By Don Shaffer
Social entrepreneurs seeking growth funding often get caught up in the culture of venture capital: They position their enterprise as a rocket business, look for a miracle angel investor and start giving away equity. They’re not thinking about how the investors will get their money back, or whether other options might better support their goals.
At the same time, conventional funders often see social enterprises as too risky or too hard to understand, especially if they’re building a new supply chain, sacrificing some profit to maximize social value or using a hybrid business model.
Fortunately, there are ways around traps and barriers like these for social enterprises that are past the bootstrapping stage. First, here are a few general guidelines:
- Before you seek financing, define what you ultimately want to do. Are you planning to sell this business? Do you see it as a legacy business that you’re building to last? A long-term, slow-growth plan won’t nix your chances for funding; you’ll just need to look at different kinds of funding.
- Seek out funders that focus on social enterprises and that have expertise in your field. They’ll have a better understanding of the market opportunity, and they won’t expect your business to compromise its mission in order to grow.
- Expect a funder to add value beyond financing, such as connections to a network of advisors or technical assistance.
Below are the ins and outs of five funding options — some top of mind, and some you may not have considered.
1. Debt financing
Borrowing money over a defined period of time — from a bank or an alternative lending institution — allows you to maintain your ownership position and thus retain control of the enterprise. This is a good option for enterprises that have the cash flow to make payments and the assets to secure the debt.
Debt financing takes a variety of forms, each with its own underwriting standards: working capital lines of credit, asset-based loans (secured by account receivables, inventory and other assets), equipment loans, mortgages and so on. You will want to seek advice on the best structure. The key questions to ask at the outset are: How will I be able to pay back the loan, and what is the lender likely to do if things go sideways?
2. Equity investment
Selling an ownership interest in a business is often the only option for enterprises that have promise but lack the cash flow to service debt or the assets to secure a loan. When adding equity investors, it’s especially important to consider what they bring to the table beyond money, since they will be co-owners of the business.
Key questions are: How will investors earn a return? What return do they expect, and in what time frame? Be sure that their expectations match yours. How strong is their alignment with your mission — and will they support decisions that privilege the mission over other values, such as profit and rapid growth? What kind of partner will they be in difficult times?
3. Program-related investment
Foundations provide program-related investment (PRI) financing to support mission-related enterprises while maintaining their principal and possibly earning some profit. PRI funders tend to have greater risk tolerance than conventional funders and offer low interest rates — but they have several downsides.
PRI funders are hard to find, and they fund in narrow areas. RSF, for example, offers PRI loans only in its food and agriculture focus area, and foundations stick to projects that are related to their mission. Foundations tend to move slowly, so you won’t get the money right away, and they may have cumbersome reporting requirements. Also, many for-profit social enterprises won’t qualify for PRI funding — you must show that the public benefit outweighs the private benefit, or be seeking funding for a charitable program or project.
Key questions: Given the amount of work required to obtain and maintain PRI financing, would you be better off pursuing a grant or equity? What is the loan going to allow you to do, and do you have the cash flow to make payments?
4. Direct public offerings
A direct-public offering (DPO) is an investment opportunity offered to the public directly, without an investment bank and without minimum asset requirements for investors. The offering can be equity shares, debt financing, revenue shares or other types of investment.
DPOs can be an effective and flexible way to tap your community for capital. They work best for companies that have a broad and defined constituency in a particular geographic location. They’re not a great option for raising a modest amount of money — the time and cost involved in state registration varies, but it can be significant (especially if you need to register in more than one state). At the same time, some states cap the funds you can raise at $1 million, so you may not be able to raise enough money through a DPO.
If you’re interested in pursuing this route, take a hard look at your community support — are enough people willing to invest? Also make sure you know all the applicable state regulations and fees before you start the process.
5. Integrated capital
Integrated capital is the coordinated use of different forms of capital (equity investments, loans, gifts, loan guarantees and so on), often from different funders, to support a developing enterprise that’s working to solve complex social and environmental problems. At RSF Social Finance, we’re reorienting our entire operation around this strategy.
Integrated capital is ideal for enterprises that are breaking fresh ground and need patient capital. It allows for longer development times by including some types of investment that don’t need to produce a return, such as grants. It gets enterprises through the “valley of death” — that difficult area where they have a promising business model, technology, product or service, but need more capital to realize their potential and don’t qualify for traditional financing. And when community foundations and local investors participate, integrated capital creates a community commitment to the enterprise’s success.
What does this look like in practice? Common Market, which provides a distribution link between threatened Delaware Valley farms and urban communities that lack access to fresh foods, has grown rapidly through a series of integrated capital financings, the most recent one enabling purchase of a $1.67 million warehouse space that significantly increased its capacity. At the time (2012), Common Market was not large enough to support the mortgage loan, but RSF was able to fund it with the backing of $350,000 in pledge contributions (which can be called upon in case of default) from the W.K. Kellogg Foundation, the Claneil Foundation and the 11th Hour Project; a $35,000 guarantee from the Common Market community placed as an investment in the RSF Social Investment Fund; a $250,000 RSF Local Initiatives Fund guarantee; and a $100,000 Local Initiatives Fund grant.
Parting advice: How to avoid fundraising frustration
Obtaining any of the forms of financing above requires proof that you can grow: You have a business strategy you can execute; you’ve demonstrated that there is market demand for what you do; your model is bringing in revenue; and you have sophisticated financial reporting and controls. By itself, a compelling mission is not enough.
If you’re not sure where you fit in or what you need to show to gain the support of investors so you can move beyond bootstrapping, ask funders for advice. People love to give advice. But, as in dating, don’t act desperate. If you’re pretending to earnestly want advice while you’re really just brazenly pitching everyone you meet, people will see through that.
Finally, you will have a relationship with your funders — possibly a very intense one. Take the time to get to know them (their interests, where their money comes from, their experience with other social enterprises) before you move forward. Times will get tough — are they the ones you want in the boat with you?
Image courtesy of RSF Social Finance
Don Shaffer is the president and CEO of RSF Social Finance, a San Francisco–based organization that lends money to path-breaking social enterprises, provides impact investing vehicles accessible to a wide range of investors, manages grant funds, and works to build a finance infrastructure that will allow social enterprises to thrive. RSF is currently seeking the next 25 social enterprise stars—go here for details.