Social enterprises are improving the lives of the most disadvantaged people in the world, from the streets of Nairobi to the classrooms of India. To fuel their growth, new financing tools are needed. The Social Enterprise Exit (SEE) Fund could be a game changer. By buying minority shares in successful later-stage social enterprises, the SEE Fund will allow earlier investors to exit. This will help build a liquid equity market for social enterprises, attracting new investors and new entrepreneurial talent to this important sector.
Lack of Exit Opportunities Puts a Handbrake on the Growth of Social Enterprises
Social enterprises bring the ingenuity seen in the corporate arena to the world’s most pressing development issues. Social entrepreneurs use innovative business models to address problems, such as access to maternity care in Ugandan villages, education in India, and food security in Rwanda.
In the traditional business arena, equity is an important tool for financing companies, particularly early stage companies with uncertain cash flows. There are a few examples of social enterprises using equity funding: Sanergy, which provides sanitation services to 8,500 people in Nairobi’s slums, recently raised equity from a consortium of impact investors; Off-grid Electric, which brings electricity to 25,000 off-grid families in Tanzania, recently raised US$16 million in equity financing. However, success stories like these are few and far between.
Although equity has emerged as a promising way to fund social enterprises, a lack of exit for early stage funders is hampering the growth of equity funding in this sector. Put simply, potential funders are unsure how they will get their money back from an investment in a social enterprise, and this makes them less likely to invest in one in the first place.
JP Morgan and the Global Impact Investing Network (GIIN) conducted a survey of 125 impact investors with a total committed capital of US$10.6 billion in 2013. Investors ranked “difficulty in exiting investments” as the third biggest barrier to the growth of impact investing. They ranked “liquidity and exit risk” as the second biggest risk factor to their portfolios. There are a few social stock exchanges but they are not yet liquid.
As well as limiting the flow of capital, a lack of exit also stymies the flow of talented people into social enterprises. A lack of exit means that social entrepreneurs have little chance of receiving financial reward for success or recouping money invested to start new enterprises. It also deprives early stage social enterprises of a useful tool for attracting talented people—in commercial start-ups, equity stakes compensate for below-market salaries.
So how can the international development community remove this handbrake on the growth of social enterprises?
Catalyzing Investment in Social Enterprise: Creating a Social Enterprise Exit Fund
By creating a Social Enterprise Exit (SEE) Fund, development institutions have a real opportunity to address the issue of exit. The mandate of the SEE Fund would be to take minority stakes in successful later stage social enterprises. In the short term, the SEE Fund would improve the flow of financial and human capital into social enterprises. In the longer run, it would help spur a more liquid equity market.
Social Enterprise Exit Fund: An Instruction Manual
To set up an SEE Fund, the international development community needs to, first, rally investors; second, agree on a mandate and structure for the fund; and third, hire an experienced and driven fund manager. To seed the fund would require 5–10 funders each willing to commit at least US$50 million. This would create a pool of capital large enough to entice and recycle more early stage investment. Potential funders could include government aid programs like USAID and JICA, development finance institutions like the World Bank, and philanthropic investors like the Gates Foundation or the Skoll Foundation.
Once the SEE Fund is launched, how would it operate? The Fund would look to make 5–10 investments per year, with funds called from investors over five years. The Fund would generally take minority positions: this allows active investors to drive the growth of the business. The following investment criteria could serve as a starting point for discussion:
- Track record of social impact, with evidence of direct improvement on the lives of the poor in developing countries.
- Annual revenues in excess of US$3 million and at least break even in terms of profits.
The first criterion ensures that the social impact is central to the investment decision. The revenue of threshold of US$3 million is open to debate but is included to ensure that only mature, profitable enterprises are investable.
Supporting a Next Generation of Social Enterprises
Given that the first wave of equity investments in social enterprises began nearly a decade ago, the SEE Fund is one among a range of much-needed financial tools that will enable the growth of the social enterprise sector. Social enterprises have proven their ability to have a social impact through sustainable business models. If more financial and human capital can be attracted to social enterprises, the impact on human development could be huge.