If you're running a social venture, you're probably familiar with the challenge of raising capital for growth. And despite the Global Impact Investing Network's recent report that over $8 billion was invested by impact investors in 2012, it is still common to hear a lot of complaints from both sides: investors bemoan the lack of quality deal flow and social entrepreneurs say it's difficult to find interested investors.
Honestly, we've heard this for a very long time. Greg has worked with some of the world's most accomplished social entrepreneurs for over 30 years; Cathy is a former impact investor who has also worked extensively with pioneering impact angel groups like Investors' Circle and Toniic. We came together over a Skoll Foundation-funded project a few years ago to explore business models for social entrepreneurs. And the number one question that came up in our surveys and interviews with several hundred successful global social entrepreneurs was: Should I seek capital from an impact investor?
The answer is almost always "No". Despite our belief in the power of impact investing and the need for capital to scale, most social entrepreneurs should not seek this type of capital unless four fundamental conditions are met:
1. Your business model is stable.
How well can you demonstrate your ability to generate sufficient financial returns for a potential investor? Cash flow needs to be stable and regular; you must have a track record of recurring or growing revenue that is documented for any impact investor to look seriously. Many angel investment groups will not even consider you if you are pre-revenue. Lenders need to see your ability to pay back cash starting today. According to our research, social entrepreneurs seem to evolve their business models over five to 15 years, and income stability may take longer.
2. You have a convincing plan toward profitability.
Are you profitable? Is your potential market big enough? If not, can you make a case for future profitability based on similar business models used by others in different sectors or geographies? One of the reasons that alternative energy and mobile telephony businesses have taken off in developing markets is they are both system workarounds, driving on demographic trends and able to be plunked down in new places with little required of local infrastructure. Even then, an investor may be hesitant unless the entrepreneurial team has a strong track record of success with other ventures.
3. You don't need your cash more than an investor does.
Do you know how you will pay your investor back? Impact investors want a return and usually have a time horizon over which they need to get it. Will you have the free cash flow — cash over and above what is needed to keep your venture thriving — to provide this return? Debt will require interest and principal repayments. Equity investors may not need immediate cash, but they need a pay day. For most social ventures, the option of an initial public offering in which outside investors save the day by repaying previous equity investors is highly unlikely, and social entrepreneurs often resist the idea of their ventures being bought out by someone else.
This leaves some form of stock repurchase by your company. Where will the cash come from? By then, perhaps five or ten years after the equity investment, the pot of money your investors are expecting could be quite large. In entrepreneurship circles, they often say "cash is king." Understand the cash demands of an investment and make sure you can handle them. Don't be lured by the idea that you can figure out how to repay the investment later.
All forms of impact investment will limit your flexibility to direct your company's cash flows in the future and you need to consider if you need this cash for mission or for other reasons now, before you take the investment.
4. You, your investor, and the terms of the deal are mission-aligned.
Impact investors are definitely not one-size-fits-all. Once you've found a potential match by stage, industry, impact area and geography, you also need to consider the implications of the investment on the mission and impact of your business, and be sure you and your investor are on the same path. Root Capital, a lender to small-scale farmers in the developing world, discussed a potentially large market-rate loan from a major bank a few years ago. According to a recent Columbia Business School case study, Root Capital struggled with the implications of this kind of deal on the overall mission of the business, and what the pressure to pay it back would have on whom they would lend to, what interest rates they could give and what support services they'd be able to provide — all critical pillars of Root Capital's work.
Social entrepreneurs need to remember that impact investors want to see stability and high potential and should not be depended on for the experimentation and risk-taking that gets you to that point. That, according to Acumen and Monitor, is what "enterprise philanthropy" is for. In their recent report "From Blueprint to Scale," they argue that the early validation of new and untested business models is best supported by philanthropy, with return-seeking investors coming into the process once the model is validated.
Impact investing is not the panacea for everyone but is an incredible tool for the select group of businesses and organizations who are in the right place at the right time to start to return capital in the way that investors need it.
Insights from HBR and the Bridgespan Group