«SESSION IV: SOCIAL ENTERPRISE AND PRIVATE ENTERPRISE THURSDAY, AUGUST 2, 11:00-12:45 P.M. PHILANTHROPY AND ENTERPRISE: HARNESSING THE POWER OF ...»
This surely has value beyond the direct social impact achieved by the organization during the investment period. When a grant is made to a charity, it is often more of an expenditure than an investment, in the sense that the grant covers a portion of operating costs for the organization to do its work during a given period of time. In the next period, the organization needs a new grant. Donors are essentially paying for service delivery. In the case of enterprise, philanthropic support can help move the organization away from future dependence on any philanthropic subsidies. Philanthropic support for enterprise, even when it takes the form of a grant, is more of an “investment” in that (if successful) it yields benefits into the future. How should this ability to create future impact with less (or no) philanthropic support be factored into the “social return” of an enterprise investment?
Failing to place a value on this will underestimate the social impact of an enterprise investment.
Setting the terms of engagement. Philanthropists who want to support enterprises also face a more complex array of options for structuring the deal. An enterprise may have the potential to repay the philanthropist for the financial support, now or later. Financial support can take the form of grants, recoverable grants, loans at various rates and on various terms, loan guarantees, and, in the case of for-profit enterprises, equity. In addition to the form and terms of initial financial support, the deal between a philanthropist and an enterprise can include conditions for follow-on funding, provisions for non-financial support (management assistance) or involvement (board membership), and exit strategies. These deals can be as simple as a basic charitable grant or as complex as a private equity transaction. In determining the terms of engagement, philanthropists investing in enterprises will have to grapple with how their support can create the most beneficial impact relative to the resource expended. Does the enterprise need a subsidy? If so, what is the best form (grant, low 23 Jed Emerson is the primary developer of the blended value concept, see www.blendedvalue.org for
interest loan, etc.)? How long should one be willing to subsidize a social enterprise? Martin Fisher acknowledged that it is likely to take a long time before KickStart is able to achieve sustained profitability, but in the meantime, it is generating tremendous income gains for Kenyan and Tanzanian farmers, far in excess of the subsidy required. 24 Could some enterprises, because of their social impact, justify indefinite financial support? What conditions, positive or negative, should trigger an “exit” by the philanthropist? How will a positive exit be achieved? Most of these organizations are not likely to go public or even be acquired. How can the deal be structured to provide the right incentives and rewards to the management team for successful performance? How can it be structured to make the most cost effective use of the philanthropic capital?
It is important to note one significant implication of the possible range of deal structures with regard to determining a “social return on investment.” The “investment” element must be calculated to reflect the net financial resources used to achieve the impact.
Obviously, a $1 million grant has to be treated quite differently from a $1 million loan, even at 0% interest and even if the probability of repayment is only 50% ex ante. The grant is gone. With the loan, the philanthropist is likely to get back some capital, perhaps all the capital to use in the future. One way to think about this is to focus on the net costs of the investment (including transaction costs, monitoring costs, costs of in-kind assistance, etc.) relative to making a market rate investment of comparable risk.
Aligning incentives to assure the creation of intended social impact. When philanthropists invest in enterprises, they need to be confident that the incentives inherent in the enterprise are aligned with their intended social impact, or that safeguards are in place should financial rewards ever threaten to pull the organization away from the desired social impact. For most enterprises, managers will face decisions in which they have to make trade-offs between financial returns and social impact. Defining the optimal balance is not easy, since financial success may allow an organization to have greater social impact in the long term. How can a philanthropist develop confidence that a given enterprise is likely to produce the intended social impact? The best assurance is provided when market forces are perfectly aligned with the intended social impact. When the natural alignment is not obvious, it is wise for an investing philanthropist to look at other factors that could affect social performance. For instance, the legal form of an enterprise can vary widely, with different options falling into the broad categories of nonprofit, for-profit, cooperative, 25 or some combination. In the United Kingdom, social entrepreneurs can now choose a new legal form, the “community interest company,” that allows limited financial returns to equity investors. Legal forms affect governance, forms of financing, and possible financial rewards to those in control of the organization. Perhaps more important than legal form is who controls the organization, by law and in practice, and what are their values and interests. In the case of for-profit social ventures, it is helpful for control to be kept in the hands of those who care about the social impact, but also understand the role of financial success as a means to that end. 26 Finally, Martin Fisher, “Income Is Development: KickStart’s Pumps Help Kenyan Farmers Transition to a Cash Economy,” Innovations, (vol. 1, no. 1, Winter 2006): esp. 26-30.
25 In the category, I am including a variety of member-serving structures such as mutuals, credit unions, collaboratives, etc.
26 For more on for-profit social ventures, see “For-Profit Social Ventures,” with Beth Battle Anderson, in Social
the culture, processes, and staffing strategies of an organization can work to align effort with the intended social impact.
Scaling the organization and the impact. How can philanthropists be sure that their enterprise investments will lead to significant, widespread impact? One potential drawback of an entrepreneurial approach to social problems is the existence of many small, fragmented efforts with little learning and sharing between them. The innovations embedded in the socially successful enterprises may not reach the vast majority of locations and individuals who could benefit from them. This might be fine if all solutions were truly local, but we have strong evidence that innovations in this sector can and should spread to new locations.
Consider microfinance. If entrepreneurial business ventures are to put a serious dent in poverty, they need pathways to spread what works to new markets where it is also likely to work.
Geographic expansion typically requires new talent and capital. Both can be problematic. Social enterprises often require hybrid skills, blending business, political, and social savvy. We need to expand and develop talent pipelines; philanthropists who invest in social enterprise have a vested interest in supporting the development of those pipelines.
Capital is a problem because investing in the original innovation seems to provide more visceral satisfaction than investing in the expansion, even though greater social returns may come from supporting the expansion. Many social entrepreneurs and philanthropists are attracted by the enterprise model because they believe it will reduce the need for outside capital to scale and that commercial success will significantly increase chances of raising capital for scale. For instance, One Roof, Inc, a for-profit social venture that provides essential services to the poor through a network of stores in Mexico and India, grew out of the nonprofit World Corps where leading staff members “determined that private capital, rather than philanthropic dollars, was the best means by which to ‘scale up’.” 27 This logic is clear, but we do not have evidence yet that mainstream capital will flow to these ventures or that they will be sufficiently profitable to finance their own expansion. Microfinance spread for over two decades largely with support from philanthropists, governments, and aid agencies. Private investment capital is only now starting to flow into the field. Beyond microfinance, there are not many recent success stories of enterprising social innovations that have scaled to affect millions of lives. Philanthropic support is likely to be needed for considerable time in the expansion of social enterprises. This support may fund experiments with new expansion strategies and structures, such as creative franchise systems, licensing of programs or technologies, and alliances with corporations, governments, or other social sector organizations. Philanthropists may also consider supporting the creation of new funding platforms that can help fuel expansion.
GETTING THE MOST OUT OF THESE EXPERIMENTS
We know from the success of microfinance that philanthropic support of enterprise activities can play a crucial role in combating poverty, but we do not know much about how to engage in this kind of investing effectively. We do not know its strengths and limits.
Standards of practice do not exist. Performance benchmarks and evaluation criteria for social enterprise are often lacking. We need a better understanding of the conditions under See history page at www.OneRoof.com.
Philanthropy and Enterprise 12 J. Gregory Dees which business ventures can achieve significant, positive, lasting social impact. We need better understanding of how philanthropists and social investors can best contribute to that impact. And we need better understanding of the institutional structures and supports that would allow social enterprise to thrive. If we can deepen our understanding in these ways, we may find a new approach to social change, one that strategically blends philanthropy and business.
How can we gain this deeper understanding? We will gain it by learning from experience. Current activities create a cluster of experiments testing different ways to bring markets to bear on serious social problems. Some of these experiments will be successful; a significant number will fail or fall far short of expectations. The result should be the development of useful knowledge to increase the chances of success in the future. To assure that these experiments are not in vain, however, we need to approach them in a way that allows us to draw out the lessons, in a way that makes us better at supporting healthy, sustainable social development. The failures need to be “constructive failures.” 28 This means capturing and sharing experiences, both the good and the bad. This means supporting rigorous research, not just financially, but with the active cooperation of philanthropists and social entrepreneurs. Philanthropists who venture into this arena are pioneers and will play a key role in shaping the institutions and standards that will guide us in the future.
For a discussion of constructive failure in philanthropy, see Peter Frumkin, “Failure in Philanthropy: Toward