Angels: social enterprise needs you
Finding funding can be one of the key catalysts for growth for any business. But social enterprises face particular challenges. We need angels, says Jonathan Jenkins
The social investment market is proving to be a particularly dynamic place in which to operate. Its current stage of evolution is coinciding with a backdrop of state austerity, economic fragility and (hopefully) the pinnacle of social need.
Unlike the traditional financial markets, social investment has not been left freely to mature in response to market forces. Instead, with good intentions, the market has been pumped full of steroids, a few cans of Red Bull and a dash of Pro Plus, with the intention of finding a short-term silver bullet to the nation’s woes.
The missing middle
The result, not surprisingly, is a distorted marketplace, which is extremely advanced in some respects (such as the work of the Sir Ronald Cohen-backed Social Finance on social impact bonds and unclaimed assets to seed a Big Society Bank), but in others it is well behind the curve, in particular the “missing middle”. Example 1: if your social venture is looking for some initial, most likely grant, funding up to £50,000 or so, there are a fair number of opportunities open to you. UnLtd, for example, funds around 1,200 social entrepreneurs per year in the £2,000-£20,000 range. When other funders are taken into consideration, there must easily be 1,500 start-up/early stage social ventures receiving funding on an annual basis. Example 2: if you are looking for scalable debt/equity investment of £250,000 or above, there are funds available (eg Bridges Ventures, Big Issues Invest). The total number of deals at this level, I would suggest, is fewer than half a dozen per year. There is no lack of applicants for these funds, but there is a clear lack of investment-ready, credible applications. As Sarah McGeehan at Young Foundation says: “There has been an exciting surge in the availability of growth funding for scalable, ambitious social enterprises. But for many businesses, the path to scale and growth is less clear.” The market goes from funding more than 1,500 start-ups to supporting fewer than six at scale. While you could try to argue that the social enterprise sector gives light of day to too many start-ups, this is tempered by the stats that more than 235,000 people want to start a social venture in any given year (GEM 2008). Therefore, less than 1% of those motivated to start a social venture actually do so. If anything, should Big Society get grass roots traction, this market imbalance may only get worse.
Elephant in the room
We have a social investment marketplace where it is relatively easy to start up a social venture, and possible to grow it to scale once you’ve achieved an investable level of maturity. The elephant in the room is the rather obvious and sizeable gap in equity and venture philanthropy funding between around £50,000 and £250,000 – the well documented “missing middle”. So what are the key problems preventing investment in this space?
- Cost: institutional money (the formal social investment funds) can’t operate at this level due to the pure economics of transaction costs.
- Pricing: on many of these transactions, if you commercially price the risk, the numbers simply don’t work for equity investment. Even if the transaction costs were lowered, standard pricing models wouldn’t work. Cashflow often is not stable enough for debt investment.
- Confusion: over financial versus social return models, blended models and the language employed by the social enterprise sector.
- Unrealistic expectations about financial returns: the number of opportunities for a genuine social and commercial rate financial return is limited.
- Exit: very few social ventures would agree to pre-determined exits (trade sale, flotation) for equity investors.
Enter the angels
These limitations are not about to change; these are structural issues with the marketplace. So rather than try to shoe-horn current opportunities into formal traditional methodology, we need something else. Private money needs to come into this space. This can involve individual pricing of risk and expected return, personalised due diligence and a more open attitude towards exit strategy. We need angels. The sector is crying out for them. Fortunately, nature abhors a vacuum. A number of pioneers have stepped forward:
- Coutts Bank has launched its Social Enterprise Advisory service connecting its clients with mentoring, and possibly investing, opportunities. Andrew Haigh, head of Coutts’ Entrepreneurs Client Group, says: “Social enterprise resonates well with our entrepreneurial client base. Our clients have had their business success, and social enterprise is a fantastic opportunity for them to use their skills and experience in a philanthropic way. I think we will see successful entrepreneurs become less interested in simply writing out cheques to charities, rather we will see more supporting social enterprises to achieve scale, be it through mentoring or business angel funding.”
- VCap has launched an incubator and seed fund to make equity investments of £50,000 to £150,000 in social businesses. Stephen Rockman, founder of Vcap, says: “We’re bridging one part of this funding gap by providing hands-on equity investment to social entrepreneurs building scalable businesses. Our investment model is designed to generate a commercial return without compromising social impact.”
- Resonance and ClearlySo are both already running early-stage social investment angel networks.
- British Venture Capital Association already has a social enterprise committee in place, in response to its membership.
- Venturesome, part of the Charities Aid Foundation, has been one of the leading practitioners of the UK social investment market, doing more than 250 deals since 2002 by using a range of non-grant financial mechanisms, such as unsecured debt, underwriting, quasi-equity and equity.
- A variety of crowd funding solutions are evolving, eg Buzzbank, although none have achieved critical mass.
But we need more scale than these flagbearers can create on their own.
Call to action
In an approach to an angel network umbrella organisation to ask their networks whether their members were interested in any sort of social venture, I was curtly rebuffed with the rather patronising: “No angels will invest any of their financial portfolio in anything that doesn’t maximise shareholder return. That’s not how they work. Period”. I simply don’t believe that is true. I have seen the buzz at social enterprise events such as those run by Coutts and ClearlySo; TV’s Secret Millionaire and How the Other Half Lives increasingly focus on the positive impact on the investor as well as the financial beneficiary; James Caan recently joined the board of The Big Issue. I am not naïve enough to believe all angels will suddenly change their investment strategies and criteria overnight. Far from it. I don’t believe there is a raft of investments offering huge commercial returns. But there is significant evidence to show individual investors are increasing interested in somehow getting involved. Angel networks that don’t start to include these opportunities on occasion will get left behind. So my call to action is to all angels who might be interested in investing some of their financial or philanthropic portfolio into this social venture space to step up and challenge their formal/informal angel networks to provide them with the sort of opportunities that abound. And if the networks can’t deliver, go to one that can. As Sinclair Beecham, the founder of Pret A Manger, says: “I guess the best way to compare investing or giving to social enterprise versus traditional charitable giving is akin to the old adage of teaching someone to fish versus giving them a fish to eat. The goal of most social enterprise businesses is to achieve financial sustainability. Thereby, a gift or loan from a modern philanthropist will continue to do good and not merely run out when the money is spent. And how satisfying is that?” If we crack the retail market, we can crack the missing middle. In the longer term, we need retail investment products using existing retail investment channels (such as the much mooted social ISAs). That will happen in time, but right now is the time for the angels and dragons to nail this bloody elephant, once and for all. Jonathan Jenkins is Director of Ventures at UnLtd, The Foundation for Social Entrepreneurs. UnLtd Ventures operates the UnLtd Advantage investment readiness programme, working with social ventures to attract investment from the institutional social investment community. www.untldadvantage.org.uk
Closing the gap
Dr Mohammad Al-Ubaydli, founder and chief executive of Patients Know Best, which integrates into the NHS Connecting for Health network to offer secure tools for patients to work with clinicians, on finding investment for his social enterprise: “After our first year, the idea of patient-controlled medical records was still radical and any investor performing due diligence on the company saw several unknowns. For example, would customers find the service useful, and could our team deliver? The valuation we got reflected the risks in investors’ minds. “Seedcamp chose us as one of the top six start-ups out of 1,500 across Europe. We took their small …50,000 investment, got Bupa as our first paying customer, and delivered the first version to them. It was a serious constraint on resources relative to the term sheets we were offered, but it meant we dramatically cut the risk for investors. By the time Channel 4 approached us as investors, we had a far better track record to show them. “Entrepreneurs should reduce risk for everyone involved. If your plan is to reach profitability with £10m invested and one million users, find another plan that requires just £100,000 investment and 10,000 users. Before requesting the £100,000, ask for £10,000 and show you have spent it efficiently. And before asking for the £10,000 from a grant committee, assemble a team of experts in the company to give credibility and reassure that the money will be in good hands.”