Social Entrepreneurship And Venture Capital

Research Paper on Social Entrepreneurship and Venture Capital/Start-Up Funding

Nothing can be nobler than wanting to improve the conditions of the world both on an environmental and sociological level. Those individuals and businesses that choose to take on society's problems are a special breed and they face an uphill battle not only in performing their work, but finding the financial resources to grow the business so that it can fulfill its mission. This paper will examine the industry of social entrepreneurship and how venture capital funding is playing a role in improving life for all.

First, to define what a social entrepreneur is. According to one widely accepted definition, social entrepreneurs "adopt a mission to create and sustain social value, act boldly without being limited by the resources currently in hand" and "exhibit a heighten sense of accountability...for the outcomes created."(Dee, Gregory). The majority of social enterprises are legally established as not-for-profit organizations, but a growing number have set themselves up as for-profit firms, with the owners agreeing that the business profits are to be reinvested in continuing the organization's social objectives.

Social enterprises face two ongoing hurdles towards achieving their mission, goals and objectives. The first is the nature of the business. Social firms are often referred to as "double bottom line" businesses, meaning they are designed to make a profit while fulfilling a social mission (Clark, Gaillard). This dual goal can be seen as paradoxical, which is often difficult for both employees and funders to come to terms with making it harder to motivate all parties towards achieving sustainable profits. The second hurdle is that the sources of funding for social businesses are more limited than the for-profit arena. Foundations and government grants have traditionally been the primary source of funding, but they provide mainly short-term grants. Social entrepreneurs need medium to long term financing.

Despite these hurdles, the social entrepreneurship industry is growing. Just a decade ago virtually no business schools focused on social causes and business. Today, most top business schools do, such as Stanford University's Social Innovation Review which established the Global Entrepreneurship Monitor to measure social entrepreneurship around the world, and Harvard University's Initiative on Social Enterprise. In addition, the number of nonprofits operating in the US grew by 74% between the years 1987 and 1998. (The Independent Sector Press Release, July 2001).

The industry has grown for several reasons. Problems with declining natural resources and global warming have given rise to more organizations dedicated to preserving the world's environment, likewise, social and world wide issues such as AIDS, poverty and terrorism have led to more organizations being created to help combat these issues. Corporate scandals and run away executive compensation have given businesses focusing on philanthropic endeavors more media prominence as the "good guys", which has raised the public's imagination and support.

There is growing pressure for corporations to focus on their social impact coming from shareholders and customers as well as from concerned employees within. Thus, to help improve their images, many corporations have established foundations to provide funding to businesses working on social issues.

To be successful, social entrepreneurs need more than just a noble mission. With the down turn in the economy over the past five years, social enterprises have experienced major government funding cuts and increased competition for funding from foundations. In order to support operations, many social enterprises have to diversify their revenue streams. This means creating a funding strategy that includes fee-for-service along with traditional grants, and financing strategies based on courting individual donors and venture capital investors.

The venture capital market is more associated with for-profit firms where the investors can realize (hopefully) long-term investment returns, and quick pay back through IPO offerings. This is not the case with most social enterprises where the profits are reinvested back into the business and not distributed to owners or shareholders. Thus, non-surprisingly, the venture capital market is much smaller for this industry, but it does exist and it is robust.

In 2003, the Rise Initiative on Social Entrepreneurship (RISE) completed a comprehensive study on the venture capital market for social funding. The researchers sought answers to two main questions:

* "Are there sources of equity capital that will make it more likely for a company with both financial and social or environmental objectives to succeed?

* How much capital is available from these sources and what are their own objectives for success?" (Clark, Gaillard)

The RISE study provides the most in-depth picture on the venture capital (VC) funding for social causes. The study found that there is over $1.9 billion of total capital available for investing, and the wealth is spread over many specific interests such as healthcare, education, the environment, the arts and international development. This diversity led the researchers to classify the VC market into four funding types: VCs with a conscience; VCs with an industry change focus; VCs with a focus on leadership or development and the nonprofit social investment VC fund. Please see appendix A for a detailed description of these funds.

The social VC market acts very much like for-profit venture capitalists in that the VCs focus their success "first in financial terms, and then on social or environmental terms." (Clark, Gillard) VCs in this industry use stringent social or environmental screens to ensure that their funds are invested in organizations that match the VC's mission and where the invested funds will be used to make the maximum impact. Some of the criteria VCs use in order to evaluate this are the "value and professionalism of [the organization's] staff and operations, or by the positive impact [the organization] can have on communities where they are located and whom they hire." (Clark, Gaillard)

The study finds that social VC funding amounts to about 6% of the overall VC market, and noted that there was a significant decline between 2001 and 2002 with a drop of 41% in social funding between those years. The study believes that the social VC market is still maturing with investors managing less than $25 million, which is