Many start-ups dream of getting venture capital funding. After all, what is more exciting than getting millions to develop your new killer App or sharing platform? Venture funding brings in not only the cash to pay operating expenses for a few years, but also the cachet of being a funded start-up in a competitive field.
Unfortunately, like eager bands signing with a record label, we tend to forget the strings attached. Venture capital seeks a tenfold return or more, it wants a seat on the board, and it demands a say in the direction and pace of progress. Often, it has the power to kick out the initial founders.
In fact, for many start-ups, venture capital is not the answer. According to green entrepreneur and investor Noam Gressel, venture capital is a good solution only in very specific circumstances. It is the most expensive and riskiest money, and by design impatient. Venture capital works well for start-ups with technologies that require limited R&D and have low capital expenses. They need to have the potential to scale rapidly and produce outsized returns. Even then, it is a numbers game, with most start-ups failing. For social entrepreneurs, venture capital is all wrong: the risk is too high, the infrastructure to get funding is lacking, and the return cycle of 3-10 years is too short.
What kind of investment should social entrepreneurs be looking for? You will need a finance person in your team who understands the financing possibilities. Here are five categories of funding, ranked from the most obvious to the most surprising.
1. Government grants and research grants: while these may have complicated application processes and strings attached, there are great opportunities for companies at the forefront of specific innovation sectors.
2. Philanthropic support: Well-known and lesser-known private foundations fund promising social start-ups. The new charity is savvy: nowadays foundations require coherent and well thought-out business plans. Sometimes funding comes in the form of competitions, as in the Dutch Postcode Lottery’s €500,000 Green Challenge.
3. Impact investment: This is a new category of funding which adds social and environmental indicators to the usual financial indicators of profitability and return on investment. Some investment funds allocate part of their portfolio to impact investment, as do some large banks. While this represents only a small fraction of overall investment for these organisations, the available sums for start-ups are significant and rapidly growing.
4. Get financing from your own profits: This is an obvious but overlooked category. As Gressel argued in dialogue with our Creative Leadership Program participants, profit is a tool that allows you to make a broad impact, and gain market recognition that your services are necessary and attractive. A minimal viable product or service should be designed in right from the start – social entrepreneurs are sometimes so focused on impact that profitability takes a back seat. Early market recognition unlocks additional funding opportunities: it is healthier to finance a serious purchase order with private equity than to bring in an equity investment. Finance the projects rather than the company.
5. Partner with large companies: In order to scale faster, try using the client base of a strategic partner. You can partner with companies who give you a lot of support, much of it in-kind. Large companies are interested because they want to know what is out there, and they will help nurture your company without wanting a seat on the board or asking for a lot of financial return.
All too often, the call for social entrepreneurs to “think like business entrepreneurs” is misinterpreted as copying conventional business models. But if it were that easy, we wouldn’t be facing the dire need for social innovation. Social enterprises should be copying the strategic thinking of business entrepreneurs: they should ensure they have a value proposition that is truly compelling and a strategy for scalability.
Social entrepreneurs can reframe the misfit with venture capital as an advantage: while tech entrepreneurs focus on venture capital, social entrepreneurs have access to a much broader range of funding opportunities:
- Government grants and research grants
- Philanthropic support
- Impact investment
- Get financing from your own profits
- Partner with large companies
The goal is to find funding that is aligned with your social mission and impact. We hope these five categories will encourage you to find money in unexpected places. Let us know how this is working out for you.