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Guest blogger Josh Weissburg is the Philanthropy and Innovation Project Manager at the Aspen Institute, where he works to identify models and measures of social change. He is also a co-founder and Director of Africa Operations at Renew LLC, an investment consulting firm that connects small and medium size businesses in emerging economies to U.S.-based investors and businesses.
There is tremendous clamor around the idea that the creative use of investment capital (and, indeed, the business sector in general) can and should further positive social change with greater efficiency and more effectiveness than philanthropy alone.
This conversation is underway at the highest levels of global business and finance (see TIME magazine’s cover story, “Making Capitalism More Creative,” by Bill Gates – a re-packaging of Gates’ Davos speech on the subject; see also Michael Kinsley’s edited volume of thoughts on and critiques of the Creative Capitalism concept). Based on such arguments, the “social capital market” can be construed broadly, to include almost the entire marketplace for capital, goods and services, or much more narrowly, depending on whom you ask.
All well and good. But what does this mean for the social innovator faced with the two very concrete challenges discussed in my previous posts: the need to build an enterprise and deliver impact? And where in all of this does the foundation, looking to find social innovators and enable them to build solid enterprises with demonstrable impact, find itself? What type of funding should the social innovator pursue? What funding vehicles are available to the foundation?
From the macro perspective, a range of funding instruments, from pure grants to market-beating investments, is emerging. Scott Collier, managing director of the Austin, Texas VC firm Triton Ventures, walks us through the spectrum of options available to funders (my commentary in brackets):
- Program Grants: Currently maintained at a nominal 5% of total assets, these investments are absolutely certain to produce a negative 100% financial return. So perhaps it would make sense to take this allocation to a lower percentage to make room for other investments that carry better returns (you can’t do any worse after all) and a different type of impact. [Note that, negative 100% return notwithstanding, grants can still be structured creatively to support social enterprises for years after they are spent, as discussed by George Overholser in a previous post.]
- Program Related Investments: Deployed as loans at below-market yields, the risk-adjusted returns over time might be zero or negative but still better than the negative 100% generated by Program Grants. [400+ private foundations currently have about $500 million allocated to PRI. PRIs account for only 1/10th of 1% of ~$500 billion in total U.S-based foundation assets. But that may be changing as big players like the Gates Foundation move in this direction. This blog post describes one particularly intriguing example of PRI at work].
- Mission Related Investments: This category comprises mission-directed investments that fall outside the limits of what can be considered part of a foundation’s 5% qualifying distributions. In aggregate these MRIs would target, on a risk-adjusted basis, just a return of capital or perhaps a small return beyond that, but still a below market return in exchange for driving a substantial mission impact. [Note that vigorous debate is underway on the question of whether (and if so, how much) return must be sacrificed to obtain mission-related goals.] Investments in this category could provide a tremendous boost to the nascent social business space.
- Mission Aligned Investments: After evaluating for ROI potential, investments would get priority in this segment given the degree to which they enhance the mission. A good corporate citizen in a country where the foundation does work might be enough to tip the balance in favor of investment. Over time this could become a significant percentage of the income-producing portfolio and given the magnitude of dollars involved it could encourage corporate behavior to move in positive directions.
- Mission Neutral Investments: The lowest social standard of the five, investments in this category would be held after ensuring that a reasonably sound “doing no harm” standard is upheld.
Intriguing examples exist along the spectrum, but, as Tony Wang at the philanthropy strategy firm Blueprint Research & Design noted in a post to his blog, as one moves down the spectrum toward the “doing well by doing good” approaches of mission related, aligned and neutral investments, the socially-driven investor begins to compete increasingly with investors who have no stated social goals. Wang quotes Hewlett Foundation president Paul Brest wondering whether such “mission investments” do have an impact (since presumably many of them would have received investment from another source anyway). Writes Wang:
So if I were to characterize this part of the SRI movement that believes in doing good and doing well, I would argue that socially responsible investors have to believe on some level that the financial market valuations of risk/reward are incorrect and that incorporation of other considerations can lead to better valuations – if they believe their capital is making a difference. There are plenty of market inefficiencies, all the way from early-stage financing (social venture capital) to later-stage financing (ESG [environmental, social and governance] and SRI hedge funds and index funds) and some of the social funds have solid investment philosophies that should lead them to outperform the market (even if the social funds in aggregate aren’t performing better on average – remember, not all investors, even social investors, are created equally).
Examples of funds that aim to compete with the market and win by pursing a social aim include Generation Investment Management LLP (an “ESG,” meaning it screens for environmental, social and governance factors), Gray Ghost Fund (invests in microfinance), New Cycle Capital (invests in the green economy and – interestingly – the “domestic emerging market”) and Good Capital (host of the noted SoCap conference). And there are plenty more; The Monitor Group, with the support of the Global Impact Investing Network, conducted a superb study of the potential locked up in this market.
Many philanthropists and organizations are just beginning to puzzle this landscape out. But a collection of tools and practices do seem to be emerging to help social innovators and their funders sift through the options and make smart choices about the “business end” of their operations.
One of the first questions any individual or organization looking to deploy capital to advance social change must ask is, “should I invest this money for financial return, or should I give it away?” Even wealthy philanthropists who have no need for financial return must consider both options; after all, if a social change can be achieved via financial return (or simply generate return of the principal), that return can in turn fund subsequent social change.
In some cases, answering that question is easy. If your goal is to provide food and shelter to the homeless or improve the lives of incarcerated populations, these aims are unlikely to fit the investment paradigm; conversely, if you aim to help mitigate climate change, you would likely be ill-served making grants to clean-tech companies that would otherwise likely attract private capital. Other times, the choice is much less cut-and-dried. The Acumen Fund (which, it should be noted, targets the very poor, a group not traditionally associated with bright investment prospects) has developed a useful system to evaluate whether its investment for modest return approach will really do more good than a pure charity approach to the same problem. Acumen performs this BACO (best available charitable option) analysis before it enters any investment (the BACO tool is available here).
Similarly, one of the first questions any social innovator must ask is “what kind of capital do I need to build an enterprise that will support my theory of change?” (For those that read the first post in this series, this is the question Start Abroad never answered definitively, a mistake that led to its demise.) Here, too, tools are beginning to emerge that help social innovators figure out what kind of funding they need, in what order and from which sources. William Foster of The Bridgespan Group, writing in the fall 2008 issue of the Stanford Social Innovation Review, lays out when a nonprofit should pursue growth capital and in what form. And of course, capital providers offering a combination of capacity-building services and targeted growth capital, such as NFF Capital Partners (see previous post), are popping up to meet this need.
While the marketplace sifts through the many funding models in play, savvy social innovators and funders alike will no doubt want to keep an eye on which ones show promise. But ultimately these models will stand or fall to the extent that they enable social innovators to meet their core needs: a good theory of change and a strong enterprise to bring it about.