In the first in this series of blogs, I looked at current use of alternative models of risk finance in the UK social investment market and the possibilities for increased use. In this blog I focus on some of the ways that different forms of risk finance are currently used overseas.
Perhaps unsurprisingly while specific situations and language may differ, many of the broad challenges of providing finance to entrepreneurial social organisations are experienced across the globe.
Last November, I attended Mars’s Social Finance Forum in Toronto and attended a session called: ‘Know your exits: Alternative strategies for impact ventures’.
The blurb for the session explained: “A sale or IPO is a challenging exit for an impact venture, but there are other routes to a return. Learn more about alternative structures like revenue-based financing and seed investment notes that offer entrepreneurs patient capital and investors a pathway to a structured exit”
One of the speakers at the session was Andrea Armeni of Transform Finance, who talked about their work promoting alternative models of finance to create transformative social change.
Transform Finance’s recent report Innovations in Financing Structure For Impact Enterprises looks at the use of alternative structures in Latin America. It looks at the problems of traditional models of investment into ‘impact enterprises’ from both the investor side and the investee side before citing some case studies of approaches used in the region.
For investors these challenges include:
- higher perceived credit risk
- lower potential returns
- longer time horizons
- harder and slower path to scale
- fewer exit opportunities
- higher transaction costs
For investee the list of challenges is:
- long-term commitment to enterprise
- less emphasis on exits
- complex operating environments
- concerns about preserving the mission
- high costs of failure
The report looks at some of the alternative models of investment that have emerged to tackle these challenges. They include Enclude’s Variable Payment Obligation, which sees the advisory firm work with local banks to provide $25,000-$50,000 loans repaid as a percentage of revenue to ‘especially women-owned’ small enterprises who would not be able to take on traditional loans, while providing business support and training to help the businesses to grow.
Another example is Elios Foundation’s use of the Demand Dividend model (promoted by the Miller Centre for Social Entrepreneurship at Santa Clara University) to invest into the Belize-based agriculture venture, Maya Mountain Cacao. The $200,000 investment came with a two-year repayment holiday followed by repayment of 50% of ‘Free Cash Flow’ over predicted seven-year period. ‘Free Cash Flow’ appears to mean cash that is not needed to cover operating costs however it is easy to imagine potential conflicts between investors and investees about how much cash is ‘free’ at any given if future costs are not easy to predict. This may explain why this model, while theoretically appealing, does not appear to be widely used.
Beyond Latin America, other uses of alternative risk finance cover broad spectrum ranging from investment-style ‘venture philanthropy’ to commercial investment with a development focus.
At the ‘venture philanthropy’ end, the Heron Foundation’s Enterprise Capital Grants are ‘equity-like capital’ – multi-year grants provided alongside co-investors to enable nonprofit enterprises to achieve revenue growth. They explain: “Just as traditional capital investments are intended to enhance revenue growth, investors providing philanthropic equity should expect revenue growth, either earned or contributed, in the nonprofit.”
Adding that: “The main difference between traditional and philanthropic equity is that the investor allows that revenue to be retained by the nonprofit.”
One of several examples of more commercial funds providing risk finance to achieve development goals is ResponsAbility, a fund aiming to increase renewable energy supply in sub-suharan Africa. The fund is backed by the German development bank, KfW and its Norwegian equivalent, Norfund and aims to bridge the gap between the social need for renewable energy and the lack of conventionally bankable investments able to meet that need by providing a mixture of equity and quasi-equity investments.
This blog provides some brief snapshots of ways that risk finance is being used for social good beyond the UK social investment. If you’re aware of other examples that it would be useful for me to consider in my research please let me know.
The third and final blog in this series will provide some highlights of our new research talking to UK charities and social enterprises about their risk finance needs along with recommendations for ways that the UK social investment market might be able to respond to those needs.
‘Risk’ image credit: Nathan Huth
