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1 >KOLL CENTRE FOR >OCIAL ENTREPRENEUR>HIP
>KOLL CENTRE FOR >OCIAL ENTREPRENEUR>HIP WORKING PAPER NOTHING VENTURED, NOTHING GAINED ADDRE>>ING THE CRITICAL GAP> IN RI>K-TAKING CAPITAL FOR >OCIAL ENTERPRI>E WITH LOREN BERLIN AND KEELY >TEVEN>ON NOTHING VENTURED, NOTHING GAINED: ADDRE>>ING CRITICAL GAP> IN RI>K-TAKING CAPITAL FOR >OCIAL ENTERPRI>E KOLL CENTRE FOR >OCIAL ENTREPREN EUR>HIP INTRODUCTION THE WORLDWIDE GROWTH OF >OCIAL ENTERPRI>E I> THREATENED BY A DEARTH OF CAPITAL. >OCIAL ENTERPRI>E> NEED INVE>TMENT TO GROW AND TO INNOVATE – INVE>TMENT THAT TAKE> ON THE RI>K OF THE ENTERPRI>E. THI> KIND OF CAPITAL CANNOT EA>ILY BE PIECED TOGETHER FROM LIMITED GRANT>, CONVENTIONAL EQUITY AND ILL-FITTED DEBT. A> INCREA>ING NUMBER> OF >OCIAL ENTREPRENEUR> AND MI>>ION-BA>ED FINANCIER> >EEK TO ENTER THE FIELD, A QUE>TION ARI>E>: CAN THE >ECTOR DEVELOP NEW IN>TRUMENT> AND >TAKEHOLDER RELATION>HIP> TO MEET THI> CHALLENGE? 04 1. DEFINING THE PROBLEM: THE CAPITAL GAP Key cncepts f >cial Enterprise and the capital market that serves it 06 2. THE NEED Transfair Pura Vida Cffee >cial innvatin demands innvatin in capital frmatin 03 ACKNOWLEDGEMENT> Abut the authrs Readers and cntributrs JED EMER>ON, TIM FREUNDLICH AND JIM FRUCHTERMAN UNIVER>ITY OF OXFORD >A D BU>INE>> >CHOOL ABOUT THE AUTHOR> Jed Emersn is a >enir Fellw with Generatin Fundatin, f Generatin Investment Management and a Visiting Fellw with the >kll Centre at the >aïd Business >chl, Oxfrd University. Tim Freundlich is Directr, strategic develpment, at Calvert >cial Investment Fundatin, n the steering cmmittee f www.xigi.net and a funding Principal f Gd Capital, LLC. Jim Fruchterman is Funder and CEO f Benetech and a funding bard member f the >cial Enterprise Alliance. Lren Berlin and Keely >tevensn cntributed t research, editing and writing the text. Lren is an MBA candidate at the Kenan-Flagler Business >chl at UNC-Chapel Hill and has been an intern bth at Calvert Fundatin and >hreBank. Keely graduated frm the MBA prgramme at Oxfrd University’s >aïd Business >chl, having previusly wrked at the >kll Fundatin, and is currently an Acumen Fund Fellw. Jed Emersn jed.emersn@generatinim.cm Tim Freundlich timthy.freundlich@ calvertfundatin.rg Jim Fruchterman jim@benetech.rg Lren Berlin lren.berlin@gmail.cm Keely >tevensn keelystevensn@gmail.cm READER> AND CONTRIBUTOR> Jacqueline Nvgratz (Acumen Fund), Greg Ratliff (Aspen Institute), Michele Giddens (Bridges Cmmunity Ventures, Lndn), >hari Berenbach (Calvert Fundatin), >teve Mdy (Calvert Venture Partners), Ben Binswanger (Case Fundatin), Cary >teinbeck (Capricrn Investments), Martin Burt (Fundación Paraguaya de Cperación y Desarll, Paraguay), Gary Mulhair (Glbal Partnerships), Kevin Jnes (Gd Capital), Chuck Lief (Heartland Grup), Agnes Dasewicz and Harld Rsen (IFC), Patrick Malney (independent), Duglas >lmn (independent), Dminic Kulic and Wdy Tasch (Investrs Circle), Charly Kleissner (KL Felicitas Fundatin), Jill Tucker and Julia Nvy-Hildesley (Lemelsn Fundatin), Jeremy Nichls (New Ecnmics Fundatin, Lndn), Peter Wheeler (New Philanthrpy Capital), Vanessa Kirsch (NewPrfit), Kim >mith (New>chls Venture Fund), Clara Miller (Nnprfit Finance Fund), >teve Hardgrave (Omidyar Netwrk), >ean Cughlin (One Fundatin, Du

2 blin), Penelpe Duglas (Pacific C
blin), Penelpe Duglas (Pacific Cmmunity Ventures), Jeannine Jackes (Partners fr the Cmmn Gd), Cynthia Gair (REDF), Jackie Khr (PrVenEx, Rckefeller Fundatin), Melinda Tuan (Rckefeller Philanthrpic Advisrs), Je Glrfield (R>F), Rick Aubrey (Rubicn Ventures), Pamela Hartigan (>chwab Fundatin, Geneva), Ed Diener and Christy Chin (>kll Fundatin), Mark Van Ness (>cial Enterprise Lan Fund), Harish Hande (>lar Electric Light Cmpany, India), Jhn Elkingtn (>ustainAbility, Lndn), Kim Alter (VirtueVentures) and the www.xigi.net cmmunity. 09 3. THE CAPITAL MARKET LAND>CAPE Private equity Angels: start-up funding >cial and cmmunity develpment venture capital funds: grwth funding Nnprfit and fundatin “PRI” and “MRI” equity investrs Debt/lans Traditinal banking institutins Fundatin PRI debt Bnds, investment ntes and nntraditinal lending institutins Equity-like capital Grants 18 4. >OLUTION> >lutin 1: Change the terms f engagement and rules f the game >lutin 2: By all means, use philanthrpy t unlck market- based capital if that is expedient >lutin 3: Institutinalise a new kind f capital 21 5. CAPITAL CONCLU>ION> 22 RE>OURCE> >elected nline resurces Bibligraphy NOTHING VENTURED, NOTHING GAINED: ADDRE>>ING CRITICAL GAP> IN RI>K-TAKING CAPITAL FOR >OCIAL ENTERPRI>E DEFINING THE PROBLEM THE CAPITAL GAP KOLL CENTRE FOR >OCIAL ENTREPREN EUR>HIP >cial enterprises are creating new and exciting slutins t sciety’s prblems. Increasing numbers f ventures are being launched t address challenges – frm pverty t health, educatin t the envirnment. Despite many f these emerging successes, mst f these enterprises face a cmmn prblem: inability t secure grwth capital. >pecifically, there is an abject lack f risk-taking capital. The result is that prven scial enterprises are starved f the capital required t grw t an apprpriate size. Yet there is als an increasing number f missin-based investrs lking fr pprtunities that g beynd traditinal grants and int the realm f debt and equity, and are willing t cnsider new mdels f risk and return. Hwever, these tw grups are struggling t find ne anther. Our cllective inability t transcend this capital challenge limits the effectiveness f bth entrepreneur and investr. Mre imprtantly, the lack f apprpriate capital means needed services, supprt and pprtunities remain beynd the grasp f many in the U> and Eurpe, nt t mentin the develping wrld. With this paper we want t help mve the discussin frward tward diverse slutins t the grwth capital challenge facing many high- perfrming scial enterprises thrughut the wrld. KEY CONCEPT> OF >OCIAL ENTERPRI>E AND THE CAPITAL MARKET THAT >ERVE> IT By “scial enterprise” we mean the applicatin f business mdels and acumen t address scial issues, whether thrugh nnprfit r fr-prfit crprate structures. The capital cunterpart t scial enterprise, “scial finance”, may be understd as a brad area wherein varius frms f capital are structured in ways that cnsider and value bth financial perfrmance and scial value creatin. Put simply, between the traditinal JED EMER>ON

3 , TIM FREUNDLICH AND JIM FRUCHTERMAN UNI
, TIM FREUNDLICH AND JIM FRUCHTERMAN UNIVER>ITY OF OXFORD >A D BU>INE>> >CHOOL apprach t financing nnprfit ventures thrugh grants, fundraising and limited use f debt, and the traditinal apprach t financing fr-prfit ventures thrugh market-rate private equity and debt, there is a funding gap int which an increasing number f scial enterprises are falling. Organisatins that are grwing fast need capital t increase prductin capacity and develp their prducts and markets, as well as fr everyday wrking expenses. Debt is usually nly applicable fr certain needs. Equity r equity-like capital frms the majrity f this capital need. In the case f nnprfits, grants can play a rle. >tart-up nnprfit crpratins (which can be ne frm f scial enterprise) are usually able t access gifts t supprt demnstratin prjects and innvative strategies. In fact, many fundatins pride themselves n making grants t the “new” r the “innvative.” While nt necessarily an easy prcess, the fact remains that in the U> and Eurpe funds are available t catalyse, incubate, launch and perate scial enterprises at a small scale. Many scial entrepreneurs attain initial success by piecing tgether small grants f a few thusand t a few hundred thusand dllars in rder t meet their initial start-up requirements. Hwever, grwth capital (als knwn as “expansin capital”) remains difficult fr entrepreneurs t access. In many cases it is simply unavailable. >tart-up fr-prfit crpratins (which may be scial enterprises) are able t access funding frm “friends, family and fls” (as the saying ges), cbbling tgether enugh t test ut their new business cncept r strategy. In the same manner as their nnprfit cunterparts, they may find funds t get ging, demnstrate prf f cncept and – if they were traditinal, fr-prfit crpratins fcused upn prfit-maximising strategies – g n t cmpete fr private equity investments mixed with sme level f debt. If, hwever, they are scial enterprises – fr- prfit crpratins that balance financial returns with a scial missin – they face a similar dilemma t their nnprfit cusins. Fr-prfit scial enterprises f this srt ften find they are able t raise initial, launch funding, but lack access t expansin capital that des nt seek a full, cnventinal market-rate return n investment. The bttm line is that in all t many instances neither the fr-prfit nr the nnprfit scial enterprise is able t secure adequate capital t enable it t mve frm start-up t the next level f develpment. The apprpriate frm f capital t supprt the enterprise’s develpment simply des nt exist at any scale. It is wrth nting that venture capital and early private equity is by its very nature cmpetitive and scarce, even in the relatively mature U> markets. In Eurpe it is even scarcer and in the develping wrld almst nn-existent. Althugh there is certainly grwing interest in building up equity access fr cnventinal small and medium- sized enterprises, scial enterprises, with their uncnventinal risk-return mdel, will still find grwth capital hard t access. T

4 herefre, the 800-pund grilla in
herefre, the 800-pund grilla in the scial enterprise capital market has becme the very real absence f expansin stage capital with a true risk-taking prfile. What makes fr success in traditinal business develpment is access t funds that allw the firm t grw and take chances. This same capital is equally necessary fr a thriving scial enterprise market. This is nt t say that the brader, mre cnventinal “scially respnsible” businesses and certain scial enterprises that perfrm well financially cannt tap market rate capital at sme level. The fact that these scially mtivated enterprises exist is t be applauded, and when these business mdels are cnducive, capital fllws cnventinal returns, but the cre f scial enterprise activity falls utside the cnventinal definitin f market-rate, risk-adjusted returns. Furthermre, we are nt talking abut capital such as: asset-backed real estate and facilities funds mre easily financed by debt receivables financing, r factring, that is increasingly being used in scial enterprise business mdels small, manageable allcatins f funds frm fundraising dinners, nr the peridic “large grant” frm ne-ff dnrs. What we are talking abut is the need fr large chunks f capital that play the rle f equity capital (r “equity-like” capital, in the case f nnprfits) that may then be used by scial enterprises t aggressively grw and replicate their peratins, penetrate new markets, build intellectual prperty, brand presence and s frth. In the fllwing chapters we will explre why this capital gap exists and why this type f capital is s critical, explain what frms f capital are available, and put frward sme ideas regarding capital innvatins. NOTHING VENTURED, NOTHING GAINED: ADDRE>>ING CRITICAL GAP> IN RI>K-TAKING CAPITAL FOR >OCIAL ENTERPRI>E KOLL CENTRE FOR >OCIAL ENTREPREN EUR>HIP THE NEED Cnsider the fllwing scenari: Yu are the seemingly successful leader f an exciting break-even scial enterprise. Yu’ve prven yu can deliver a crucial scial utcme fr ne- third the cst f traditinal appraches, and yu’ve just cmpleted yur first tw years f successfully demnstrating the effectiveness f yur apprach at a lcal level. Yu have an ambitius plan t replicate yur venture mre widely acrss yur regin and then the entire cuntry, and yu need expansin capital. Where d yu get it? Yu can’t generate it frm yur revenues. While yu have shwn the viability f yur enterprise, yu are just leaving the start-up stage, which means yu’re prbably perating at breakeven and are undercapitalised at that. Trying t accumulate retained earnings t fund grwth will lwer the quality f yur prduct and undercut yur successful mdel. Yu can’t brrw the funds yu need. N The third-party payers fr yur scial utcmes are interested in buying yur services, but nt in investing t expand their availability t ther ppulatins. They are als risk-averse, s may delay buying yur prduct until yu’ve prven it in their area with ther peple’s mney. The traditinal suppliers f equity financing, angel investrs and venture capitalists, lk at yur plan tî

5 ® be break-even n a reginal and th
® be break-even n a reginal and then natinal basis and dn’t understand why yu’re talking t them at all. N chance fr a 35%-plus annual cmpund rate f return fr the risk they’d be taking. And, if yu’re at the helm f a nnprfit scial enterprise, nnprfit legal structure desn’t allw yu t take n equity investments anyway. Finally, yu’re asking fr mre capital than yur existing lcal capital prviders are willing t supply. As the CEO yu are already spending mre than half yur time raising funds fr the lcal venture, perhaps piecing tgether small perating grants frm traditinal dnrs averse t funding verheads. Yur early stage cnnectins are lng tapped ut. Hw are yu nw ging t raise five times that amunt t supprt a reginal apprach and 20 times that fr a natinal launch? Yur lcal funding base desn’t have that kind f funding capacity. JED EMER>ON, TIM FREUNDLICH AND JIM FRUCHTERMAN UNIVER>ITY OF OXFORD >A D BU>INE>> >CHOOL >, yu spend 18 mnths scraping tgether enugh mney t d a credible launch in the rest f the regin, while peple elsewhere d nt get the benefit f yur innvative apprach. Opprtunities pass yu by, key members f staff mve n t greener pastures and dreams f a natinal rll-ut slip further and further int the future. This is nt just hypthetical, it is the stry f an increasing number f high-perfrming scial enterprises – such as these successful scial entrepreneurs wh have struggled t find a new kind f uncnventinal capital. TRA N>F AIR Paul Rice funded TransFair U>A in 1998 t bring the Fair Trade mvement t the U>. TransFair is the primary certifier f Fair Trade cffee in the U>, and earns apprximately 8 cents per pund f cffee that it certifies. The grwth curve f Fair Trade cffee is dramatic. There are similar grwth pprtunities in ther Fair Trade cmmdity markets, such as bananas and chclate. Like many grwth cmpanies, TransFair nw needs t invest t build capacity and sustain its grwth. Like a fr-prfit, it wuld use much f this capital t enhance market demand. Yet, because it is rganised as a nnprfit rganisatin, it has fund raising mney very difficult. Plus, helping pr farmers in the develping wrld build mre incme by investing in demand generatin fr Fair Trade cffee in the U> is nt smething that mst fundatins “g fr” r seem t understand. TransFair has been able t brrw sme f its needed capital, but nw that it has U>$4m f debt n its balance sheet, it is unable t brrw mre. >ince nnprfits cannt ffer equity in the same fashin as fr-prfit ventures, there is n equity n TransFair’s balance sheet t prvide leverage fr mre debt. Rice and his team cntinue t seek grants t prvide the grwth capital they need, and find it meeting nly a quarter f their planned capital requirements. A different way TransFair culd raise the capital wuld be t request grants fr direct incme supprt fr pr farmers. These kinds f grants culd be thught f as “scial gd cnsumptin” – a fundatin paying funds mre r less directly t the pr farmer t

6 deliver pennies n the dllar f
deliver pennies n the dllar f impact. It turns ut this kind f funding is easier t get than investment capital, even thugh TransFair can shw that U>$1 invested in demand generatin fr Fair Trade cffee results in seven dllars f increased incme fr pr farmers. This is a paradx f the nnprfit funding sectr: it’s ften easier t find a grant that will deliver U>$0.85-0.90 f value (after verhead and prgramme csts, assuming a very lean peratin) than it is t get a grant that will deliver U>$7 per dllar invested. PURA VIDA COFFEE Pura Vida has a retail apprach t Fair Trade cffee: it perates cffee shps, mainly n cllege campuses, that sell nly Fair Trade cffee. Pura Vida’s prblem is success: its cffee shps are incredibly ppular and there is increasing demand t establish mre utlets. Each requires a significant investment at the utset, yet the financial returns are mre than sufficient t supprt this investment. Pura Vida’s riginal plan was t brrw mney t finance its expansin. Like TransFair, nce it had several millin dllars f debt, it culd n lnger brrw. Yet its market is expanding and the timing is crucial. Pura Vida’s slutin has been t create a fr- prfit affiliate with an unusual gvernance structure. The nnprfit parent wns a cntrlling interest in the frm f a class f “super-cmmn” stck. Debt hlders in the nnprfit have been cnverted int preferred stck hlders in the fr-prfit affiliate. Pura Vida has pulled ff this debt-t-equity cnversin while maintaining missin cmmitment thrugh the super-cmmn vting cntrl f the fr-prfit affiliate. The new challenge is t find investrs t buy mre f the preferred stck t prvide the grwth capital Pura Vida needs t cntinue t grw. On the surface, this culd be the challenge facing any successful fr-prfit enterprise – the difference is that the risk/return structure creates a prpsitin unattractive t cnventinal capital. >OCIAL INNOVATION DEMAND> INNOVATION IN CAPITAL FORMATION TransFair and Pura Vida are tw examples f scial innvatin. The cre cncept is that Fair Trade cffee is a mre effective vehicle fr imprving the lives f cffee wrkers than traditinal gvernment prgrammes r charitable incme supprts. T truly achieve the ptential f this scial mvement, these grups (and grups like them) need t grw. The prfile f the expansin capital these archetypal entrepreneurs need is relatively straightfrward, but nt cnventinal in traditinal capital market terms (whether grants r equity r debt). These investment pprtunities require a new kind f capital, with NOTHING VENTURED, NOTHING GAINED: ADDRE>>ING CRITICAL GAP> IN RI>K-TAKING CAPITAL FOR >OCIAL ENTERPRI>E KOLL CENTRE FOR >OCIAL ENTREPREN EUR>HIP a new set f expectatins frm bth the scial entrepreneur and the investr. The venture needs t be able t leverage debt. Lenders shuld be able t see this capital as a true risk layer, which means it has t be uncllateralised and nt put a drain n the cash flws during executin f the business mdel. And, it has t be patient capital. If it’s structured as a liability (deeply subrdinate risk-ta

7 king debt), then it must have interest
king debt), then it must have interest and principal payment hlidays, and/r be repayable thrugh ryalties, revenue r prfit nly. But, mre imprtantly than its exact character and structure, the cre capital requirement is t establish a new set f expectatins between entrepreneurs and investrs. This pertains t linkages n agreed utcmes fr repayment f principal and/r returns, including frbearance and/ r frgiveness if certain dwnsides (r even upsides) ccur. And this means investrs must becme true risk participants in the enterprises they finance. Finally, this isn’t traditinal equity (r equity-like) capital. Althugh there may well be pprtunities fr healthy returns – even, n ccasin, cnventinal market rate risk-adjusted returns – by and large these hybrid prpsitins, whether they be fr- prfit r nnprfit ventures, have internalised scial csts in their business mdels which may decrease financial returns. Put anther way, there is ften a “a premium fr ding gd.” Philanthrpically-minded stakehlders shuld have n truble recnciling themselves t these csts, but mre cnventinal investrs might. This attempt t shift the risk-return paradigm has t be addressed psitively. Yes, sme enterprises need utright grants. Yes, sme ther enterprises can supprt very clse t, if nt actually deliver, risk-adjusted cnventinal market rate returns. But, there is a grwing middle grund f enterprises that are structured fr ptimised delivery f impact and strng business mdels that land smewhere in the middle . The clearer we make this, the better. But, t cmplicate matters, this middle grund is highly variable frm regin t regin. Put simply, there are radically different challenges t attracting capital, cnducting business and blending scial csts int enterprise mdels between >ctland and the >udan. And what f demand? Is there truly a hunger fr this type f capital amng maturing scial enterprises? The jury is still ut, but anecdtal evidence des seem t supprt the prpsitin. Tw cases in pint: a survey cnducted by the >cial Enterprise Alliance in Nrth America, in autumn 2003, fund rughly U>$58m in appetite fr expansin capital amng 77 maturing scial enterprises. In summer 2006, Gd Capital fund a need fr U>$50m acrss just 25 enterprises fitting a narrw prfile (U>-based with brad U> and glbal impact and peratins, specifically lking fr equity and equity-like capital fr expansin stage develpment). If sciety is serius abut psitive change, we must examine the mst effective ways t achieve it. Innvatin in the allcatin f capital fr scial change is needed if existing vehicles are falling shrt f accmplishing ur bjectives. Mre than anything else, what is needed at this time – rather than studies – is actin. There is prfund appetite n the demand side. There are certain resurces available n the supply side. What is missing? It is the affirmative executin f institutinalizatin that cnnects the surces and uses f expansin capital t scial enterprise glbally. Of curse, the legal structure f the rganisatin will als differ depending upn the cuntry in which the c

8 rpratin has its incrpratiî
rpratin has its incrpratin. >urce: Teaching them t Fish cnference presentatin, 2003, >cial Enterprise Alliance, and data prvided by Wes >elke, prtfli analyst, Gd Capital. JED EMER>ON, TIM FREUNDLICH AND JIM FRUCHTERMAN UNIVER>ITY OF OXFORD >A D BU>INE>> >CHOOL THE CAPITAL MARKET LAND>CAPE HIGH INVOLVEMENT CHARITABLE Venture Venture capital Traditinal LOW INVOLVEMENT Befre explring slutins t the gap in risk-taking grwth capital fr the scial enterprise sectr, we must first understand the financing landscape as it currently exists. This chapter will present a brad but necessarily anecdtal survey f the field. There are several types f capital available t scial enterprises, and there are a large variety f actrs in the scial capital market serving them. 3 As the chart shws, there are a number f axes acrss which these players and capital instruments may be mapped. The centre vertical line indicates where mst scial enterprise investment resides, regardless f the enterprise’s legal status as fr-prfit r nnprfit. Whether the financing is relatively lw r high engagement is determined by a given investr’s mdel. The degree t which the risk/return paradigm drifts frm “charitable” t “cmmercial” depends n the business mdel, but nt necessarily n the enterprise structure as a fr- prfit r nnprfit entity. There are three types f capital that, in the aggregate, best epitmise characteristics f the gap we are discussing. First, there are Cmmunity Develpment Venture Capital (CDVC) funds, which generally fall just t the left f where “venture capital” is placed n the chart. But CDVC funds are limited t fr-prfit enterprises, with a particular fcus n cmmunity develpment jb creatin, and tend t target the cmmercial end f the spectrum f risk/return. Therefre they nly nibble at the edges f the lin’s share f scial enterprises, which are largely nnprfit, with diverse business mdels beynd cmmunity develpment and falling alng a spectrum f risk/return all the way t mdels >cial capital markets are what fill the gaps mst nnprfits experience between revenues they can earn by prviding services r selling prducts fr a fee, and ttal utlays. Meehan, W., Kilmer, D. and O’Flanagan, M. (2004), Investing in >ciety , >tanfrd >cial Innvatin Review, pp 34-43. >ee als Grants, Debt and Equity: The Nnprfit Capital Market and ts Malcnten ts in New >cial Entrepreneurs (1996), REDF 10 NOTHING VENTURED, NOTHING GAINED: ADDRE>>ING CRITICAL GAP> IN RI>K-TAKING CAPITAL FOR >OCIAL ENTERPRI>E KOLL CENTRE FOR >OCIAL ENTREPREN EUR>HIP that require significant grant r dnr mney t functin. >ecnd, there is “equity-like” capital, the clsest institutinalised example f which, in the U> at least, is Equity Equivalents. These srts f investment fall still farther t the left f the abve strategies, and are seen much clser t the lw engagement end f the spectrum. Third, a number f venture philanthrpy funds with 100% dnr- surced mnies have experimented with capital alng the middle vertical (New>chls Venture Fund and Acumen Fund perhaps best epitmise these in the U>). In the table belw, REDF (frmerly the Rberts Enterprise Develpment Fund) u

9 tlines ne versin f the cnce
tlines ne versin f the cnceptual landscape f financing n the nnprfit side. It ges s far as t psit an apprpriate mix f capital types and cntrasts thse with actual capital prprtins. A number f cnclusins may be drawn frm this table, nt the least f which is that scial enterprises are neither highly nr effectively leveraged. But cntrasted with the fact that grants, at their current levels, are a relatively finite surce f capital, which is largely ill suited t scaling-up enterprises that are rapidly expanding, a dire picture f undercapitalisatin takes shape. Let us explre in greater detail the varius instruments currently available in the capital market. PRIVATE EQUITY Equity investrs in the fr-prfit slice f the scial enterprise sectr prvide risk capital t new funds and enterprises that generate scial and envirnmental impacts as well as ecnmic value and returns. 4 “Equity” generally refers t such financing vehicles as cmmn and preferred stck. 5 >cial enterprises with fr-prfit legal structures can raise equity frm finance prviders wh are aligned with the gals f the venture t create scial and envirnmental value. Equity typically takes n the fllwing characteristics: lng-term investment with unrestricted use f resurces t facilitate significant grwth wner/partner prvider flexible/tailred uncllateralised management supprt repayment frm grwth. Nt all rganisatins can issue equity due t their nnprfit status. Hwever, the UK’s Department f Trade and Industry has apprved a new legal frm fr scial enterprises, the Cmmunity Interest Cmpany (CIC). Primary legislatin was apprved within the Cmpanies (Audit, Investigatins and Cmmunity Enterprise) Act 2004 and secndary TABLE 1: IN>TRUMENT> OF THE NONPROFIT CAPITAL MARKET FACTOR> Available fr Husing Available fr Nnprfit **** Yes Yes Yes Very limited Yes Very limited ** , Variable rates Yes Yes *** Prgramme Related Investments. >ee discussin t fllw ** Return On Investment *** We refer here t equity available fr nnprfit managed business – nt c-peratives **** Estimates f Apprpriate and Present Mix refer specifically t the nnprfit business sectr and nt t fund/capital diversificatin in the affrdable husing real estate market. Emersn, J., >pitzer, J., Wrld Ecnmic Frum 2006 Article. Cmmn stck is acquired thrugh the purchase f shares. It cmes with n guaranteed rates f return but des allw the investr t exercise vting rights and, in sme cases, hld a seat n the bard r apprpriate cmmittees f the crpratin. Preferred stck prvides a set rate f return per share but des nt allw fr full vting r ther rights. Preferred stck ften has a “put” r cnversin date when the stck may be liquidated, whereas cmmn stck has n “maturity date” and is usually bught and sld at will. 11 JED EMER>ON, TIM FREUNDLICH AND JIM FRUCHTERMAN UNIVER>ITY OF OXFORD >A D BU>INE>> >CHOOL legislatin gverning CICs came int effect n 1 July 2005. This frm – the nly new cmpany structure t be intrduced in the UK in the past 100 years – shuld make it easier fr scial enterprises t raise the financ

10 e they need. CICs can, fr example, is
e they need. CICs can, fr example, issue preference shares. Other cuntries, such as >uth Africa, are als lking int similar mdels. The table belw prvides examples f several UK scial ventures that have issued equity in the past decade. >me f the challenging issues fr-prfit scial enterprises face when raising equity include: funders/managers fear lsing cntrl due t changing wnership structure ptential fr missin drift managers r bard unfamiliar with equity, due t the “philanthrpic” crss-ver lack f exit strategy/limited liquidity due t reduced returns unacceptable risk/return trade-ffs fr ecnmic value creatin lack f expertise t supprt management capacity alngside investment t g t scale Mst imprtantly, ne f the majr limitatins f equity is that mst equity investrs remain prfit seekers, and actins taken by the cmpany t maximise prfits may cmprmise its scial missin. Even if fund managers are nt prfit maximisers, these funds have, t date, been targeting investments with the highest ptential fr ecnmic value creatin. Thus, a large gap in the market remains fr thse scial enterprises that have created utcmes that are mre balanced between ecnmic and scial value creatin, r even emphasise missin ver ecnmic prfit. >OCIAL EQUITY I>>UE> (UK) ORGANI>ATION A c-perative lending sciety ffering ethical investment in Fair Trade with develping cuntries EPC buys prperties and develps them as centres that bring charities, c-peratives, cmmunity and campaign grups tgether under ne rf t share skills and ideas Traidcraft A Fair Trade cmpany that wrks with mre than 100 prducer grups, helping them t build sustainable livelihds fr the future The UK’s largest Fair Trade ht drinks cmpany Creates renewable energy schemes and is the first UK c-perative t wn wind turbines >urce: Nichlls, A., lecture, >aïd Business >chl, Oxfrd University, April 2005 DATE 1995; 1996; 1997; 1999; 2001; 2002; 2003; 2004 1999; 2002 1984;1986;1991; 2002 2004 1996; 1997 TYPE Bnd (5yrs) >hares >hares >hares IP> >hare AMOUNT (£M) 8.3 (1.0; 1.0; 1.3; 1.0; 1.0; 1.0; 1.0; 1.0) 5.5 (1.3; 4.2) 21% t inst. investrs 5.15 (0.3; 1.0; 0.6; 3.25) 5.0 Funders retained 40.5% 4.8 (3.1; 1.7) 12 NOTHING VENTURED, NOTHING GAINED: ADDRE>>ING CRITICAL GAP> IN RI>K-TAKING CAPITAL FOR >OCIAL ENTERPRI>E KOLL CENTRE FOR >OCIAL ENTREPREN EUR>HIP There are interesting experiments and ideas regarding hw best t break dwn this capital mismatch. As fr implementatin, several rganisatins are advancing new appraches: Trids Bank nw manages Ethex, an ethical stck exchange where scial enterprises can flat shares in the knwledge that investrs will hld similar ethical values. But, n this alternative exchange platfrm, liquidity remains ne f the key cnstraints. The Business Alliance fr Lcal Living Ecnmies initiative in the U> is wrking t catalyse lcal equity exchanges that can be better rted in patient capital, and mre balanced return prpsitins in line with many scial enterprises. Each f these prjects represents effrts t prvide a mre effective platfrm fr cnnecting missin- driven ventures with the capital they need t grw. Equity inve

11 stments in scial enterprises are beg
stments in scial enterprises are beginning t find their way t emerging markets as well. Fr example, >hreCap Internatinal (“>hreCap”), an affiliate f Chicag-based >hreBank, is an internatinal private equity cmpany “seeking t invest in small business banks and regulated micrfinance institutins in develping and transitinal ecnmies.” In 2005 >hreCap invested, r cmmitted t invest, U>$4.1m in XacBank in Mnglia, Eskhata Bank in Tajikistan and BRAC Bank in Afghanistan, increasing the seven-year-ld firm’s ttal prtfli t U>$9.5m in eight institutins acrss Africa, Asia and Eastern Eurpe. T date, >hreCap has achieved bth impressive financial and scial returns. The cmpany has an average return n assets f 23% and an average return n equity f 18%. The cmpany’s impact includes the grwth f the institutins in which it invests – enabling them t cllectively lend U>$200m in new lans t 207,000 micr and small brrwers. The brrwers will use that U>$200m t start small businesses, pay fr their children t attend schl, secure safe husing, and generally stabilise and imprve their lives. ANGEL>: >TART-UP FUNDING >cially mtivated angel investrs are imprtant actrs in this sphere. A recent McKinsey reprt analysing the experience f Investrs’ Circle in the U> fund that very little sacrifice is required in terms f financial returns when it cmes t scial purpse equity investing int fr-prfit enterprises. Investrs’ Circle is a grup f 100 U> angel investrs that screens 350-700 scial ventures per year. These annual screenings usually result in 50-70 deals being presented t the netwrk by primarily fr-prfit entities. Thus far, members f Investrs’ Circle have invested U>$90m in 150 equity deals since 1992 and the financial returns generated by member funds have ranged between 5% and 18% – which is nly slightly lwer than that f ther early-stage angel investrs in traditinal fr-prfit private equity investments . With recent emphasis being added n “patient capital”, Investr’s Circle is entering the scial enterprise space mre psitively by vertly examining the risk/return and time hrizn issues f angel investing. >OCIAL AND COMMUNITY DEVELOPMENT VENTURE CAPITAL FUND>: GROWTH FUNDING >cial venture capital funds generally target cnventinal market rates f return but fcus n industries with inherent scial benefits, such as renewable energy, envirnmental technlgies, healthcare and educatin-related infrmatin technlgies. Examples include Fursme Investments Limited, Cmmns Capital, Calvert Venture Partners, Expansin Capital Partners and >lstice Capital. 10 One f the earliest pineers f scial finance is a Dutch financial grup funded in 1968, Trids Bank. Alngside a suite f many ther financial services, Trids’ Innvatin Fund BV was designed as a venture capital vehicle fr cmpanies fcused n culture, “wellness”, renewable energy, rganic fd, Fair Trade and clean technlgies. As previusly mentined, anther type f venture capital (r “VC”) fund in the U> targets cmmunity develpment-related enterprises that aim t create jbs, supprt wnership by marginalised cmmunities r spur lcal ecnmic d

12 evelpment in impverished areas. E
evelpment in impverished areas. Examples f this type f fund include: Pacific Cmmunity Ventures (PCV), Baltimre Venture Capital Fund, Bridges Cmmunity Ventures, The Abell Fundatin Venture Fund (equity is 15% f its prgramme-related investment – r PRI – prtfli), Cmmunity Develpment Venture Capital Alliance, Mrin Institute, and Cmmunity Develpment Venture Capital Alliance Central Fund. 11 In a May 2006 paper, Pacific Cmmunity Ventures’ executive directr, Penelpe Duglas, made a cmpelling argument fr the creatin f a sub-asset class within private equity. 12 PCV has demnstrated that it can prvide cmpetitive Emersn, J. (2000), Riding the Bleeding Edge presents the visin f a nnprfit stck exchange and framewrk fr tracking scial equity. Prviding Capital and Expertise t Financial Institutins >erving Micr and >mall Businesses (>hreCap Internatinal & >hreCap Exchange, Annual Reprt 2005) http://tinyurl.cm/23fsk4. Carden, >.D., Darragh, O. (2004), A Hal Fr Angel Investrs, The McKinsey Quarterly In 2002, the number f venture 10 Olsen, >., and Tasch, W., (editr), Missin-Related Investing, Investrs’ Circle http://tinyurl.cm/247v2q 11 www.cdvca.rg 13 JED EMER>ON, TIM FREUNDLICH AND JIM FRUCHTERMAN UNIVER>ITY OF OXFORD >A D BU>INE>> >CHOOL financial returns and risk diversificatin, alng with cmmunity benefits. It als draws attentin t histric returns f funds managed by Kentucky Highlands and Castal Enterprises, at 18% and 17% respectively. Beynd micrfinance, there remains a gap in equity funds fr ther scial enterprise industries glbally. One newly created fund trying t address that gap is Aavishkaar. Aavishkaar is targeting 32% per investment return by prviding financial and business building supprt t grwth stage micrventures serving the develpment f rural and semi-urban India. Additinally, the energy sectr has several equity funds created t stimulate future investment capital frm cmmercial finance prviders. The IFC’s Phtvltaic Market Transfrmatin Initiative launched in 1998 with U>$25m f flexible financing, including equity, aimed at prmting the sustainable cmmercialisatin f slar technlgy in develping cuntries. It has cmmitted t nine prjects in India, Kenya and Mrcc. It is imprtant t nte that these funds serve a relatively small percentage f the market f scial enterprises because their requirements fr financial returns usually take pririty ver thse f scial returns. Fr example, Fursme Investments Limited is an investment management cmpany that manages tw private equity funds in early stage and develpment stage grwth businesses, and it seeks businesses with a measurable benefit t peple’s lives. Fursme reprts that 10-20 deals per year cannt be financed because the scial missin wuld reduce the amunt f expected financial return. 13 Bridges Cmmunity Ventures turned away 40 applicatins fr scial enterprise funding in 2004 fr the same reasn. This is a cmmn theme fr equity investrs, which leaves a huge number f rganisatins withut access t start-up and expansin capital. NONPROFIT AND FOUNDATION “PRI” AND “MRI” EQUITY INVE>TOR> Nnprfit rganisatins and Fundatins are be

13 ginning t cnsider investment f
ginning t cnsider investment f their fund balances and endwments (respectively) in scial enterprises. In the U>, when catalysed first and fremst by a scial purpse, and nly secndarily by expectatin f financial returns, this type f capital is categrised as “prgramme-related investment” (PRI). 14 PRIs therefre tend t be “belw market”. When financial returns are sught, and expected t be at market rate, the term “missin-related investing” (MRI) is used. As a U> fundatin prgramme, Rckefeller Fundatin’s PrVenEx has reviewed ver 250 deals and made 12 investments since 1999, ttalling U>$12.2m with expected returns f 3%-10%. 15 The FB Hern Fundatin 16 is anther example f a U> fundatin which actively invests in husing, emplyment and enterprise pprtunities fr the pr, using bth debt and equity instruments. It has distributed mre than U>$17m in PRIs and U>$45m in MRIs. This cnstitutes mre than 25% f its assets. 17 A further U>$150bn culd be released fr scial purpses if all fundatins did the same with their assets, given that there are apprximately U>$600bn in fundatin assets. The third example is nt a fundatin, but a U>-based nnprfit rganisatin named Acumen Fund. Acumen Fund raises dnr capital and, thrugh a prtfli apprach, uses debt and equity instruments t aid in the develpment f scial enterprises delivering critical gds and services t the glbal pr. The grwth f the scial enterprise sectr has inspired grant-making frm nntraditinal surces, including the Internatinal Finance Crpratin (IFC), the private sectr arm f the Wrld Bank. T supprt the develpment f high-impact scial enterprises in emerging markets, the IFC launched its “Capturing Value” cmpetitin in which it awards U>$500,000 in prize mney t emerging market cmpanies that are bth generating an ecnmic prfit and accunting fr scial, envirnmental and crprate gvernance practices. Accrding t the IFC, the cmpetitin functins nt simply t prvide 12 Duglas, P., >irull, B., Nvember, P. (2006), Develpment Investment Capital: Three >teps t Establishing an Asset Class fr Investing in Underserved Markets. Fr a cpy f the paper, cntact bsirull@pcvmail.rg T read a review f the paper, visit www.scialfunds.cm/news/article. cgi/2008.html. 13 Hward, L. and Giddens, M. (editr) (2004), Equity-like Capital fr >cial Ventures, Bridges Cmmunity Ventures, Lndn. 14 Interestingly, if market rate returns are attained, a PRI designatin may still apply. It is a matter f intent, nt utcme. In the U> a PRI is a designatin by the IR> that allws a fundatin t relax its fiduciary r “prudent man” rules f investment, and t cunt an investment twards its grants payut requirement. 15 Hward, L. and Giddens, M. (editr) (2004), Equity-like Capital fr >cial Ventures, Bridges Cmmunity Ventures, Lndn. 16 The FB Hern Fundatin fcuses n prmting five wealth creatin strategies: hme wnership, business develpment, childcare, cmmunity develpment and access t capital. 17 FB Hern Fundatin website www.fbhern.rg 14 NOTHING VENTURED, NOTHING GAINED: ADDRE>>ING CRITICAL GAP> I

14 N RI>K-TAKING CAPITAL FOR >OCIAL ENTERPR
N RI>K-TAKING CAPITAL FOR >OCIAL ENTERPRI>E KOLL CENTRE FOR >OCIAL ENTREPREN EUR>HIP grant funding t scial enterprises in emerging markets but t als raise awareness abut the wrk f these enterprises in rder t generate interest frm the internatinal investing cmmunity. It is the IFC’s hpe that “Capturing Value,” whse judges include representatives frm the United Natins and the Wrld Resurces Institute, will catalyse investment in emerging markets, where scial entrepreneurs als struggle t secure funding. 18 DEBT/LOAN> Debt, defined as mney laned at a stated interest rate fr a fixed term f years, is available in scial enterprise capital markets in a variety f frms. Like mst capital instruments, debt structuring is based n the classic risk/return equatin. That is, the higher the risk assumed by the debt issuer, the higher the crrespnding interest rate charged t the debtr. While interest rates are an imprtant cmpnent f the debt calculatin, they must be cnsidered in relatin t ther aspects f the debt capital, including the type f debt (eg subrdinated debt), the structure f the payments (eg is there a balln payment?), the life term f the lan, and the pints assciated with clsing the lan. Because debt capital creates liabilities n the balance sheets f enterprises, it needs equity r net assets t be leveraged. Many types f debt financing are currently available t scial entrepreneurs – here are a few examples. TRADI TI ONAL BANKING IN >TITUTI ON> Traditinal banking institutins in the U> prvide debt capital t scial enterprises in tw frms: business lans and lans that qualify fr Cmmunity Reinvestment Act (CRA) credits. It is – theretically – pssible fr a scial entrepreneur t qualify fr the same traditinal business lan used by fr-prfit entities. Hwever, while this srt f debt capital is mre readily accessed by fr-prfit scial enterprises than nnprfit nes, it is nt easily accessed by either, wing t the inherent risks invlved in financing an entity that puts equal emphasis n financial return and scial missin. Debt capital is als available t U> scial enterprises thanks t the Cmmunity Reinvestment Act. Enacted in 1977, the CRA bliges depsitry institutins t invest in the cmmunities they serve by financing prjects that address cmmunity needs. T that end, U> banks ffer a limited number f lw r zer-interest lans t nnprfit scial enterprises t meet their Federal bligatins. Unfrtunately, the availability f debt capital in the frm f CRA lans has decreased recently due t changes in the regulatins. FOUNDATION PRI DEBT In additin t traditinal grants, fundatins may ffer lans t scial enterprises. Many majr U> fundatins have made such prgramme-related investments, but, in ttal, less than 1% f U> fundatins by number have made PRIs, and just ne-tenth f 1% f ttal assets f fundatins are in such missin-based investments. 19 An example f a PRI lan facility is the Esmée Fairbairn prgramme. Launched in 2003, it ffers bth secured and unsecured lans f between £10,000 and £250,000 t the UK vluntary sectr at interest rates frm 0% t 7%, fr terms f up t five years. The pr

15 gramme is a pilt t help extend th
gramme is a pilt t help extend the fundatin’s supprt beynd grants, and t learn mre abut the demand fr lan finance. It is run in c-peratin with Charity Bank, which prvides due diligence and lan administratin services, as well as acting as a cllectin agency. BOND>, INVE>TMENT NOTE> AND NONTRADITIONAL LENDING IN>TITUTION> An increasing number f innvative structures and facilities have crpped up in recent years t prvide fixed-incme investment instruments t fund scial purpses: Citylife has issued six zer cupn bnds t investrs wh are prepared t frg capital grwth and interest incme n their mney, but wh are guaranteed it back after five years. The bnds invest the interest in scial enterprises and lcal cmmunities t regenerate scial, ecnmic and intellectual capital. The bnd is held under trust and investrs have a bank-guaranteed return n their investment. Citylife structures five-year fixed-term lans with cmpund interest. 20 Cmpartams is Latin America’s biggest prvider f micrfinance – small lans aimed at budding entrepreneurs in areas f severe pverty. In rder t access finance t grw t reach ne millin clients, it ffered a U>$45m bnd – the first f its kind fr the micrfinance sectr – underwritten by Banamex, the Mexican subsidiary f Citigrup. 21 BIGinvest is an rganisatin that lends and prvides capacity supprt directly t scial enterprises and cmmunity develpment finance institutins (CDFIs) in the UK. It has accessed £3.5m f lan funding and is accredited fr Cmmunity Investment Tax Relief (see belw) and as 18 >ee discussin at www.envirnmental-finance.cm/ nlinews/2809ifc.htm. 19 >urce: Fundatin Center’s Bi- Annual PRI Reprt. 20 Citylife is an independent UK charitable rganisatin, incrprated as an Industrial and Prvident >ciety. Zer cupn bnds are issued at belw face value, and then, rather than paying interest, slwly grw t their full face value at maturity. 21 Accin Internatinal website: www.accin.rg 15 JED EMER>ON, TIM FREUNDLICH AND JIM FRUCHTERMAN UNIVER>ITY OF OXFORD >A D BU>INE>> >CHOOL a whlesale CDFI. It fills a market gap in financing scial enterprises and CDFIs, wrking in partnership with CDFIs and banks t build underwriting capacity and demnstrating that deals can be underwritten successfully. It is an initiative f The Big Issue, >hreBank, Bank f >ctland and the Phenix Fund. Calvert Fundatin has lng ffered its registered Cmmunity Investment Ntes – thrugh which investrs can channel capital int disadvantaged cmmunities – t retail investrs in the U> as an pen-ended investment nte prgramme. Its current ftprint is apprximately U>$100m, surced frm 2,500 investrs, placed int almst 200 entities glbally. In January 2005, the Calvert Fundatin annunced the “wiring” f its Cmmunity Investment Ntes – the first time that such cmmunity investment instruments have been available electrnically fr bth individual and institutinal investrs, thrugh brkers acrss the U>. This capital is then structured fr a brad range f nnprfit and fr-prfit brrwers, including an increasing number f scial enterprises (including a recen

16 t U>$10m scial enterprise cmmitme
t U>$10m scial enterprise cmmitment catalysed by supprt frm the Case and >kll Fundatins). Traditinally, hwever, capital has been used t finance affrdable husing, micrfinance and ther asset-based strategies. The Cmmunity Investment Tax Credit (CITR), intrduced in the UK in 2003, was develped in an effrt t increase the availability f funds fr scial enterprises and small businesses lcated in disadvantaged areas. A frm f ecnmically targeted investing, CITR accunts ffered a tax credit f 5% f their depsit a year fr five years, as well as interest n their depsits. But Charity Bank, ne f the main prviders f CITR funding, stpped accepting depsits under the scheme last August, and Trids Bank tk depsits fr less than a mnth last year and is n lnger ffering CITR accunts. Bth are wrking with plicy makers t address sme f the scheme’s practical difficulties. 22 In the U>, in particular, there is an increasing number f revlving lan funds, such as Nnprfit Finance Fund, which prvide analysis and flexible, frequently unsecured, financing that nnprfits typically can’t get frm ther surces. Acrss the U>A, NFF wrks with ver 170 funders, including financial institutins, fundatins and gvernment agencies, t develp new ways f meeting the capital grwth needs f the nnprfit sectr. >everal innvatins were sparked thrugh the creatin f lan guarantee funds which have altered the risk prfile fr investrs in scial enterprises. In Hungary, the IFC’s Hungary Energy Efficiency C-financing Prgram structured guarantees and technical assistance t catalyse U>$5.7m in lending fr energy efficiency by lcal financial institutins. Hmeless Internatinal’s Cmmunity-Led Finance Facility has nearly £11m in funding which prvides lans and technical assistance fr cmmunity-based rganisatins implementing slum redevelpment prjects in India and Kenya. The guarantee prtins f this facility allwed debt prviders such as Citibank t cmmit capital t prjects in these pr cmmunities where they never befre wuld have invested. Furthermre, Tembeka >cial Investment Cmpany in >uth Africa was riginally created in 1996 as a guarantee fund t leverage funds frm lcal banks t scial ventures such as micrfinance institutins. As a result f a technical market study in 2002, it decided t becme mre f a whlesale financial services prvider thrugh sft lans and equity t NGOs, trusts, credit unins, cmmunity rganisatins and develpment cmpanies serving disadvantaged cmmunities. The Glbal Exchange fr >cial Investment (GEX>I), has als wrked t create incentives, risk limitatins, and develpment investment services. In partnership with VantagePint, GEX>I has brught tgether insurers, bankers, scial entrepreneurs, and develpment aid agencies t create a glbal >cial Investment-Re-insurance Facility (>IRIF). 23 The >IRIF prpsal is t apply develpment aid funds t guarantee and insure market-riented private sectr develpment investment relevant t the realisatin f the UN Millennium Develpment Gals. EQUITY-LIKE CAPITAL Equity-like capital avids prblems that scial enterprises have histrical

17 ly had with issuing equity. 24 It typi
ly had with issuing equity. 24 It typically takes the frm f a deeply subrdinated lng-term lan (junir t all ther debt). If structured apprpriately it can serve as patient capital similar t preferred stck. This differs frm the equity described abve in that investrs using equity-like instruments tend t be mre fcused n keeping scial value creatin a pririty ver financial value creatin. Current prviders f equity-like finance in the UK (Venturesme, Astn Reinvestment Trust and Lcal Investment Fund) have all had very different experiences with the mdel. In the U>, a cdified example f this srt f capital is the Equity Equivalent Investment 22 Cnnn, H., Brwn’s scial banking scheme fails t catch n, The Observer, 2 April 2006. 23 >ee dwnlad f reprt at www.gexsi.rg/dwnlads.htm 24 Hward, L. and Giddens, M. (editr) (2004), Equity-like Capital fr >cial Ventures, Bridges Cmmunity Ventures, Lndn. www.bridgesventures.cm/ dwnlads/scial_venture_fund.pdf 16 NOTHING VENTURED, NOTHING GAINED: ADDRE>>ING CRITICAL GAP> IN RI>K-TAKING CAPITAL FOR >OCIAL ENTERPRI>E KOLL CENTRE FOR >OCIAL ENTREPREN EUR>HIP (EQ2) – lans that functin smewhat like equity fr nnprfits and cunt twards Cmmunity Reinvestment Act fulfilment fr bank investrs. 25 Bridges Cmmunity Ventures defines “equity- like” capital as high risk, relatively high return, patient, and uncllateralised, lking instead t future cash flws t prvide repayment. These are indeed many f the characteristics that must necessarily be included in any risk capital structure. In general, we find that the UK market has begun t accelerate its experimentatin n develping capital that meets this prfile. 26 Further research and develpment in this area f capital finance is being undertaken by rganisatins such as the Calvert Fundatin and Gd Capital in the U>, and >cial Investment >ctland, Trids Bank and Bridges Cmmunity Ventures in Eurpe. GRANT> Nnprfit scial enterprises have traditinally accessed dnatins frm individuals and thrugh grants frm gvernment, fundatins and crpratins. 27 Of curse, these resurces require n financial repayment. Grants frm private surces, HIGH RI>K INVOLVEMENT IN BU>INE>> LIQUIDATION RIGHT> >urce: BCV Interviews, Hme Office reprt n Patient Capital, >cial Enterprise in the Balance, CAF (2004) 100% fte n shrt perids Lw (except venture philanthr p y) n/a Nne N FEATURE> OF DIFFERENT FUNDING IN>TRUMENT> 0-50% -50% – c.10% Repayment hlidays >me (th rugh partners) Repayment Nne/subrdi nate N 10-20 N limit Undefined Depen ds n success High (thrugh bard) IPO, sale, layut Resi dual Thrugh wnership 10-20 Variable up t 30% 5-7 years Depen ds n success High (thrugh bard) Ryalty, repayment r APO >ubrdinate >tructured in lan agreement 1-8 Fixed 5-18 Fixed term Lw Repayment First pririty N 25 Federal Reserve Bank f >F: www.frbsf.rg/cmmunity/ investments/eq2.html 26 It shuld be nted that Bridges Cmmunity Ventures is nt in the business f supplying equity-like capital t nnprfits, but rather equity t fr-prfits. www.bridgesventures.cm 17 JED EMER>ON, TIM FREUNDLICH AND JIM FRUCHTERMAN UNIVER>ITY OF OXFORD >A D BU>INE>> >CHOOL such as fun

18 datins, are typically shrt-term,
datins, are typically shrt-term, prject-based cmmitments f relatively small amunts f capital. Thugh smetimes renewed annually, these are ften ne-time injectins f capital that may be paid ut ver ne t three years. equity f the nnprfit sectr, in truth they usually small amunts f capital cmmitted ver a shrt time perid restrict majr grwth restrictins n the use f funds results in limited resurces targeted fr general peratins/ develpment and may prvide incentives fr activities nt well aligned with the strategy fr achieving its scial missin and prfessinal management due t the incredible attractin f “free mney” applicatin prcess is ften bureaucratic and drawn ut, and the hidden csts f fundraising and reprting cause inefficiencies 28 scial enterprises that d nt hld charitable tax status usually cannt receive grants. Because f the third-party payer structure f a significant prtin f the nnprfit sectr, much scial gd gets funded by grants. Hwever, grants mre accurately represent cnsumptin f capital, nt investment. And, if a funder sees scial gd as a cmmdity, then their interest is in funding the lwest-cst prvider f the cmmdity. Cmmdity purchasers are generally disinterested in funding innvatin r value-added services. Instead they reward suppliers that eliminate “frills” such as research, additinal administrative infrastructure aimed at imprving rganisatinal efficiencies, r emplyee educatin and develpment. Of curse, scial entrepreneurs want t create the mst efficient and effective means f delivering a scial utcme. But the risk capital t expand a successful enterprise usually desn’t cme directly frm its custmers: mst enterprises wuld be heavily cnstrained if they culd nly tap expansin capital frm their prfit margins. In the fr-prfit sectr, venture and ther expansin capital fill these needs. In cntrast t investing in a prduct r service, the mantra in venture investing is that the three mst imprtant things in an expanding enterprise are the management team, the management team and the management team. That’s because venture capitalists are investing in peple they believe can create huge value. The effect f this is t direct funds nt simply t the delivery f a service r prduct, but t build an rganisatin capable f taking an idea, innvatin r service/prduct t its next level f develpment and thereby create greater lng-term capacity fr the rganisatin t deliver quality and value t any given market r cmmunity. This venture capital apprach is fcused n building rganisatins and management capacity upn the base f demnstrated success r innvatin. When applied t investing philanthrpic capital, this translates t high levels f engagement and the adptin f business-based practices – essentially grant capital invested in an ambitius plan t create r expand an enterprise that will have results that far exceed what wuld have happened if thse same funds were spent n cnsumptin f scial gd. Therefre, if grants are t functin mre like equity fr the sectr, sme innvatins in deplying r structu

19 ring grant capital might need t be: e
ring grant capital might need t be: establishing lnger, larger relatinships t lwer fundraising csts and measure impact mre clsely, including multi-year grants designing dnr syndicates arund standardised fferings high engagement management and capacity supprt frm dnrs. In the final analysis, the current landscape f capital fr scial enterprise is smewhat ill frmed. There is increasing activity and interest, but very little activity squarely fcused n the risk-taking expansin capital needs f scial enterprises, whether fr nnprfits r fr-prfits. The mst cmpelling pprtunity fr the field is t institutinalise new facilities fr capital and engagement structures. A number f interesting experiments will likely be initiated in the near t intermediate future. 27 The U> had U>$241bn in philanthrpic funds in 2002, prvided by 37 millin individual dnrs, 60,000 fundatins, 400,000 crprate investrs and bequests. Gvernment grants ttalled ver U>$65m. Meehan, W., Kilmer, D. and O’Flanagan, M., Investing in sciety, >tanfrd >cial Innvatin Review, >pring 2004, pp34-43. 28 Fr-prfit capital market: U>$2-4 spent per U>$100 raised fr legal, marketing, admin. Nt-fr-prfit capital market: U>$10-24 per U>$100 raised fr buying dnr lists, direct mail/telephne calls, and CEOs spend 30-60% f time n fund-raising. Meehan, W., Kilmer, D. and O’Flanagan, M., Investing in sciety, >tanfrd >cial Innvatin Review, >pring 2004, pp34-43. 18 NOTHING VENTURED, NOTHING GAINED: ADDRE>>ING CRITICAL GAP> IN RI>K-TAKING CAPITAL FOR >OCIAL ENTERPRI>E KOLL CENTRE FOR >OCIAL ENTREPREN EUR>HIP >OLUTION> Central t any slutin must be the intentin t create a relatinship between prviders and users f capital wherein the investr becmes a risk partner in the endeavur and the scial entrepreneur cntracts t mve apprpriate and manageable value back t the investr ver time. Upn this fundatin a new kind f risk-taking expansin capital can be imagined, surced either thrugh a new kind f investr prfile, thrugh blending mre traditinal philanthrpic and cmmercial capital, r bth. >OLUTION 1: CHANG E THE TERM> OF ENGAGEMENT AND RULE> OF T HE GAME The mst audacius ptin in terms f surcing capital is t recast sme f the rules we’ve taken fr granted. Investr engagement needs t cmplement the develpment f true risk-taking expansin capital. We need a new “cntract” – a re-evaluatin f the relatinship between investr and enterprise. Investrs have t be apprised f the cst f ding gd thrugh these deals, in the same way that scial enterprises need t face the frictin that exists in their business mdel between missin and prfitability. Bth parties have t figure ut the central expectatins arund the ften-challenging intersectin f risk, return and scial value creatin: which metrics matter t whm and why the business and scial impact is best intertwined. Enterprise managers have t dig deeper and supply a ratinale that is bth cmpelling and distilled 19 JED EMER>ON, TIM FREUNDLICH AND JIM FRUCHTERMAN UNIVER>ITY OF OXFORD >A D BU>INE>> >CHOOL t a utilitarian cre that is accepted by numerus stakehlders. The investr then needs t internalis

20 e this value t create a new expectat
e this value t create a new expectatin f return – that is essentially a prcess f valuing external scietal benefits within the returns f the deal. Philanthrpy is catalytic and critical; it has a fundamental rle t play. Investing in cmmercial activity fr market returns, yet with a cncern fr peple and planet, is well-established and creating psitive impacts in the wrld. But new hybrid mdels in the middle – scial enterprises – require smething f bth these wrlds. And thugh there is n hierarchy f virtue between the left, right r middle f the spectrum, there is beauty and utility in a well-balanced business, creating real scial impact withut the need fr separate ill-integrated service prgrammes running in parallel. >OLUTION 2: BY ALL MEAN>, U>E PHILANTHROPY TO UNLOCK MARKET-BA>ED CAPITAL IF THAT I> EXPEDIENT It’s time t be pragmatic. If investrs wn’t embrace new values, subsidy has t be brught in (and bth the early adptin f the new, and the blending f the ld, can cexist). In an ideal wrld, perhaps, all investrs wuld be able t accept a hmgeneus prpsitin with regards t these cnsideratins. Then n dnr r philanthrpic investr wuld be cnstrued as subsidising anther mre market-rate investr. Then again, mainstream capital markets are rife with all manner f crss-subsidisatin. Tax credits, guarantees and lw-interest lans frm varius gvernment and quasi-gvernment agencies (r even private fundatins) curse thrugh deals in many sectrs f the ecnmy. At the same time, we must realise that getting investrs t understand a mre balanced return ges against much f the cnventinal wisdm f the market. >, while we might advcate a mre balanced expectatin, a gd argument can be made fr nt pushing bulders up hills – using “sfter” capital t leverage and supprt mre cnventinal market rate capital is ften the mst expedient path. > the answer is “bth”: encurage investrs t ffer capital and use strategies that blend grants and sft mney t unlck mre market-rate capital. We shuld nurture a new set f expectatins amng an ever-widening investr base – ne that respects blended value – while simultaneusly mixing grant r cncessinary investment capital int deals with mre market rate capital. Over time, hpefully, investrs will becme increasingly cmfrtable with new ways f thinking abut the gals f their investment. But fr nw, whether the new capital shws up in the exact frm required, r in cmpnents that can be blended int the frm required, is academic except fr the transactin csts t the scial enterprise. >OLUTION 3: IN>TITUTIONALI>E A NEW KIND OF CAPITAL Regardless f the manner in which the capital cmes t the table, we must then turn t the specifics f the risk-taking expansin capital t be deplyed. Fr scial enterprises within a fr-prfit structurally. The challenge fr these enterprises Hwever, advancing specific answers t the challenge f the lack f risk-taking capital t fill the expansin gap fr nnprfit scial enterprises is a little mre cmplicated. Let us examine a number f cncepts, culled frm scial enterprise practitiners and pineeri

21 ng wrk being dne t develp ne
ng wrk being dne t develp new scial finance instruments. 29 It is ur cntentin that a number f these will need t be adpted, adapted, and deplyed by investrs in scial enterprises ver the cming years. What might the characteristics lk like f ideal risk-taking expansin capital fr the nnprfit scial enterprise? The assembled capital has t understand the csts and benefits f ding gd. Mst f the slutins that have been either prpsed r tested draw frm the fllwing characteristics: links t success – repayment and/r yield dependent upn utcmes r revenues minimised debt service – nn-amrtising principal and/r capitalising interest deep subrdinatin – ability t supprt ther debt patience – Lng terms, even unspecified and rlled frward, r determined by revenue flexibility – the ability t use prepayment r demand fr repayment t curse crrect exit – a strategy fr hw investrs and enterprises can end the relatinship. 29 In additin t input frm ur readers and cntributrs, the authrs wish t acknwledge a fcus grup discussin that was cnducted at www.xigi.net in June 2006, during which numerus practitiners cmmented upn and prpsed a number f these mdels and instruments. 20 NOTHING VENTURED, NOTHING GAINED: ADDRE>>ING CRITICAL GAP> IN RI>K-TAKING CAPITAL FOR >OCIAL ENTERPRI>E KOLL CENTRE FOR >OCIAL ENTREPREN EUR>HIP Let’s explre a few mdels that culd prve attractive: Bnd.” Thugh technically a liability, this the investr. In ne scenari, the scial enterprise >cial Value Nte, a zer cupn bnd tied t In this manner, minimised debt service and T the abve mdel culd be added the flexibility f the ptin t “call” the nte back frm investrs, essentially repaying it early at the will f the enterprise after a certain time perid, say three years. Alternatively, the investrs culd “put” the nte back t the enterprise (demand repayment) if certain benchmarks f missin r financial management were nt met. Anther example culd be a “Preferred >hare” mdel. This cmbines the patience f a lng rlling term with minimised debt service, flexibility, links t success and deep subrdinatin. A base cupn is stipulated, but nly t be paid upn successfully reaching benchmark X, thugh it is capitalised regardless. Thereafter, when Y happens investrs get anther structured payment f a premium f interest. And, if in any year threshld Z is met, a prtin f principal value is returned. That said, there is n maturity stipulated, debt service is nt necessarily in play, links t business events drive carefully structured yield and there is a stipulated flexibility in repayment built int the mdel. But, again, this is still technically a liability n the balance sheet f the nnprfit scial enterprise. 31 A relatively straightfrward mdel is simply t cnstruct what has n ccasin been called a “grant with a put”. In this scenari a funder simply makes a technically but nly lsely recverable grant t a scial enterprise. It stipulates that it will have n recurse t the assets f the enterprise. But, a success threshld n a cre prgramme and business metric is identified, abve which the

22 grant begins t be repaid. This exte
grant begins t be repaid. This extends thrugh t a ceiling upn which the ttal grant plus a premium has been repaid t the funder. This can be a relatively elegant and simple mdel that meets many f the characteristics deemed attractive in this type f capital. Thse seeking a wrk-arund t the inability t wn a nnprfit utright might cnsider a “Revenue Rights” structure. Fr example, investrs prvide a scial enterprise with U>$1m tday, then, ver time, receive a certain percentage f its revenue abve a certain threshld, r number f units sld, r whatever the apprpriate benchmark might be. Thugh an interesting mdel, it raises the challenge f truly understanding margins and being apprpriate t a given business mdel. Hw wuld this affect the financial statements? Wuld scial enterprises and their bards cnsider such a cntract? Much grundwrk wuld need t be dne t cnsider such a structure, but in certain circumstances it culd be quite attractive, and perhaps escape being cnsidered a liability at all (r at least ne with a set value). This is bviusly the mst radical f the examples in meeting sme f the characteristics sught after. Little use has been made f these mdels t date. And, unfrtunately fr nnprfits, they generally shw up as liabilities (with the pssible exceptin f the revenue rights mdel). In the case f a liability, n matter hw carefully structured the expectatins, and well matched the terms, a nnprfit enterprise that shws debt n its balance sheet will encunter difficulties when arranging its finances and seeking further capital. >, by cmbining the characteristics f linking t success, minimised debt service, deep subrdinatin, patience, flexibility, and a plausible exit strategy, and adding a shared cntract between investr and entrepreneur n understd value and the cst f ding gd, a structure appraching equity-like expansin capital can be fashined. 30 Emersn, J. (2001). Please see the article by that same name at www.blendedvalue.rg. 31 The Calvert Fundatin is wrking t get legal and accunting apprval that wuld actually let this sit n the nnprfit balance sheet as a net asset. These mdels have als been referred t as “Grants with Puts”. 21 JED EMER>ON, TIM FREUNDLICH AND JIM FRUCHTERMAN UNIVER>ITY OF OXFORD >A D BU>INE>> >CHOOL CAPITAL CONCLU>ION> It becmes clear there is a rich landscape f actrs and strategies in the capital markets serving scial enterprise, yet a significant gap remains in the availability f risk-taking capital t fund the expansin f prmising rganisatins. The utcme? Much f the pprtunity represented by these maturing scial enterprises remains blcked r is channelled int verly slw, rganic grwth. Attainment f an ptimal capital structure remains ut f reach. Perversely, start-up scial entrepreneurs are ften able t absrb grant capital (r “friends and family equity”) t get the ball rlling, while later-stage enterprises stall due t the massive gap between start-up capital and later-stage missin-riented debt financing. Regardless f the enterprises’ fr-prfit r nnprfit status, if their risk/return mdel isn’t “strng enugh” in cnventinal terms, they

23 tend t stall in the expansin phas
tend t stall in the expansin phases befre lwer-risk debt capital becmes available. What then happens is the rt f much frustratin fr investr and nnprfit scial enterprise alike, as the enterprise is left t fit debt capital and grant capital int an equity capital gap. And fr- prfit enterprises struggle with equity investrs that are seeking cnventinal returns, when their hybrid scial purpse business just des nt supprt this. Regardless, investrs and entrepreneurs experience the pains f the mismatched expectatins that fllw. What is clear is that many new investment pprtunities and instruments will be created – because the gap in the market will demand it. Investrs are lking fr ways t structure their capital in mre effective terms and scial entrepreneurs require new frms f capital t cmplement the next stage f their develpment. With that in mind, it must als be understd that with these new appraches and investment initiatives there will als be a level f failure. High- risk capital – by its very definitin – carries greater expsure fr bth investr and investee. Where there is innvatin there will be failure. Hwever, that failure may be hedged if thse invlved take care t leverage the existing knwledge and draw upn the talent present in the business and nnprfit sectrs which may best be applied t this challenging task. In undertaking what is in sme ways a capital experiment that will take us int new terrain, it is imperative that adequate attentin be paid t clarifying the specific terms and expectatins f thse engaged in each investment. Traditinal term sheets and understanding f returns may well nt be enugh t get the deal dne. Regardless f balance sheet and deal term cnsideratins, if the expectatins between stakehlder and enterprise are carefully and hnestly defined, and the terms structured t match the needs f the enterprise as discussed in this paper, it is pssible t envisin the evlutin f a hst f successful risk-taking expansin capital instruments which may meet the needs f nt nly thse specifically invlved in the deal, but als an array f stakehlders, frm cmmunity residents t prgramme participants t lw-incme individuals seeking new stairs upn which t climb twards real ecnmic develpment and nt simple reliance n grants and relief. Imprtantly, thugh perhaps a brader issue, is the reality that in the absence f significant, shared understanding and experience with regard t these instruments, the high transactin csts f executing every deal as a new cutting-edge negtiatin are ging t be prhibitive, limiting the number f such investments and thus the amunt f capital capable f mving int these emerging markets. In rder t build a viable capital market in this area, thse creating the financial innvatins f the future must take adequate care t dcument their wrk, terms and practices in rder t ppularise investment mdels, engage in syndicatin pprtunities and, thrugh shared r cmmnly endrsed due diligence practices, decrease the transactin csts f individual investments and the market as a whle. Finally, at its cre, this wrk requires a rethinking f capital investing and enterprise

24 develpment. This includes the need
develpment. This includes the need fr us t advance a brader understanding f the full, blended value created by capital and brught t market by ventures f all types – nnprfit and fr-prfit. The financial landscape and instruments presented in this paper in many ways represent the missing links between mainstream investing and traditinal philanthrpy. And this capital gap will cntinue t shrink as increasing numbers f peple transcend the artificial value barrier between “ding well and ding gd.” 22 NOTHING VENTURED, NOTHING GAINED: ADDRE>>ING CRITICAL GAP> IN RI>K-TAKING CAPITAL FOR >OCIAL ENTERPRI>E KOLL CENTRE FOR >OCIAL ENTREPREN EUR>HIP >ELECTED ONLINE RE>OURCE> Accin Internatinal www.accin.rg BIGinvest www.biginvest.c.uk Blended Value (resurces n “blended value” and “blended value investing”) www.blendedvalue.rg www.blendedblg.rg Calvert Fundatin (infrmatin n cmmunity develpment, micrenterprise and scial enterprise investments) www.calvertfundatin.rg CDVCA (Cmmunity Develpment Venture Capital Alliance) www.cdvca.rg Citylife www.citylifeltd.rg Cmmunity Investing Center www.cmmunityinvest.rg Esmée Fairbairn Fundatin www.esmeefairbairn.rg.uk/lans.html FB Hern Fundatin www.fbhern.rg GEX>I (The Glbal Exchange fr >cial Investment) www.gexsi.rg Gd Capital www.gdcap.net Nnprfit Finance Fund www.nffusa.rg Partners fr the Cmmn Gd http://pcglanfund.rg R>F www.rsfundatin.rg >cial Edge (an nline scial entrepreneurship cmmunity) www.scialedge.rg >cial Enterprise Alliance (a scial enterprise member assciatin) www.se-alliance.rg Xigi.net (database, blg and mapping f the scial capital market) www.xigi.net BIBLIOGRAPHY Bi-Annual PRI Reprt, Fundatin Center Carden, >.D. and Darragh, O. (2004), A Hal Fr Angel Investrs, The McKinsey Quarterly 2003 Clumbia Business >chl Research Initiative n >cial Entrepreneurship (RI>E) reprt Duglas, P., Develpment Investment Capital: Three >teps t Establishing an Asset Class fr Investing in Underserved Markets Emersn, J. (2000), Riding the Bleeding Edge Emersn, J., >pitzer, J., Wrld Ecnmic Frum 2006 Article Gair, C., >tepping Out f the Maze www.redf.rg/publicatins-newsletter.htm GEX>I reprt www.gexsi.rg/dwnlads.htm Meehan, W., Kilmer, D., and O’Flanagan, M. (>pring 2004), Investing in >ciety in >tanfrd >cial Innvatin Review, pp 34-43. >ee als (1996) Grants, Debt and Equity: The Nn-prfit Capital Market and Its Malcntents, in New >cial Entrepreneurs, REDF Emersn, J. and Bridgespan Grup, Mney Matters, available at www.blendedvalue.rg Hward, L. and Giddens, M. (editr) (2004), Equity-like Capital fr >cial Ventures , Bridges Cmmunity Ventures, Lndn Olsen, >., and Tasch, W. (editr) (2004), Missin-Related Investing, Investrs’ Circle (2005) Prviding Capital and Expertise t Financial Institutins >erving Micr and >mall Businesses, >hreCap Internatinal & >hreCap Exchange, Annual Reprt Cnnn, H., Brwn’s scial banking scheme fails t catch n, The Observer, 2 April 2006 http://tinyurl.cm/25agjk (2004) >cial Enterprise in the Balance, CAF RE>OURCE> 23 JED EMER>ON, TIM FREUNDLICH AND JIM FRUCHTERMAN UNIVER>ITY OF OXFORD >A D BU>INE>> >CH