The finance paradoxon for social enterprises
Starting a social venture should be easy. Isn’t it that a social enterprise with its half charitable half commercial structure can access both charitable and commercial sources of funding? Wrong, argues Andreas Renner, social finance expert at Sosense. The financial sector cannot keep up with the vibrant development within the sector; solutions to fund social enterprises still need to be found.
In former times the world seemed to be simple. Corporations existed to make profits. Charitable organisations took care for the social well-being where public welfare left a gap.
This model obviously is exaggerated. How drastically the categories have been shuffled becomes clear when we look at a new player in the market – social entrepreneurs. Their ambition: To demonstrate how to a good portion of “entrepreneurial spirit” may help to tackle our social challenges.
The rationale is: The fact that an organisation has a charitable status says relatively little if it is able to produce the greatest social impact possible. The converse argument that a for-profit enterprise does not produce a social value added is as wrong as it is misguided. Companies are founded because a customer demand is identified. Typically, such an individual demand does not contrast with social wellbeing, in the contrary.
Social entrepreneurs blend a social mission with business acumen. They explicitly make use of entrepreneurial values and principles. They puzzle out new models to transfer innovation, problem solving competence, customer orientation, professional management structures and efficiency to areas that traditionally had been reserved for the charitable sector.
The key idea is: A business model which is financially self-sustaining, can be replicated and scaled. Profitable enterprises have access to almost unlimited growth capital (a favourable risk/return ratio presumed), while charitable organisations compete against each other within a capped market for donations and philanthropy – a win-lose situation.
Most importantly, the social impact of a functioning social enterprise increases alongside the company’s growth; it is a win-win situation.
The business model spectrum
The question if an organisation is set-up as a charitable or as a for-profit entity has hardly any relevance from a social entrepreneurship perspective. A maximum social impact can be achieved within different legal settings, depending on the strategy chosen.
In a simplified manner a social entrepreneur can chose between three alternative models:
- He opts for the charitable sector but works out a business model to generate a significant revenue contribution from market revenues, thereby reducing the dependency from grant income and potentially becoming financially self-sustaining (e.g. see our blog about the street magazine surprise)
- He opts for the model of a „social business“ as designed by nobel award winner Muhammad Yunus, as indicated in the center of the above chart. A social business seeks to operate in a profitable way but does not pay out dividends to its investors. Profits are re-invested or do not occur as the company may sell its products and services to disadvantaged target groups at low prices which do not allow to accumulate profits. The joint venture Grameen Danone Foods as well as our Sociental AG with Sosense platform are examples for such hybrid social purpose enterprises.
- Last not least he may set-up a mission-driven for profit enterprise, i.e. a for-profit legal entity is chosen to pursue a socially-driven business model. The Berlin based start-up Coffee Circle which was described in the blog “Risk or Venture” is a good example. The B-Corp certification is a new tool which allows to differentiate such an enterprise from mainstream competitors. Coffee Circle is one of the first companies in the German speaking area that is underway to get certified.
Which models allows to generate the greatest social impact? – As the legal structure is a priori not a good indicator to judge about the impact achieved, we can rephrase the question in a simple way: Which model is best suited to attract sufficient funding to be successful?
Here the tricky part begins. The majority of social start-ups fail before they are in a position to attract capital to nourish both company growth and impact. This may sound at first sight paradox.
The finance paradoxon
Theoretically social entrepreneurs, and particularly young social start-ups live in heaven. They can access more different sources of capital than charities that e.g. cannot attract equity investors or than mainstream for-profit enterprises that typically cannot access donations or grants from foundations.
The reality is different. There do exist various starter kits for social entrepreneurs such as awards or fellowships. However, many social entrepreneurs are confronted with a funding gap when it comes to financing the next stage of the company to reach a stage of maturity which allows to attract also commercial funds. Social start-ups often are caught between chairs and just slightly miss the criteria of each source of funding, even if there is good will on each side:
- For local banks the risk is too high.
- For venture capital firms the upside potential from an increase in company value in case of a later exit is too.
- For foundations it is an unfamiliar situation and typically a constellation not foreseen an a foundation’s statutes to allocate funds to corporate entities; besides, it is often not easy for a foundation to oversee all legal risks of from a charitable law perspective.
Often those social start-ups are successful that were lucky to meet the right business angel at the right time. As there exists no market place for social business angel investments, such a financing strategy is difficult to plan. That is: While social enterprises have a much greater choice to opt between different financing tools, they receive a much smaller piece of the cake then expected.
Ultimately, the finance industry could not keep up the rapid pace within the social enterprise sector. Felix Oldenburg, head of Ashoka Europe and initiator of the Ashoka Social Finance Initiative, describes the situation as follows:
There is a high wall which separates the world of foundations from the world of commercial investors. Each world has its own rules and codes. The social entrepreneurs who do not really fit in either of these worlds, sits on top of that wall. They look down on each side and contemplate which side they should jump down if they do not want to starve on top of the wall.
This dualism is a challenge for any of the three type of social enterprises sketched in the chart above. It seems, however, that it creates the greatest challenges for the hybrid model of a “social business” as a business that does not pay dividends to its investors. It is positioned exactly in the middle, with no tendency to either side. It does not surprise therefore, that the most known social businesses are all spin-offs of multinational companies that fully funded the set-up costs of these ventures from their own budget – it is very difficult to find alternative sources of funding.
Sosense seeks to actively contribute to build a market for social risk capital. In particular, we want to inspire corporations to enlarge the circle of social entrepreneurs that benefit from a strategic corporate engagement. It is a rewarding endeavour to accompany promising social start-ups in their most critical phase and to strengthen Switzerland as a location for social innovation.