Choosing a financier for social ventures

The title of this post might sound absurd. If you’re newly off the blocks, chomping at the bit to get started on your new venture, have lined up a prototype, done enough rudimentary tests to convince yourself that it works, and need the money to fuel subsequent growth, the last thing you’d want to do is consider turning away someone who wants to finance you! Surely?

Well, no. As I always say in my own ventures or those run by my students, that might well be “penny wise pound foolish” as the English aphorism goes. In other words, it might solve your immediate problem but be a real limitation later on.  Let me explain.

Worldwide, most entrepreneurs bootstrap their enterprises by scraping together personal funds, or cajoling so-called friends-and-family. This is true in the developed world, of course, but more so in the developing world where the alternatives to very early stage risk capital are few and far-between. Here, one has to be wary of the expectations of the friends-and-family members. Will they unwittingly presume on their closeness to expect something other than what they’re entitled to (as a percentage of the entity that they might own)? Will they want to intervene operationally, or make “helpful” suggestions (well-intentioned but often dysfunctional)?

For those of us passionate about social impact in the developing world – by my simple definition these are ventures whose benefits to society vastly exceed benefits that accrue to the individual entrepreneur – there is an additional choice to be made about going with a so-called impact investor as opposed to a conventional for-profit one. Impact investors will evaluate the venture at least partly on social impact, as opposed to purely on the monetary results. Sometimes the choice is clear, the impact part of the idea is too large for it to appeal to a pure for-profit investors, and the entrepreneur has no real choice. Many times, however, there is a sufficiently large for-profit piece which generates a genuine choice.

In such circumstances, I’ve often been in ventures that started off with ‘impact’ investors and then developed in a way that the venture became more relevant to conventional investors. That transition has often, even mostly, been rocky. To my mind, the difficulty comes from the differences in objectives. For example, for a medical device that has universal applicability, the impact investor might wish it to be sold in poorer locations at lower price points by obtaining a subsidy from the relevant parts of society, whereas the conventional investor might prioritize wealthier patients who can afford to pay out-of-pocket, generally in richer countries.

Finally, consider grants. These are often offered by governments and foundations to encourage risk-taking and innovation, appropriately in my view.  Indeed, in the developed world, many of the very important life-changing innovations have been built on a bedrock of publicly subsidized R&D, so it’s entirely usual for ‘grants’ to be at the heart of most change. In a sense, the public and society subsidize the generation of the basic insight since that is risky and takes a lot of time and cumulative effort, and then individual entrepreneurs free-ride on this publicly available knowledge to create practical solutions.

So, one way to see grants in the developing world is that they are a tiny substitute for this massive knowledge stock in the developed world.  But the interfaces between the grant-stage of a venture and the appeal-to-investors’ stage should be clearly defined. Many times it isn’t, especially when the grant-giving agency is new to this sort of gig. It breeds unnecessary friction and confusion between the entrepreneur, the grant-giving agency and the financial investor, of which it’s best to be aware.

If there are problems with friends-and-family, social impact investors and grants from foundations and governments, why not just go to professional investors? Two reasons. First, all these entities have legitimate and valuable purposes and are appropriate for many ventures. My goal is simply to highlight some issues that arise when using them even though they can all still be valid options. Second, there just aren’t enough professional risk-capital providers in developing countries. The institutional infrastructure to provide risk capital has not developed sufficiently yet.

I encounter identical issues in Brazil, India, Indonesia and Kenya, for example. The conceptual issue of the underdevelopment of the institutions that provide risk capital is the same throughout the developing world. it’s particular manifestation, however, varies from one place to the next.

So, caveat emptor! Buyer (of investments) beware!

 

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