return their investors’ capital.

Greenfield says he’s seeing more deals that meet Rethink’s investing criteria than the team has the funds to invest in. “There are a lot of great companies that I’d be happy to invest in, if I had less deal flow,” he says wryly. (Or more money. Rethink is hoping to raise a second fund as its current fund is more than half committed.)

Rethink won’t settle for companies offering improved versions of products already on the marketplace. For instance, digital books, which have sopped up hundreds of millions of VC funds, flub Rethink’s criteria. Greenfield and Segal insist on trailblazers. “It’s no longer just a hypothesis,” Greenfield adds. “The world has to need this particular company. Focusing on what needs to change is the best investment strategy. And that’s a point that’s larger than my own fund.”

Greenfield is no starry-eyed newcomer to educator or to investing. He’s been in and out of universities for years: he earned a PhD in English from Yale University, spent time on Wall Street, taught in colleges and finally settled back into finance. By contrast, Rethink cofounder, Rick Segal, has been an investor longer than at least one of the entrepreneurs he now backs has been alive. He started Seavest Investment Group in 1982 and made smart bets on Wireless Generation and SchoolNet.

There are three significant reasons why Rethink’s form of “social investing” seems to be working.

The ‘First Seller’ Advantage

For starters, there’s a powerful “first seller” advantage in education. Schools frequently make a choice to use a core product and stick with it for a long, long time. It may take a couple of years for staff to learn to use the new tool. IT support staff for handling technology and answering questions is typically scarce and not eager to flip flop among products. So once a school decides to invest in a significant product, it may be a customer for years.

Or another way of saying it: To win acceptance, a product has to attack an unconquered problem, rather than merely offering a supposedly better way of addressing needs that are already being (somewhat) satisfied with status-quo wares. To justify the hassles (and expense) of installing a new product and training teachers to use it, it must address a deep, unmet need of the school or district.

“You want to get into a position where you’re providing a service that no one else can provide,” Greenfield says. For investors, that means have a clear grasp of users’ pain points—and a conviction that existing big players aren’t likely to adjust their products and solve that problem.

“We see an awfully large number of companies that should be a feature of a larger product,” Greenfield notes. “A lot of the time, that larger product is a Learning Management System. People love to build and rebuild LMS. That’s not where the biggest needs are. “

When a school does encounter a significant product that fills an unaddressed need, it can lock into that solution for a long time.

From a company’s vantage, that means that the revenue it can earn from winning a new customer may be steady (or even increasing) over several years—a better outcome than the often-fickle market for consumer products, Greenfield notes.

“Any edtech company that reaches $10 million in revenue will make you money,” Greenfield asserts. “It may not make you a lot of money but when I look at consumer web companies that lose 40% of their customers every quarter, that’s kind of a sickening and difficult business.”

Being ‘Real’ Counts

So-called “social investing,” which seeks a societal gain in addition to a monetary return, may make the most sense in a sector that is, well, inherently social. No matter how socially minded a solar panel maker may be, such enlightenment doesn’t help a solar cell convert more light into energy.

But a company’s attitude is worth more than brownie points in school environments.

Every day, school administrators are tugging toward ambitious—and often conflicting—goals: Raising student achievement. Improving the lot of the teaching staff. Placating grumpy parents.

That means that they need more than a product with a low price; they’re seeking “partner” organizations.

From the vantage of schools, too many companies still treat schools strictly as “customers,” notes Dr. Robert Dillon, director of technology and information for the Affton School District near St. Louis. Schools that are thoughtful about using technology are looking for like-minded organizations that will try to respond to their needs.

“The Affton School District actively searches for companies that treat educators as partners and co-creators in the mission to change the educational ecosystem,” Dillon notes. “We know that the village that we need to support our students has to extend into our corporate partnerships. The shift for companies is an attitudinal one that results in a more high touch and relational sales force,” he adds.

There is another corner of the business world where building a culture around supporting partners can have a big payoff—namely the “small and medium” business sector. For instance, Harvard Business School chronicled how United Stationers, a multi-billion dollar wholesale distributor of business products, significantly turned around its business by returning to its roots which “… were grounded in a set of more intangible factors—the company’s strong values and its culture of collaboration and individual respect,” said CEO Cody Phipps.

That rings true with the education marketplace, which increasingly experts realize looks and behaves more like an SMB market than an enterprise market--a point made cogently by long-time enterprise entrepreneur Umang Gupta, who now devotes himself to education investments.

Mind the Numbers

Which leads to a third tenet of Greenfield’s investing thesis: Pay attention to the math of investing.

Although hundreds of aspiring edtech firms have won angel and seed investments in the past five years, only a handful of funds focus on “adolescent” companies, ones seeking to raise single digit millions of dollars that are still proving they can execute on their business model.

Rethink is in this category, along with the likes of Learn Capital, Owl Ventures (started by former Catamount partners), GSV Capital, New Markets Venture Partners and a few others. Facebook’s Mark Zuckerberg and his wife, Priscilla Chan, have recently hired a manager to develop an investment fund in this area, as well.

In the consumer software world, funds in this category have benefited from the outsized returns of a few bets and so raised investment funds measured in the hundreds of millions of dollars. Those kinds of companies are consequently driven by grim mathematics to make oversized bets in hopes of crazy returns.

Putting in more modest investments—and counting on more gains—makes for a sane strategy.

Rethink invested in Engrade, for instance, in 2012; the company took in approximately $8 million in ventures funds. (Greenfield invested privately a year earlier). Two years later, Engrade was acquired by McGraw Hill, which reportedly paid about $50 million. Exactly how much Rethink took from the deal depends on the terms, of course. But Greenfield concedes that if he earned those returns over, say, five to seven years, he would not be as cheerful about the returns.

Update: Since this article was first published, another Rethink portfolio company had a liquidity event: Boston-based Smarterer was acquired by Pluralsight for $75 million in mid November.

Acquisitions are not the only way for investors to earn returns, although Greenfield says that just about every company in his portfolio has been wooed by a larger organization or private equity fund. Some will likely head to the public markets. Greenfield says he expects that there are other edtech firms that could go public—based on their revenue and customer base—if they so chose. Among them: BrainPop, TurnItIn.com, Naviance (a division of Hobsons), and SchoolDude.

Way back in May 2011, we included this note in newsletter no. 14:

Sound like that advice still rings true.