Finding the Right Investor: What Social Entrepreneurs Need to Know

October 30, 2017

Adjunct Professor Cathy Clark studied how social entrepreneurs and investors get matched up

Matching social entrepreneurs and impact investors can be tough

 

Cathy Clark is one of the world’s leading academic experts in impact investing, the practice of investing for societal good as well as financial gain. She is an adjunct professor with Fuqua’s Center for the Advancement of Social Entrepreneurship (CASE) and also directs Fuqua’s impact investing initiative (CASE i3). Clark‘s latest venture is Smart Impact Capital, an online toolkit to help social entrepreneurs identify and attract the right kinds of capital for their enterprises. It was developed during five years running an accelerator with USAID for entrepreneurs working to improve health outcomes for low-income populations in Africa and India. More than 500 entrepreneurs in 30 countries helped give feedback along the way. It launched to the public earlier this month.

In this Fuqua Q&A, Clark discusses some of the investment vehicles social entrepreneurs can use, and why the differences between them are so important.

What are some of the difficulties social entrepreneurs face in finding capital?

Any entrepreneur who has some kind of impact they are trying to accomplish with their business and is trying to find capital that is aligned with what they want to do – whether in education, health, poverty, financial inclusion or elsewhere – needs capital to make that happen. But the field is very complex. The first step is how much and what type of capital you want, the second is who has it, and the third is how you negotiate it.

People make mistakes when trying to get to the right people; they make mistakes interpreting what people say; and they make mistakes while trying to get a good deal. They might be negotiating with government agencies, private investment funds, private foundations, family offices, or individual angel investors, and all of them want different things. We learned that many social entrepreneurs are running around the globe trying to raise this capital, and that they’re not always sure whom to target. When they sent us their investor target lists, we found they were working hard to get connections and set up meetings with investors who weren’t a good fit for them. That’s a lot of wasted energy.

So it’s not surprising that many social entrepreneurs who have been around for a while tell us that the capital they had gotten in the past was actually not the right kind of capital for them. There’s an information gap: entrepreneurs don’t know who to go to, and they don’t know what to ask for. So they meet their first investor and just try to be whatever that investor wants them to be, often through a need to make payroll. Not only that, some investors don’t know where they fit either. I have been to conferences where there are impact investors who can’t deploy their capital because they can‘t find deals, and yet there are social entrepreneurs saying, “We’re right here!” But the truth is that those matches are complicated. It’s about geography, industry, stage, cash flow, timing, exit potential and other factors, but people on both sides don’t always understand all the variables. Given this complicated and evolving marketplace, we’re trying to democratize what an investment bank would do, to help both investors and entrepreneurs find the right partners more easily.

Why is it important for social entrepreneurs to understand the different kinds of capital available to them?

The field of impact investing has exploded, as the Forum for Sustainable and Responsible Investment reported that in 2016, 1 out of every 5 professionally managed dollars in the U.S. was screened or invested for impact, up a third from 2014. This sounds great because there’s more capital out there for everybody. But the innovation in the space is actually disempowering the people that we’re trying to help, because the expansion of capital suppliers has made it even more confusing for entrepreneurs to find the capital that works for them.

Everyone knows there are grants, as well as debt and equity funding. But when you get into the social impact space there are 11 different kinds of investment vehicles ranging that combine those elements in different ways. The difference is in the conditions for how you return the investment, and those conditions matter to your venture. It really matters if you have to make debt payments immediately. And if you are selling a piece of your business, are you selling a piece of your business to one person who is an expert, who can lead you to your next source of funding, or are you going on a crowdfunding site and selling a piece of your business to 300 people who you then have to manage? These are big, strategic decisions. But people are often going to conferences to meet investors and figuring it out based on what they hear there, when they might not have met the person who is offering the exact kind of capital that suits them best. They need to be much more proactive.

What’s an example of how a social venture might find its way to the right kind of capital?

Consider an entrepreneur looking to expand a maternity clinic chain serving very poor women in Kenya. Let’s say this enterprise has two clinics and wants to build three more. Does that enterprise generate enough revenue from its existing clinics to make a debt payment every month? If the answer is no, then of course they need to be careful about taking on debt. Another option is equity. But if that enterprise does not see itself eventually selling to a larger company – maybe because they think a larger company would go upmarket and leave the most in-need clients behind – then what do they do? The impact space has invented alternative vehicles that blend debt and equity and allows enterprises to navigate this problem. One example is revenue-based financing, which is already used to produce movies, and in other industries. You pay a percentage of your revenue each month, so if you don’t have revenue in a given month then you don’t owe anything that month. It can be deferred and there are often caps on it, and allowances for it to take longer than expected for the investor to get their return. That’s very different to how debt and equity usually work, which is very time-bound, rather than bound to revenue when you have it. It takes a lot of time to grow a clinic, to get several of them to break even. So they have to get capital that’s going to wait it out with them. And there are more investors willing to use this kind of vehicle to achieve the impacts and financial returns they care about.

Crowdfunding has become a popular way for some ventures to raise capital. How does that work in the social impact space?

Some entrepreneurs see crowdfunding as a holy grail that will give them more control. Talking to investors is difficult, and some entrepreneurs think they can put their venture online and people will magically give them money, and they won’t have to take as much advice as they would from a fund manager on their board. But if you get 300 individual investors through a crowdfunding platform, you’ll still have to communicate with those 300 investors, who will be on your capitalization table for a long time. There are some impact crowdfunding sites where entrepreneurs have done very well, but it works best when investors are investing in a tangible, physical product that they would use themselves. Great for an organic snack company; not so good for a new low-cost glaucoma device. Also, you can get crowdfunding as a grant, equity or debt and there are completely different regulations for each, in the U.S. and around the world. Experts say if you crowdfund through debt or equity, you’ll want to have a third of it in hand from your own network before you get on the platform or you are unlikely to complete the campaign. These are all important things for entrepreneurs to know. We’re trying to enlarge the set of solutions and help people consider a broad array of options in what is a really complex decision, then boil those options down to help people make decisions that are tailored to their needs, quickly and accurately. Ultimately, we want healthy, growing enterprises that can use capital to fuel their impact – and to make the direct impact investment fundraising process easier for everyone trying to create impact through enterprise.

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