Naki B. Mendoza :
As innovators and social entrepreneurs tinker with ideas and explore potential solutions to global challenges, they inevitably face the do-or-die question of how to get the financing they need to lift their new ventures off the ground.
Securing that money is almost always named as one of the top challenges by entrepreneurs – but it’s not just about knowing where to get money, but about who might be the right funder at that time in a company’s growth.
The options of where to turn are only increasing as types of innovative finance from crowdfunding, peer-to-peer lending and venture capital, to angel investors and foundation funding continue to grow.
Development donors, too, are increasingly exploring how to put their money to work in supporting entrepreneurs – sometimes that offers a great opportunity to test an idea or explore scale and access to networks, but the financing often comes with strings attached.
It then prompts the question: When should social enterprises seek donor funding?
Size doesn’t matter
Funding opportunities are not reserved for only the biggest of social ventures – projects exist for enterprises of all sizes, age and maturity of business operations.
A number of funding programs exist that target small and early-stage social innovators, which is an area where the donor community has typically stepped in with seed capital. But donors are now increasingly looking at addressing the financing dilemma known as the “missing middle” – those businesses that have outgrown microfinance, but are too small for mainstream private equity or commercial bank investments. The Development Innovation Venture program of the U.S. Agency for International Development is a year-round funding competition and the agency’s take on venture capital, although financing officially comes in the form of nonreimbursable grants. Similar to venture capital aims, DIV is meant to test relatively unproven concepts from social enterprises of all sizes and stages of business. This is the program for the experimenters, the innovators and the mad scientist ventures, designed to push new ideas with the expectation that a great business or innovation will surface amid the inevitable flops.
Sida, the Swedish International Development Cooperation Agency, channels resources to small and early-stage entrepreneurs through its challenge funds. Similar to USAID’s DIV program, pools of funding are available for select applicants to test new business ideas around thematic areas of development – agriculture, water scarcity or extreme poverty, for example – regardless of size.
“The most important thing is where we identify needs and if their goal meets our goal,” Carmen Lopez-Clavero, a manager for private sector collaboration at Sida, told Devex.
What’s available
Donors are looking to creative financing mechanisms to strengthen opportunities and enhance ecosystems that will enable entrepreneurs to scale.
Beyond funding the individual enterprise, through funds like DIV, a broader set of credit instruments instead aim to scale wider across industrial sectors.
While donor agencies don’t take up equity in ventures, their funding activities are by no means limited to grants. USAID, for example, relies heavily on a cadre of credit guarantees to unleash small business growth in developing countries. Among them are portfolio guarantees which partially back local bank lending to specific sectors of development. Portable guarantees also allow otherwise credit-starved social enterprises to shop around for competitive commercial loans from private banks.
“We’re looking for the private sector to make the same bet,” USAID Field Investment Officer Eric Naranjo said.
The size of the guarantees and the partnerships with financial institutions that oversee clients across a sector enables a much broader reach.
Sources within the donor agency say that the growing practice of credit guarantees – $13.1 billion was made available in its first 14 years – is one example of a broader shift from scaling individual enterprises to larger development ecosystems. The evolving model, in essence, involves scaling the money itself to multiply the reach for individual enterprises.
Many of these new funding models are still quite new and the ways donors engage with entrepreneurs continue to evolve. Sida, for example, said that formal funding relationships with the private sector only began in 2009. This has forced an internal learning process of sorts as it adapts to the needs and requirements of a new sector of business.
“We’re trying to learn from entrepreneurs themselves to be a little more flexible,” Lopez-Clavero told Devex. “It’s an internal mindset that we have to change – how to adopt more of an entrepreneurial mindset.”
Drawbacks
It may be partly due to growing pains or fundamental differences between donor agencies and social enterprises, but there can certainly be drawbacks to accepting donor capital that should factor into an entrepreneur’s decision-making process. Social enterprises need to be agile and often need to adapt quickly to survive. That can be at odds with the donor funding cycle, which can be lengthy and move slowly. Relying on that funding or waiting for it can create added risks for a company, said Jehiel Oliver, founder and CEO of Hello Tractor, a social enterprise focused on agriculture in Nigeria.
Part of the challenge is that these new financing efforts are often constrained by bureaucratic systems and it can be challenging to change traditional models of cyclical funding. Even with mechanisms like DIV, which is designed to be a venture investment vehicle, it can take up to a year for applicants to find out whether they are in the running or will be awarded the funding.
These constraints can limit a business’ ability to get to the market quickly or adapt in ways that may be necessary. But, if entrepreneurs keep that in mind and use donor financing to supplement other funding and provide added enhancements to their product, it can still be quite useful, Oliver said.
For Drinkwell, a social enterprise working to provide clean water, a variety of different U.S. government funding has enabled the company to develop technology and test systems, which ultimately allowed the company to commercialize.
However, at times Drinkwell has had to wait extended periods of time to get the funding reimbursements it had been awarded, which forced delays throughout the company, said CEO and co-founder Minhaj Chowdhury.
Reporting and metrics for donor funding can also be cumbersome and pegged to a set of benchmarks created at the start of the funding, which may limit a company’s ability to pivot.
Other investors say there is still a rigid tendency among traditional donors to focus on a social enterprise’s activities, rather than potential outcome or results as they create funding strategies. Moreover, donor financing, investors say, tends to be heavily grant-focused. This is vital for de-risking early-stage ideas, but less hands-on than the type of engaged partnerships that are often necessary to bring an enterprise to scale.
Chowdhury echoed that sentiment. Often donor funding doesn’t add much value outside of capital. Other investments may provide more support for a company in the form of networks or mentorship, he said.
Omnivore Partners, a venture capital firm, took a more critical stance, noting that “grant dependent startups that go from grant to grant don’t learn how to survive on their own.”
But some donor grants do ask recipients to cut their teeth on tried-and-tested models. Sida applies a matching component to its challenge funds, requiring recipient enterprises to match a certain portion of their grants with outside funding. In practice, this means that a business model must already be robust enough to pass the credit tests of commercial banks or generate cash flow internally.
(Naki is a reporter for Devex Impact based in Washington, D.C., where he covers the intersection of business and international development).
