Social Entrepreneurship and Venture Capital

Nothing can be nobler than wanting to improve the conditions of the world both on an environmental and sociological level. Those individuals and businesses that choose to take on society’s problems are a special breed and they face an uphill battle not only in performing their work, but finding the financial resources to grow the business so that it can fulfill its mission. This paper will examine the industry of social entrepreneurship and how venture capital funding is playing a role in improving life for all. First, to define what a social entrepreneur is.

According to one widely accepted definition, social entrepreneurs “adopt a mission to create and sustain social value, act boldly without being limited by the resources currently in hand” and “exhibit a heighten sense of accountability? for the outcomes created. “(Dee, Gregory). The majority of social enterprises are legally established as not-for-profit organizations, but a growing number have set themselves up as for-profit firms, with the owners agreeing that the business profits are to be reinvested in continuing the organization’s social objectives.

Social enterprises face two ongoing hurdles towards achieving their mission, goals and objectives. The first is the nature of the business. Social firms are often referred to as “double bottom line” businesses, meaning they are designed to make a profit while fulfilling a social mission (Clark, Gaillard). This dual goal can be seen as paradoxical, which is often difficult for both employees and funders to come to terms with making it harder to motivate all parties towards achieving sustainable profits.

The second hurdle is that the sources of funding for social businesses are more limited than the for-profit arena. Foundations and government grants have traditionally been the primary source of funding, but they provide mainly short-term grants. Social entrepreneurs need medium to long term financing. Despite these hurdles, the social entrepreneurship industry is growing. Just a decade ago virtually no business schools focused on social causes and business.

Today, most top business schools do, such as Stanford University’s Social Innovation Review which established the Global Entrepreneurship Monitor to measure social entrepreneurship around the world, and Harvard University’s Initiative on Social Enterprise. In addition, the number of nonprofits operating in the US grew by 74% between the years 1987 and 1998. (The Independent Sector Press Release, July 2001). The industry has grown for several reasons.

Problems with declining natural resources and global warming have given rise to more organizations dedicated to preserving the world’s environment, likewise, social and world wide issues such as AIDS, poverty and terrorism have led to more organizations being created to help combat these issues. Corporate scandals and run away executive compensation have given businesses focusing on philanthropic endeavors more media prominence as the “good guys”, which has raised the public’s imagination and support.

There is growing pressure for corporations to focus on their social impact coming from shareholders and customers as well as from concerned employees within. Thus, to help improve their images, many corporations have established foundations to provide funding to businesses working on social issues. To be successful, social entrepreneurs need more than just a noble mission. With the down turn in the economy over the past five years, social enterprises have experienced major government funding cuts and increased competition for funding from foundations.

In order to support operations, many social enterprises have to diversify their revenue streams. This means creating a funding strategy that includes fee-for-service along with traditional grants, and financing strategies based on courting individual donors and venture capital investors. The venture capital market is more associated with for-profit firms where the investors can realize (hopefully) long-term investment returns, and quick pay back through IPO offerings.

This is not the case with most social enterprises where the profits are reinvested back into the business and not distributed to owners or shareholders. Thus, non-surprisingly, the venture capital market is much smaller for this industry, but it does exist and it is robust. In 2003, the Rise Initiative on Social Entrepreneurship (RISE) completed a comprehensive study on the venture capital market for social funding. The researchers sought answers to two main questions:

?”Are there sources of equity capital that will make it more likely for a company with both financial and social or environmental objectives to succeed? ?How much capital is available from these sources and what are their own objectives for success? ” (Clark, Gaillard) The RISE study provides the most in-depth picture on the venture capital (VC) funding for social causes. The study found that there is over $1. 9 billion of total capital available for investing, and the wealth is spread over many specific interests such as healthcare, education, the environment, the arts and international development.

This diversity led the researchers to classify the VC market into four funding types: VCs with a conscience; VCs with an industry change focus; VCs with a focus on leadership or development and the nonprofit social investment VC fund. Please see appendix A for a detailed description of these funds. The social VC market acts very much like for-profit venture capitalists in that the VCs focus their success “first in financial terms, and then on social or environmental terms.

” (Clark, Gillard) VCs in this industry use stringent social or environmental screens to ensure that their funds are invested in organizations that match the VC’s mission and where the invested funds will be used to make the maximum impact. Some of the criteria VCs use in order to evaluate this are the “value and professionalism of [the organization’s] staff and operations, or by the positive impact [the organization] can have on communities where they are located and whom they hire. ” (Clark, Gaillard)

The study finds that social VC funding amounts to about 6% of the overall VC market, and noted that there was a significant decline between 2001 and 2002 with a drop of 41% in social funding between those years. The study believes that the social VC market is still maturing with investors managing less than $25 million, which is a relatively small fund size in comparison to for-profits VCs. The average investment size is also smaller around $1 million as compared to $6 million with for-profit deals.

Most VCs are headquartered on the east and west coasts and the majority invest in regional ventures (50%), which the study defined as being three or more states within the region. About 14% of VCs invested in more than one region of the US, and 32% invest internationally. The social venture capitalist is far from being a silent partner. They closely monitor the organizations they fund with 79% sitting on the boards of their investments. Of these firms, 91% closely monitor the financial aspects of the firm’s operations and 54% oversee the programmatic functions of the organization.

(Clark, Gaillard) When it comes to evaluating financial performance, there was a wide range of IRR’s from 4% to 50%, with the average being between 21% and 35%. Overall financial performance of the social VC market is difficult to assess because it is still a relatively young market; however, there appears to be a wide belief among investors that their returns will be similar to mainstream venture capital funds. (Clark, Gaillard). One of the largest social venture capital investors is, the Global Environment Fund, a company that follows a “hands-on” approach with the firms that they invest in.

According to the company’s website, the fund looks “to identify undervalued companies with experienced management and a clear vision of how to take advantage of the significant opportunities for growth and value creation. ” The company has $300 million in capital for environment investments in such sectors as clean water, clean energy, waste management, environmentally sustainable forestry, and clean technology. The have invested in companies such as Essex Corp (clean energy), Global Forest Products (international forestry) and Athena (safe technology).

The second largest investor is Prospect Street Ventures with $200 million in capital, this company focuses on investing into energy-related companies “that transact with the direct energy value chain”. Their investments are in the range of $5 million to $25 million. Other well known social VC firms include, NewSchools Venture Fund (education), Pacific Community Ventures (Bay Area focused, invest in small enterprising social firms), Calvert Funds (community development projects) and Coastal Ventures LLC (community based with emphasis on civil rights firms).

In addition, there are a number VC firms whose sole purpose is to seek out and provide seed money and other services to social entrepreneurs. They refer to themselves as “incubators”. Notable examples are Social Fusion; a San Francisco based non-profit VC which describes itself as a “business incubator that scales nonprofit and for-profit social ventures by merging successful business practices and positive social impact.

” The Juma Enterprise Center “supports socially conscious entrepreneurs in developing, funding and launching financially viable businesses that create jobs and economic stability for at-risk youth”, and Echoing Green which provides “seed grants” to get social entrepreneurs started with their business. Clearly there is a venture capital market for social entrepreneurs where an enterprising firm might access start-up funding. Does this mean it is right for all social enterprises, and can one rely on this type of funding? The answer is no.

To receive this type of funding a firm must be seen as enterprising, must fit within the venture capitalist’s mission and must be seen as sustainable. This does not easily fit all social entrepreneurs, and the time it takes to receive this type of funding can be a long and involved process. In addition, as mentioned earlier, many VC firms are often very active in the operations of a venture they help fund. This can lead to conflict if the VC firm has a different idea in how the work should be carried out that what the entrepreneur believes.

It can be easy to compromise one’s vision if the owner does not control the revenue. Also, the desire to receive funding can lead one down a path to secure revenue to do work that pulls resources away from accomplishing the main mission of the organization because the VC is interested in only funding a certain area of work. Both circumstances make it that much harder to be sustainable. A smart social entrepreneur should be developing a revenue mix which includes fee-for-service so that the business decreases its reliance on fundraising in order to sustain growth. Nonetheless, venture capital firms do breed success.

To illustrate, Upwardly Global is an organization which provides immigrants who have recently become US citizens with support to navigate the job market, and educates the business community on how to use this segment of the labor force. This organization started when its founder, Jessica Leu, was shocked to find that there were no organizations established to help new US citizens find jobs. She notes that many of these citizens hold advanced degrees and they are often employed in menial, hourly jobs. Upwardly Global claims it is the first and “only organization” dedicated to serving the immigrant professional.

The organization began as “kitchen table” project in the Bay Area in 1998 and has grown to serving 200 clients. The organization boasts a 90% success placement rate with many of its clients landing jobs between $25,000 and $55,000. 70% of its clients are women. Upwardly Global received much of its startup funding from the VC firm Social Fusion. Social Fusion provided the organization with controlled resources, allowing them to operate out its own office space and providing the venture with operation and logistical support in addition to financial funding.

Social Fusion also helped the organization locate additional funding groups interested in the organization’s business plan. Some of these sponsors include Citibank and Charles Schwab. Leu plans to expand into other regions outside the Bay Area with a pilot project beginning sometime in 2005 and plans to go national in 2010. One interesting comment Leu makes is that in order for the organization to have been successful it has had to “consciously [use] a for-profit approach to the mission” saying “[One] needs to get the best performance possible, as if one is a for-profit business. ” (Westmoreland)

Statistically, 85% of small businesses fail within the first five years of operation. (US Department of Labor, 2001) So it should come as no surprise that the failure rate for social enterprises is quite high. One Foundation Officer, Mike Smith of the Hewlett Foundation, says a “non-profit able to last 10 years is an incredible success story. ” So venture capital firms face significant odds when investing in a social entrepreneur that the organization will be around for the long term. It’s also tempting to think that social entrepreneurs have the highest ethics and will use the money as intended.

Not necessarily so as illustrated by the case with PipeVine, Inc. PipeVine was a non-profit which processed more than $100 million in donations a year for the United Way and was heavily invested in by corporate sponsors such as Bank of America, McKesson and ChevronTexaco. In 2003, the company diverted millions in donations pledged for other social enterprises to keep the business afloat, paying officer salaries and operations, a violation of state and federal law. Hundreds of non-profits (such as Make a Wish Foundation and Network for Good) were left without funding they had been relying on.

By September 2003, court appointed trustees found that PipeVine owed nearly $18 million to charities, the money was all spent. (San Francisco Chronicle) A number of corporate firms vowed to cover the loses, but the scandal came at one of the worst times when donation giving was on the downslide due to the struggling economy, and the public was already disillusioned by corporate scandals in other industries. The PipeVine scandal led California to adopt new rules for non-profits in how they operate and how they record and solicit funding.

The reform made into law in October 2004 is similar to the Sarbanes-Oxley reform passed by congress to address publicly traded company operations. To conclude, this paper has shown that there is tremendous interest in advancing social entrepreneurship, and venture capital funding is available for entrepreneurs in this industry. One has to access the funding wisely and weigh the pros and cons of moving forward with a venture capitalist’s money. While it is a way to start up a business, the price is not free. Sources Catherine H.

Clark, Josie Taylor Gaillard (August 2003) “Rise Capital Market Report, The Double Bottom Line Private Equity Landscape in 2002-2003” Dees, Gregory, Jed Emerson and Peter Economy (Wiley, 2001) “Enterprising Nonprofits: A Toolkit for Social Entrepreneurs” Nicole Westmoreland (online) “Upwardly Global: Creating new opportunities for immigrant citizens” Todd Wallack (June 2003, San Francisco Chronicle article) “Nonprofit kept million it collect for charity”. The Rockefeller and Golden Sachs Foundation (March 2003) “Social Impact Assessment: A Discussion Among Grantmakers”.