Introduction to Social Venture Capital
Governmental organizations, non-governmental organizations and charities used to be the major players in the battle against some of the biggest social and environmental issues. However, due the interconnected nature of our modern societies, together with the improved technology, entrepreneurs are also looking to solve social issues.
Socially responsible investing and entrepreneurship have led to the emergence of social investment funds and businesses.
In this guide, we will look at one aspect of socially responsible investing: social venture capital. The guide will explain what social venture capital is and how it works. We’ll look at its advantages and disadvantages for social enterprises, and reveal the key ways to attract social venture capital.
WHAT IS SOCIAL VENTURE CAPITAL?
Social venture capital aims at investing in a socially responsible manner in companies, which are looking to provide real social change. Social venture capital often focuses on companies that want to solve environmental and social issues, such as alleviating poverty. The firms can aim to solve these issues either directly through their product or service, or by implementing special programs in this area.
It is a highly philanthropic form of investing, as the focus is on finding companies with a strong social conscience. Despite the pivot being on socially responsible companies, social venture capital investing still emphasizes returns. It isn’t simply a form of charity work or provision of donations, social venture capitalists select investment opportunities with a healthy return on investment in mind.
How does social venture capital differ from traditional venture capital?
Whilst both social venture capital and traditional venture capital focus on attracting a healthy return on the investment, the two investing methods still differ in terms of their broader goals.
Traditional venture capital sets maximization of the financial risk-return relation as the most important goal to achieve. On the other hand, social venture capital has a broader objective. Not only does a social venture capitalist wish to maximize the financial return, they are also interested in maximizing the social or ecological return. The focal point is on making the profit while also improving the social and environmental conditions the company is focusing on.
It would be wrong to assume social capital doesn’t look at financial returns at all. In addition, the persistent myth around social venture capital is that it “doesn’t generate attractive returns”. But recent years have shown that social venture capital can, in fact, even provide healthier returns than traditional venture capital.
Research by the Responsible Investment Association Australasia (RIAA) found that responsible investment funds outperformed the ASX 300 and the average large cap Australian equities across different investment periods. Furthermore, the value of socially responsible investments increased by 24% in 2014. In the previous year, these investments had increased by 50%. Hence, the notion that social investment wouldn’t be financially attractive is a fallacy that doesn’t necessarily match the actual facts.
Who provides social venture capital?
Social venture capital is provided by specialist social venture capital firms, funds and impact investors. Many major venture capital firms tend to have special social venture capital funds operating alongside traditional funds. Furthermore, both, international and local development banks, can be a source of social venture capital.
It should be noted that social venture capital investors often have different ways to define “socially responsible”. For example, certain investors focus on ensuring the funds they invest in avoid certain industries deemed harmful for common good, such as arms trade, gambling, tobacco or alcohol, for example.
On the other hand, others focus on a more in-depth view on the company’s business model. These individual investors might focus on finding companies which target a specific social goal or which operate under a fairer business model, such as improved minimum wage.
The focus of social venture capital firms is often on the developing world. The investments are directed to developing countries and companies operating in these countries. Nonetheless, social investments are on the rise in the developed world as well and attract significant amounts of funding.
TYPES OF SOCIAL VENTURE CAPITAL INVESTORS
If we look at the types of social venture capital investors, we can see the different approach investors take on this investment method. The types of social venture capital investors include:
- Social venture accelerators – These are similar to Seed Accelerators. The focus is on providing seed funding to start-ups with potential to scale. Like traditional seed accelerators, social venture accelerators often focus on tech-based companies.
- Social incubators and funds – Social incubators and funds are another form of social venture investing. The focus of incubators is to provide start-ups and entrepreneurs with facilities and funding. In addition, there are special social incubator funds, which focus on social investment intermediaries that generally carry a higher financial risk.
- Non-profit oriented funding – Certain investors tend to focus more on non-profit investing. Social venture capital is often the perfect match for non-profit looking to deliver social impact while maintaining a social enterprise pattern.
- Business Angels – Finally, you have business angels, investing in start-ups and private companies.
Social venture capital’s successes in providing healthy returns for investors have accelerated the setting up of different funds and firms. Some of the more famous social venture capital firms include:
HOW DOES SOCIAL VENTURE CAPITAL WORK?
The basic premise of social venture capital is similar to traditional venture capital. Essentially, the investor invests capital in a company and later receives a return.
As traditional venture capital, social venture capital aims at finding the entrepreneurs and start-ups with products and services that offer growth potential. Once these start-ups are identified, capital is provided to help the company fulfill its potential.
Whilst the most important metric for venture capitalists is profit and financial return, social venture capitalists focus on other metrics during the investment period as well. To social venture capitalists the metrics that matter include:
- Financial profitability
- Business development (scalability)
- The social mission/ecological impact of the business
Therefore, the objective isn’t only about the financial return and social venture capital typically cashes out only once the social enterprise realizes a return on all of the above metrics. This means that once the enterprise has achieved the desired social or ecological goal, together with a financial return, the return is distributed back to the investor.
Social ventures can utilize a range of funding options. The most forms of social venture funding include:
- Debt capital
- Mezzanine capital
- Equity investment – Social venture capital firms also use equity investment through preferred shares.
Furthermore, in many instances, social ventures combine the use of debt capital with mezzanine capital.
THE ADVANTAGES AND DISADVANTAGES OF RAISING SOCIAL VENTURE CAPITAL FOR SOCIAL ENTERPRISES
Similar to venture capital funding, social venture capital also provides its share of advantages and disadvantages. If a social enterprise is considering social venture capital as a funding option, the following points are important to keep in mind.
The advantages of social venture capital
Many of the advantages of social venture capital are similar to traditional venture capital. Enterprises are not only able to attract capital; they will also receive the experience of the investor. Social venture capitalists can provide guidance to these enterprises and therefore, guarantee they unlock their potential quicker.
In addition, the social venture capital investment model offers a relaxed repayment model. As with traditional venture capital funding, the schedule to return the investment is flexible and businesses can focus on the essentials at the start.
Furthermore, social venture capital provides quick and sufficient funding to social enterprises. Socially responsible companies often focus on projects, which are both large scale and take time to implement. Social venture capitalists understand this point of view and are able to provide the initial capital to kick-start these projects.
But social venture capital adds additional advantages as well. Most importantly, the conditions to obtain capital are often better compared to traditional venture capital. As social venture capital doesn’t simply focus on the financial returns, investors are willing to provide capital cheaper, as it might take a longer time for a social business to turn profitable.
Finally, social enterprises naturally would benefit from social venture capital due to aligned interests and goals. Since both parties in the deal are aiming to earn money, as well as to create a social impact, it is easier to reach common ground.
The disadvantage of social venture capital
There are disadvantages to social venture capital as well. Since investors also emphasize the financial returns together with specific social or ecological requirements, the criteria to attract this investment can be challenging. Start-ups and entrepreneurs might struggle to find investors willing to fund their business. Furthermore, similarly to venture capital, the amount of control involved can occur detrimental for new enterprises.
While social venture capital focuses on other metrics of success, they still emphasize the ROI as well. However, social entrepreneurs often don’t have a self-sustainable financial model implemented right from the start. Therefore, start-ups might find other financing alternatives more suitable, as the focus wouldn’t be as heavily on the financial return. For example, crowdfunding, while expecting a return of some kind, doesn’t necessarily focus on a financial return. Furthermore, social enterprises might find philanthropy and donations better to support the social cause of the business.
In addition, since social enterprises don’t have a strong self-sustained financing model in place, the dependency on social venture capital can increase. The enterprises can be inflexible when it comes to the identity structure on leveraging capital. This can be due to inability to provide a clear exit strategy, as the enterprise is often focused on generating long-term impact. Therefore, the use of other funding channels, such as network investments and bank debt, can be limited. Social venture capital can easily become the easiest route to financing, which has then the disadvantage of increasing reliance on the method.
WHAT ARE THE KEYS TO ATTRACTING SOCIAL VENTURE CAPITAL?
Since the nature of social enterprises is different compared to other enterprises, the expectations of social venture capitalists are also different, as the above shows. As mentioned, finding social venture capital funding can be a challenge. Nonetheless, it is possible to ease the attractiveness of the enterprise by following the below points.
Alignment between financial and social mission
Since investors are looking for financial returns together with social impact, enterprises need to find a strong alignment between the two goals. The enterprise must have a compelling and effective social mission, while also laying out strong foundations for being a profitable business.
If the enterprise is able to demonstrate its ability to deliver meaningful social impact, while promising healthy financial returns, social venture capital will follow. The crucial point is to understand that both models should complement and support one another. If either one of the goals seems unattainable, social venture capitalists will have a hard time justifying investment.
A proper management team
Like any venture capitalist, a social venture capitalist will want a strong management team behind the business. Perhaps even more so in the case of social venture capital, as these investors tend to trust teams more than individuals.
For socially responsible companies a well-run management team is beneficial because it leaves more room for individuals to focus on different aspects of running the business. Since investors are looking to achieve a number of goals, a larger team can help them feel more relaxed, as each aspect is properly taken care of.
Strong ways to measure social impact
Financial success is simple to measure, as you focus on financial metrics to measure when a goal is reached. But since social venture capital is also interested in the social impact, the business must implement strategies for measuring the social impact.
Measuring social impact can be difficult, especially as start-ups tend to struggle with resources. Nevertheless, it is essential to highlight the different ways impact can be monitored for potential investors.
Understanding the best ways to monitor the impact can further help define the objective. It can bring much needed clarity, as the business can become more aware of what it is trying to achieve.
For example, if the aim is to help young people launch their careers, the enterprise can measure their success by looking at the number of young people they’ve helped to get work or the amount of young people attending their work skill seminars.
A sustainable and promising business model
Finally, social enterprises must focus on providing investors with a sustainable and promising business model. Since social venture capitalist are looking for scalability, the business model must highlight how it tries to achieve this, together with financial and social returns.
For more tips on attracting capital as a social enterprise, check out the below video:
SOCIAL VENTURE CAPITAL – THE NEXT BIG THING?
Annual global venture capital investments stood at $48.3 billion in 2014. Venture capital has helped a number of famous companies, such as Facebook and Twitter, to succeed, while these companies have had an impact on how we live our lives. Social venture capital is attempting to harness this effectiveness to ensure socially responsible companies alleviate some of society’s biggest struggles.
In the past, most social issues have been left for non-profit organisations and national governments to solve. But national governments are often faced with issues such as underfunding and high levels of bureaucracy. On the other hand, venture capitalists have tended to focus on finding investment opportunities that focus on providing hefty financial returns. But social venture capital meets these two opposite ends in the middle and combines the aspirations of the two.
Social venture capital can help companies provide change that is more meaningful. Technological innovation has proven especially useful in helping eradicate social issues from providing clean drinking water to connect rural small businesses with larger companies. Social venture capital has the potential to direct the wealth of available funds in an effective manner towards projects, which have a bigger social or ecological impact on local communities.
The last decade has seen a number of high profile social venture capital investments. J.P. Morgan and the Global Impact Investing Network researched 125 major funds, foundations, and development finance institutions and these groups made $46 billion sustainable investments in 2014. In 2015, one of the biggest destinations for social venture capital, India, saw these types of investments increase by 8%.
The shift is not simply in investment numbers, but also in investor attitudes. US Trust’s research highlights nearly 70% of millennials consider investments as a way to express social and environmental values. The percentage of older generations, which agreed with this notion, hovered around 30%.
National governments have jumped on board with social venture capital. In the UK, the government proposed to provide a 30% tax relief for social venture capital trusts. Changes such as these are likely to enhance the attractiveness of social venture capital, for both the investors and the entrepreneurs. Social venture capital has the potential to help solve the big social dilemmas of the 21st century.