In a guest blog, Tej Dhami, Managing Director of The Change Coefficient, looks at how a change in the approach to funding could help social enterprises deliver on their potential. Stone King is collaborating on this topic with The Change Coefficient and other partners.
The last few decades have seen a dramatic decline in global public goods. Be it damage to the environment or the chronic underspend in education, we are now facing the consequences of years of policy that has prioritised shareholder profit. Mission first businesses, often called social enterprises, are one promising way of directing resources to rebuild public goods. Yet despite the promise of social enterprises, we have failed to see the growth in the sector that many of us had hoped for. We believe one of the key reasons for this is the lack of appropriate funding.
We propose three keys ways of unlocking more funding for social enterprises and driving ever-increasing social value:
- 1. A new approach to assessing risk
As an investor you are taught to study financials and metrics. You analyse the strength of a company based on its balance sheet, its P&L and cash flows. In the commercial world this works because the primary motivation of any enterprise is shareholder profit and, in most cases, this aligns neatly with investor interests. Consider then a company that doesn't prioritise profit, instead it prioritises the maximisation of social value. For many such organisations the ability to build reserves or take on equity like capital may be severely restricted by the nature of their funding and legal structures. How then does an investor measure risk when debt to equity ratios look weak and ratios like interest cover offer little buffer?
We would argue a fundamentally new approach to measuring risk is required in these cases. Austerity has taught us that while charities and social enterprises have been very hurt by cuts in public funding, they have been surprisingly resilient. We believe this reflects the project-based nature of their work and their responsiveness to external change. A broader measure of resilience would, we believe, more accurately gauge the credit worthiness of charities and social enterprises and allow for increased fund flows to the sector.
- 2. Coordinated ways of absorbing risk
Risk capital remains highly challenging for social enterprises to source. This is because the super-normal profits (when total revenue is significantly higher than the total costs) that allow commercial investors to absorb higher risks, are not, and it could be argued, should not, be available in this sector. This is limiting innovation and preventing organisations from investing in their own growth. We believe more coordinated approaches are required between grant funders and social investors to create packages of funding that allow organisations to invest in themselves and their future. More equity like capital with a longer-term outlook and operational targets that focus on organisational health as opposed to project outcomes are emerging, yet more such funding is needed.
- 3. An increased focus on new business models
The predominant model for UK social enterprises is the sale of services to the government. While this is to be expected given the role and obligations of the state, it limits business model innovation. In markets such as India, where the government plays a far less active role, the proliferation of operating models from cross-subsidy approaches like Arvind Eye care to low-cost product distribution at Greenway are far more prevalent. A greater focus on helping social enterprises diversify their revenue streams will help to drive growth and sustainability in the long term and create far more investment opportunities.Bath | London | Cambridge | Leeds | Birmingham | Stone King LLP
Tej Dhami is a finance and enterprise development expert with a career that spans investment banking, equity fund management and social enterprise incubation across developed and developing markets. She has funded, supported and built social enterprises in India and Myanmar; helped more than two hundred mission driven organisations; and raised over £5m of capital through equity and debt.
The Change Coefficient helps mission driven organisations scale and maximise their impact, bridging the worlds of social enterprise, commissioning and investment. It helps voluntary, community and social enterprises to raise capital and develop sustainability strategies; commissioners deliver value for money through new forms of commissioning and investors and foundations to design and implement impact investing strategies.