Historically, solving social and environmental problems is seen as a sole responsibility of governments and non-profits but their efforts alone will not prompt long-term economic growth, poverty alleviation and nature preservation. Today we need to focus on reshaping the way society deploys its resources to solve its problems.
Social entrepreneurs are using business thinking and strategy to pursue the “blended value” – a term presented by Jed Emerson – what means integrating profit and purpose. They want to build a more inclusive, balanced and relevant economy — and they have the potential, talent and passion to do so. These industry disruptors need funding in order to create and deploy innovative solutions to solve or alleviate pressing humanity issues – and today new (or well-forgotten old) ways emerge to find social capital. And here they are:
The Kauffman Foundation reflected upon two decades of investing venture capital in promising entrepreneurs by saying, “we have met the enemy…and he is us”. It is a popular point of view that venture capital industry is old-school, over-priced and unicorn-obsessed, that it is time to disrupt VC industry in order for it to keep up with the companies it backs. But fear no more - Impact Investing is a new tool to bring greater resources to pursue philanthropic goals. According to the World Economic Forum: “Impact investing is an investment approach intentionally seeking to create both financial return and social impact that is actively measured”. It allows investors to take into account personal or fund values along with financial opportunity. There is $64 trillion in assets under management, 50% of which resides in North America and nearly $11 billion of that was invested across 4,900 impact deals in 2013 – up 250% from 2011. And the World Economic Forum report projects that impact investing will continue to grow and will reach $500 billion in 2020.
Royalty-based funding approach allows investors to get returns almost immediately instead of waiting for 5-10 years for a startup to go public or get acquired. Rather than asking for an equity stake in a business, investors lend money for a guaranteed percentage (usually 2-10%) of revenues over a period of time. This is a great way to get financed for entrepreneurs who don’t want to give up control to equity investors but need an infusion of cash for their business. The good part is that payments are tied to a percentage of revenue so entrepreneurs don’t need to worry about down months for sales. On the flip side, entrepreneurs could end up paying substantially more if product sales really take off. Another tricky side to this funding mechanism is that returns are capped so investors might end up backing the next Unicorn but will get only moderate amount back that is why entrepreneurs should work hard to convince investors that the product or service sales will generate reasonable revenue. However, this funding approach is gaining popularity in social impact space – more than $100 billion royalty-payments are made each year, according to The Royalty Exchange.
Another impact funding mechanism is Social Impact Bonds or “pay for success” which allows governments to pursue innovative social programs that may take years to yield results at a lower risk. Basically, governments decide what problems need to be addressed and enter a contractual agreement with an intermediary (or bond-issuing organization). The intermediary is responsible for raising capital from independent investors including banks, foundations, and individuals, as well as for hiring and managing nonprofit service providers. If the project achieves its stated objectives in improving social outcomes for at-risk individuals, it reduces government spending in the long-term. Therefore, the government repays the private investors with returns based on the saved government spending as a result of the program’s success. The Congress is considering the Social Impact Bonds Act – the legislation that will enable the U.S. federal government to allocate $300 million to Social Impact Bonds. While operating over a fixed period of time, “pay for success” approach does not offer a fixed rate of return and therefore in terms of investment risk Social Impact Bonds are more similar to that of an equity investment.
One of the oldest approaches to fund social impact projects is a grant - non-repayable funds or products disbursed by grant-makers (often a government, corporation, foundation or trust) to a recipient - usually a nonprofit entity, educational institution, but today they are available to businesses or an individuals. Most grants are made to fund a specific project and require some level of compliance and reporting. According to the Foundation Center, over 88,000 trusts and foundations with over $40 billion in assets every year. Last year they gave $9.66 billion in grants for social causes - up 12.6%.
Except giving away money through grants, foundations are now using Program Related Investments that allow making investments as loans or equity stakes with expectations of regaining their investments plus a reasonable rate of return. This approach allows foundations to increase the amount of money available to the social sector, while building stronger and more sustainable socially-aware entities. PRIs count towards a foundation’s qualifying distributions just as grants, helping them meet their annual 5% payout requirement. PRIs are exempted from the excess business holdings and investment taxes while financially expanding the charitable work of the foundation. Yet, despite their value, PRIs have been underutilized - less than 1% of foundations make PRIs because they are seen as too risky. Foundations are required to follow a special set of tax rules in order to avoid certain penalties but lack of IRS guidance on what qualifies as a PRI is a barrier. Generally described, a PRI is an investment not used for political campaigning or lobbying that 1) must be made primarily to further the foundation’s tax-exempt purposes, and 2) cannot be significantly motivated by the intent to make a profit. Another barrier for PRIs is lack of expertise and transaction costs. Nevertheless, between 1990 and 2009, PRIs increased from $139 million to $701 million.
Another funding mechanism that suits social enterprises is Direct Public Offering, which is similar to initial public offering in that stock is sold to investors, but unlike an IPO, a company uses a DPO to raise capital directly - without a firm underwriting from an investment banking firm or broker-dealer. According to Cutting Edge Capital, DPO refers to a public offering of securities by a business or nonprofit to both accredited and non-accredited investors in one or more states. It allows a business or nonprofit to market and advertise its offering publicly by any means – including crowdfunding platforms. Advantages of using this financing vehicle include the fact that not all DPOs require registration with the SEC - some offerings will qualify for an exemption from the federal registration requirements: intrastate offerings and offerings under $1 million (the Rule 504 exemption). In such cases, only state level registration is generally required. Direct public offerings are primarily used by small and medium size companies who are unable to attract the interest of an investment banking firm to represent them in a traditional initial public offering – it gives access to investment capital without the assistance of professional financiers, what could be the upside since the process requires a lot of costly management and attention to financial and legal reporting.
One of the old financing mechanisms is a Donor-Advised Fund - a charitable giving vehicle created to manage charitable donations on behalf of organizations, families, and individuals. To participate in a donor-advised fund, an individual or entity surrender ownership of anything they put in the fund - cash, securities, or other financial instruments, but retain advisory privileges over how their account is invested. Such participation allows taking an immediate tax deduction against the contributed amount, but there are no rules or regulations about how quickly the money actually has to be distributed. Contributions to donor-advised funds made $53.7 billion in 2013 – up 23.5%, according to the National Philanthropic Trust. That growth outpaced all other giving vehicles, like private foundations and charitable trusts - and now represent 7% of all individual charitable donations. However, the biggest criticism here is that DAFs serve as financial holding pens for the assets of people who simply want to grab a tax deduction and have no immediate plans for any actual charitable giving: DAF is the only charitable-giving vehicle that allows donors to make grants 100% anonymously and it allows these charitable contributions to be invested not only in non-profits but also in for-profits. According to the National Philanthropic Trust, the average account size in donor-advised funds is $247,217.
Social enterprise lending - or patient lending - is a form of social financing that refers to offering loans below current market rates to social enterprises. Recognizing that social projects often reach profitability later than commercial projects, this form of lending provides softer terms of a loan such as longer loan terms, lower interest rates and repayment ‘holidays’ where capital and interest repayments are not due until the project is profitable. The sources of funds vary across the spectrum of social lenders and can include government departments, private individuals, foundations and trusts. Lenders may restrict their funding strategy to newly started organizations or funding organizations throughout their life cycle – in either case, the investment is focused on achieving investee’s stated social outcomes while becoming financially sustainable. One of the most popular lending approaches for social startups is through crowdfunding platforms – especially with Kiva’s 0% interest loans.
A number of mentioned social funding mechanisms are used in crowdfunding today. Since a lot of social projects are focused on solving or alleviating pressing issues, the best way to find funding for them is to ask those around – most of impact backers will support projects that will resonate with their values and needs. Under this angle, the crowd is the best funding source in support of a wide variety of activities, including disaster relief, citizen journalism, support of artists by fans, startup company funding, movie or free software development, and scientific research. Crowdfunding allows raising funds for projects or ventures by collecting monetary contributions from a large number of people, typically via the internet. In 2013, the crowdfunding industry raised over $5.1 billion worldwide, and social causes are by far the most popular crowdfunded category with almost 30% of funding. Multiple types of crowdfunding open broad opportunities for any type of social projects: reward-based, equity, debt-based (crowd-lending), litigation, and charity. This funding approach allows anyone to make a difference even with as little as $10, what already led to some heart-breaking stories.
I know it has been a long article – and thank you for reading until the end. I will make the conclusion short: if entrepreneurship is going to change the world, it must include everyone – but everyone has to pitch in. It is your world, and you have a say in its future. “Alone we can do so little; together we can do so much.” - Helen Keller
