A Fault in Funding
An initiative undertaken by the World Bank reveals a troubling gap in the financing of social enterprises.
In 1998, the World Bank launched the Development Marketplace (DM), a competition-based initiative that aims to solicit promising new ideas for meeting the needs of people who live in underserved communities. DM hosts periodic global and regional competitions, and finalists—which can be either nonprofit or for-profit enterprises—receive grants to further their work. To date, DM has awarded more than $65 million to support 300-plus projects in developing countries, with a special focus on projects in base-of-the-pyramid (BoP) markets.
In recent years, DM has evolved into a program that broadly considers the role that private sector institutions can play in serving marginalized populations. Today, the World Bank uses DM as a platform not only for locating potential business and service delivery models, but also for demonstrating and documenting the resources that emerging enterprises need to achieve scale and to become sustainable. Among those resources is access to operating and growth capital.
Over the past decade, we and our colleagues have helped lead the DM program as it has evolved to meet changing needs. A couple of years ago, we began to note a worrisome pattern: A serious divide has opened in the landscape of social enterprise finance. On one side, much of the available supply of impact investment capital is seeking the sweet spot where attractive financial returns combine with positive development impact. Unfortunately, few social enterprises are able to offer that combination. Meanwhile, on the other side, there is a large, unmet demand from social enterprises that deserve financial support.
Some argue that if a social enterprise cannot achieve profitability (or at least financial stability) within a few years, it is not worthy of further support. Although there is merit in that point of view, it lacks an appreciation of the realities that confront social enterprises in emerging countries. Distribution channels that are normal elsewhere do not exist in these markets, and creating them can take many years. The people served by these enterprises have little or no disposable income—a factor that limits pricing flexibility and the potential for revenue growth.
As a result, many social enterprises that operate in BoP markets go through a protracted developmental period before they achieve profitability. Others are unable to reach that stage at all. These enterprises struggle to satisfy the financial criteria of most impact investors. Given time and appropriately aligned capital, however, many of these organizations can grow to become reliable providers of necessary, cost-effective services in developing countries.
Where Are They Now?
In 2010, DM undertook a two-year-long pilot study to explore the kinds of support that social enterprises might require once their early-stage, time-limited funding had run out. Under the pilot, DM would provide continuing support to selected prize-winning organizations—in particular, by helping them mobilize funds for expansion and scaling up. We limited our selection to DM prizewinners that had gone on to develop their enterprise after receiving an award; among that group, we identified 30 organizations. Our goal was to recruit enough past winners to form a reasonable sample of social enterprise experience. The 30 enterprises that we chose cover a wide range of fields: preventive health care, energy, water and sanitation, job creation, and education. One-third of these organizations are in India, another one-third are in sub-Saharan Africa, and the balance are in East Asia and Latin America.
We asked these entrepreneurs which kinds of further support they might find helpful. Some of them cited the advantages of a mechanism to connect with other DM winners. A few of them requested technical assistance. But every one of them requested help with funding. In one sense, this response might seem obvious. But in another sense, it was a surprise. Many of these organizations had earned wide recognition for their work. If even fairly prominent enterprises cannot access sufficient capital to build their organizations, what must it be like for those that are less well known?
We offered to connect these past DM winners with impact investors and foundations, and all of them enthusiastically accepted the offer. (Their funding requests ranged from $75,000 to about $2 million.) As a first step, we asked the entrepreneurs to share with us presentation material that included business plans, financial data, and the like. Here we encountered a second surprise: With only a few exceptions, most of the entrepreneurs had developed at best indifferent material to promote their enterprise. To remedy that situation, DM funded and organized a small technical assistance program to help these entrepreneurs improve their presentation capabilities.
If even fairly prominent enterprises cannot access sufficient capital to build their organizations, what must it be like for those that are less well known?
Next we connected the 30 entrepreneurs with more than 300 potential sources of funding. Foundations and other providers of subsidized funding made up about 55 percent of those sources; impact investment funds and similar organizations made up 30 percent; and the remaining 15 percent were intermediaries that had their own networks of prospective funders. About 10 of the 30 social enterprises—those that are at or near commercial profitability—had the potential to interest impact investors. The remaining 20 organizations sought further rounds of subsidized funding. By the end of the pilot in 2012, half of the impact investment prospects had received funding. In contrast, none of the seekers of subsidized funding had met with success on that front.
This exercise was not a controlled study, nor did it involve a representative sample. What’s more, some projects in our group of 30 may yet receive funding. But these results are consistent with our emerging view of the environment for social enterprise finance: The impact investment market offers opportunity for some for-profit organizations. But capital to support non-commercial social enterprises is absent or at least highly insufficient—despite the high development impact that many of these enterprises have on their communities.
What Can We Do?
The gap in capital alignment has two sides to it: On the supply side, the receptivity of investors and funders is at issue. On the demand side, the preparedness of social enterprises comes into play. DM has begun to work with various groups that seek to expand the supply of capital to social enterprise—groups that are pursuing ideas such as blended or layered capital, social impact bonds, and the like. We are also working with other groups to develop measures of social return that will encourage investors to supply capital in cases where the financial return might be low (or even negative). Alongside these efforts, DM has sponsored several initiatives aimed primarily at improving the qualifications of organizations that have a need for capital.
First, we recognize the need of social enterprises to strengthen their operational capacity. Toward that end, we have built into the DM program a process in which we work with enterprises to assess their requirements for scale and sustainability. Armed with information from that assessment, DM-sponsored social enterprises are able to contract for relevant technical services, which DM funds through grants over a period of 18 to 24 months.
Second, we have noted how entrepreneurs’ failure to define and articulate their business model limits their ability to engage with investors and funders. To overcome that problem, we have worked with the Global Social Benefit Incubator (GSBI) at Santa Clara University. GSBI offers a training program on how to develop an effective business model and how to conduct financial planning. To make GSBI training available to a geographically dispersed group of social enterprises, a team at the university worked with us to develop an online version of the program. Over the past year, GSBI Online has trained more than 45 organizations—including several recent DM prizewinners.
Third, we have learned that even the best social enterprises often lack awareness of how to raise capital. DM has partnered with Enclude (formerly ShoreBank International), an advisory firm based in London, to conduct a pilot program that will document various considerations—staging, timeline, and so forth—that are part of the capital-raising process. The program will also develop a structured method for enhancing the speed and reliability of that process.
The demand-side challenge does not exist merely at an organizational level, however. Most social enterprises operate in environments that lack adequate supportive capacity. DM, therefore, has taken steps to develop local ecosystems. In India, we have partnered with Innovation Alchemy, a Bangalore-based organization that helps us tap into a local network of intermediaries, universities, and financial institutions. In Egypt, we have partnered in a similar fashion with a group of roughly 25 organizations, including local foundations, companies, and intermediary organizations.
In 2014, DM will launch several additional initiatives. Along with programmatic funding, we have allocated money to finance the development of the operational and financial capabilities of social enterprises that seek to grow. We are also investing in ways to evaluate and document business models that demonstrate both financial sustainability and scalable social impact. In addition, we are seeking further opportunities to collaborate with groups that aim to bridge the capital divide—particularly on the supply side, because constraints in that area pose the most pressing challenge for social enterprise financing. In this way, we hope to improve the quality of services available to people in marginalized communities.