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Nothing Ventured, Nothing Gained: Addressing the Critical Gaps in Risk-Taking Capital for Social Enterprise

By Jed Emerson, EVP of Impact Assets, Tim Freundlich, founder of Impact Assets, and Jim Fruchterman, with Loren Berlin and Kelly Stevenso.l, though the Said Business School at Oxford

Social enterprises are creating new and exciting solutions to society’s problems. Increasing numbers of ventures are being launched to address challenges – from poverty to health, education to the environment. Despite many of these emerging successes, most of these enterprises face a common problem: inability to secure growth capital. Specifically, there is an abject lack of risk-taking capital. The result is that proven social enterprises are starved of the capital required to grow to an appropriate size. Yet there is also an increasing number of mission-based investors looking for opportunities that go beyond traditional grants and into the realm of debt and equity, and are willing to consider new models of risk and return. However, these two groups are struggling to find one another.

Our collective inability to transcend this capital challenge limits the effectiveness of both entrepreneur and investor. More importantly, the lack of appropriate capital means needed services, support and opportunities remain beyond the grasp of many in the US and Europe, not to mention the developing world. With this paper we want to help move the discussion forward toward diverse solutions to the growth capital challenge facing many high-performing social enterprises throughout the world.

Key concepts of social enterprise and the capital market that serves it 

By “social enterprise” we mean the application of business models and acumen to address social issues, whether through nonprofit or for-profit corporate structures. The capital counterpart to social enterprise, “social finance”, may be understood as a broad area wherein various forms of capital are structured in ways that consider and value both financial performance and social value creation. Put simply, between the traditional approach to financing nonprofit ventures through grants, fundraising and limited use of debt, and the traditional approach to financing for-profit ventures through market-rate private equity and debt, there is a funding gap into which an increasing number of social enterprises are falling.

Organisations that are growing fast need capital to increase production capacity and develop their products and markets, as well as for everyday working expenses. Debt is usually only applicable for certain needs. Equity or equity-like capital forms the majority of this capital need. In the case of nonprofits, grants can play a role.

Start-up nonprofit corporations (which can be one form of social enterprise) are usually able to access gifts to support demonstration projects and innovative strategies. In fact, many foundations pride themselves on making grants to the “new” or the “innovative.” While not necessarily an easy process, the fact remains that in the US and Europe funds are available to catalyse, incubate, launch and operate social enterprises at a small scale. Many social entrepreneurs attain initial success by piecing together small grants of a few thousand to a few hundred thousand dollars in order to meet their initial start-up requirements. However, growth capital (also known as “expansion capital”) remains difficult for entrepreneurs to access. In many cases it is simply unavailable.

Start-up for-profit corporations (which may be social enterprises) are able to access funding from “friends, family and fools” (as the saying goes), cobbling together enough to test out their new business concept or strategy. In the same manner as their nonprofit counterparts, they may find funds to get going, demonstrate proof of concept and – if they were traditional, for-profit corporations focused upon profit-maximising strategies – go on to compete for private equity investments mixed with some level of debt. If, however, they are social enterprises – for-profit corporations that balance financial returns with a social mission – they face a similar dilemma to their nonprofit cousins. For-profit social enterprises of this sort often find they are able to raise initial, launch funding, but lack access to expansion capital that does not seek a full, conventional market-rate return on investment.

The bottom line is that in all too many instances neither the for-profit nor the nonprofit social enterprise is able to secure adequate capital to enable it to move from start-up to the next level of development. The appropriate form of capital to support the enterprise’s development simply does not exist at any scale. It is worth noting that venture capital and early private equity is by its very nature competitive and scarce, even in the relatively mature US markets. In Europe it is even scarcer and in the developing world almost non-existent. Although there is certainly growing interest in building up equity access for conventional small and medium-sized enterprises, social enterprises, with their unconventional risk-return model, will still find growth capital hard to access.

Therefore, the 800-pound gorilla in the social enterprise capital market has become the very real absence of expansion stage capital with a true risk-taking profile. What makes for success in traditional business development is access to funds that allow the firm to grow and take chances. This same capital is equally necessary for a thriving social enterprise market. This is not to say that the broader, more conventional “socially responsible” businesses and certain social enterprises that perform well financially cannot tap market rate capital at some level. The fact that these socially motivated enterprises exist is to be applauded, and when these business models are conducive, capital follows conventional returns, but the core of social enterprise activity falls outside the conventional definition of market-rate, risk-adjusted returns.

Furthermore, we are not talking about capital such as:

  • asset-backed real estate and facilities funds more easily financed by debt
  • receivables financing, or factoring, that is increasingly being used in social enterprise business models
  • small, manageable allocations of funds from fundraising dinners, nor the periodic “large grant” from one-off donors.

What we are talking about is the need for large chunks of capital that play the role of equity capital (or “equity-like” capital, in the case of nonprofits) that may then be used by social enterprises to aggressively grow and replicate their operations, penetrate new markets, build intellectual property, brand presence and so forth.

In the following chapters we will explore why this capital gap exists and why this type of capital is so critical, explain what forms of capital are available, and put forward some ideas regarding capital innovations.

To read the remainder of this report, follow the link to Nothing Ventured, Nothing Gained, which was originally published on Benetech.