Editor's Note: This post originally appeared in NextBillion Español.
Last year, Ashoka hosted an event "Building the Socal Investment Ecosystem in Mexico and Central America," in which several very interesting discussions around impact investment took place. One of the Ashoka Fellows attending was David Green. When we talk about social financing and its challenges, David is one of the few people who can legitimately speak from both perspectives. On the one hand, he funded several social enterprises, and on the other hand, he developed two investment funds to support solar energy and eye care related social enterprises.
Paula Cardenau: David, which are in your understanding, the most critical limitations or barriers that social enterprises face today?
David Green: Here are a few insights (whether they are correct or not remains to be seen!) about the constraints as I see them, to "market based solutions" for the world´s social ills:
There are few examples of organizations that maximize distribution for social good while being self financing and profitable. Most corporations focus on ROI first and foremost - they have an ethical/fiduciary/legal responsibility to do so. At the other end of the extreme you have development agencies that take donor finance or taxpayer funding to "do development" where the funds often do not reach their intended beneficiaries or are inefficient in manifesting their intended purposes and sustainable approaches are not achieved. Focusing on social enterprises that are profitable while being socially transforming will help expand the world's consciousness about this "middle path" for development.
Many companies herald to the world their "corporate social responsibility." Much of this is really corporate philanthropy in disguise, along with adhering to practices that don't damage the environment or hurt employees. There is another type of business entity emerging that goes beyond CSR and can be defined as "socially transforming." These entities use their core competencies and assets primarily to bring about social impact while being profitable. The social aspect is not an afterthought tagged on for PR purposes, but is core to the value system and day-to-day business operation of the entity.
The overall idea is that for global social enterprise to take form, it needs to become its own asset class, which it is not at this stage, and for that to happen, it needs to take the form of a pro-profit social enterprise with the right type of governance to insure fidelity to social mission, and with the right type of financing. The missing link is financing, particularly "A" Round financing, to increase the examples of businesses that are socially transformative while being profitable.
The social sector is hampered in its growth by the fact that most of the endeavors are nonprofit and therefore do not have the benefit to leverage off of increasing valuation as for-profit companies do (e.g. Google with $25M in investment pre-IPO quickly became a $66B company after its IPO). There is therefore the need for for-profit social enterprises to be able to scale in sufficient volume to create a new asset class, which I call "social impact companies" or socially transforming companies' (to distinguish from CSR)
Earned income for-profit social enterprises can be characterized as not being dependent upon charity for ongoing operations (although donated capital might be substantial in the start up phase). Their organizational imperative is not about maximizing return on investments to shareholders but about maximizing distribution of products and services that result in social good, while being profitable and having a reasonable return to investors.
Cardenau: What would be the main challenges for growing this asset class?
- Social impact companies need help in valuation when raising money from commercial markets and knowing when to bring in financing in the right amount and at the right stage of milestone achievement, in order to be properly capitalized for each phase. Socially transforming companies need to walk a tightrope to be properly capitalized for each stage while at the same time minimizing dilution with a defensible valuation to prevent losing control at too early of a stage.
- Proper control and governance to insure fidelity to the social impact goals of the company.
- Right type of investors who understand the and fully buy into the social impact goals of the company and have risk return expectations in line with the social entrepreneur founders.
- Non-traditional finance that is often a combination of grants, PRI and MRI equity and regular equity
- Access to "A" round financing is another major constraint. Funds are generally available for seed, angel (when the funds are small and the amount being risked is therefore small) or mezzanine financing (when revenue is being generated from sales). However, financing to start up a company when it is ready to go (the product and distribution model have been prototyped in a pilot where all systems are 'go') and when the company is pre-revenue, isexceedingly difficult to consummate because the amount needed is greater than seed or angel investing and investors view this as high risk for pre-revenue start ups.
Therefore, I suggest that the agenda focusing on how to grow a newly emerging asset class of social enterprise with new types of financial instruments to grow the field.
Please become a NextBillion Facebook fan and follow us on Twitter.