Similar to new legal structures emerging around the world to support the growing sector of social enterprises, there are also new capital funding options that aim to better meet the needs of hybrid organizations.
While many social enterprises will do well navigating the spectrum of funding available to traditional for-profit and nonprofit organizations (explored in the first three parts of this series), depending on the circumstances, sometimes a more specialized option is a better fit.
Let’s explore four types of capital specialized for social enterprise:
Patient capital describes an approach to impact investing that Acumen pioneered to invest in companies that create sustainable solutions enabling low-income people to transform their lives.
Acumen defines patient capital as debt or equity investment capital with a long-term investment horizon of seven to 12 years, a high tolerance for risk, and a goal of maximizing both social and financial returns.
Acumen Founder and CEO, Jacqueline Novogratz, explains it as taking, “the best of the markets as well as philanthropy and aid.” The patient capital model is funded by philanthropy which allows it to go where no other capital is willing to go. This funding can help de-risk early-stage social enterprises by providing the funds needed to further validate their model and scale to the point where traditional capital is willing to step in.
As Acumen’s Accelerating Energy Access: The Role of Patient Capital report elaborates, “grants can also be used to fund operations, therefore playing a similar role to equity.” However, equity patient capital has an important role to play due to its signaling effect, meaning it helps position companies for subsequent equity raises.
One of the newest financing options on the scene, Social Impact Bonds (SIBs) are designed to fund impact outcomes. SIBs require significant upfront coordination between the key stakeholders involved:
Service providers, who receive upfront funding needed to deliver a proven intervention to a community in need,
Impact investors, who provide the capital to the service providers and later receive a return when agreed upon targets are met, and
The government, who pays investors their initial capital plus a return after the intervention has been completed and measured. The repayment of initial capital invested and exact rate of return paid is determined by how closely achieved results match those expected and outlined at the beginning.
“A social impact bond (SIB) is a contract with the public sector or governing authority, whereby it pays for better social outcomes in certain areas and passes on the part of the savings achieved to investors. A social impact bond is not a bond, per se, since repayment and return on investment are contingent upon the achievement of desired social outcomes; if the objectives are not achieved, investors receive neither a return nor repayment of principal.”
Out of all the specialized types of capital, SIBs are possibly the most controversial. On one hand, they are designed to ‘pay for success’ which means funding is tied directly to measurable outcomes. Instead of paying for programming upfront with no certainty of outcomes, SIBs allow the government to shift risk to investors and only pay for results, which are often tied to expected government cost savings.
“Seven service providers helped ex-prisoners with substance abuse and mental health issues, helping to cut reoffending rates by 9%–above a target of 7.5%. The SIB therefore delivered a financial return of 3% on capital to foundations that funded the initiative.”
Those against the idea fear that SIBs overcomplicate funding of social programs and release governments of responsibility to deliver. Even though payment only occurs when interventions are successful and the government benefits from associated cost savings, detractors argue that the combination of setting up and administering complex SIB contracts plus providing returns to investors could be more expensive in the end. Another worry is that, since the design of a SIB directly influences motivations and actions while running the intervention, it could lead to unintended consequences while trying to meet the narrow scope of deliverables outlined in a poorly designed contract.
There is still much to be explored to determine the efficacy and optimal use cases for implementing Social Impact Bonds to finance social impact.
There is another form of unique financing, called quasi-equity or revenue sharing agreements, which takes qualities from both debt and equity capital. The structure can vary, but the distinguishing factor is that repayments are linked to the future financial performance of the borrower. That is to say, when the organization generates higher income, the repayments of the loan are higher.
Daniel Epstein, founder of Unreasonable Capital explains how he defines quasi-equity as “structures of investment that take on the same win-win incentives of a normal equity investment but do not rely on “an exit” for investors to see a handsome return on their dollars.”
Epstein also explains how quasi-equity provides benefits for both investors and entrepreneurs. From the investor’s side, it allows them to invest in impactful companies that aren’t necessarily able to show a clear path to exit through acquisition or IPO (initial public offering). For entrepreneurs, it provides the opportunity to align investors with the best interests of the company, since they will only receive a return when the company does well. For both sides, quasi-equity is a financing solution that offers more flexibility as an alternative to the long-term commitment of a straight-equity deal.
PRIs and MRIs are a funding option that allows foundations who typically fund nonprofits to invest in for-profit companies with a social mission. Not every foundation supplements their giving with PRI or MRI offerings, but when available, it can provide social enterprise with less expensive capital than traditional debt or equity.
Mission-Related Investments (MRI): MRIs are financial investments made in either for-profit or non-profit enterprises with the intent of achieving mission-related objectives and normally earning market-rate financial returns. Financial instruments in this category include bonds and deposits, loans and mezzanine capital, public equity, private equity, and venture capital investments.
Program-Related Investments (PRI): PRIs are investments made to charities as well as for-profit and non-profit enterprises to further the Foundation’s program objectives, but, unlike grants, they also aim to generate financial returns, with a tolerance for below-market returns.
Resources to learn more about Program-Related Investments
Danielle Sutton is the Content Animator at Acumen where she surfaces stories to inspire and activate social entrepreneurs. In an age of information overload, she believes in learning 'the right thing at the right time' to intentionally design impactful social enterprises. You can usually find Danielle digging into the Acumen course library, playing in the mountains, or exploring marketing on The Sedge blog.