Why investing in social impact is the new venture capital

A section of Kibera slum in Nairobi: Massive efforts have been mounted to combat social problems like poverty and disease around the world. FILE 

By Ronald Cohen and William Sahlman
 

 

During the past century, governments and charitable organisations have mounted massive efforts to address social problems such as poverty, lack of education and disease.

Governments around the world are straining to fund their commitments to solve these problems and are limited by old ways of doing things. Meanwhile, social entrepreneurs are stultified by traditional forms of financing.

Donations and grants don’t allow them to innovate and grow. They have virtually no access to capital markets and little flexibility to experiment at various stages of growth. The biggest obstacle to scale for the social sector is this lack of effective funding models.

But the problem is not money, per se. Take a look at the social sector in the United States. There were a total of $700 billion in foundation assets, and, as of 2010, more than 10 million people working for non-profits. These are huge numbers. Yet there are massive inefficiencies in capital allocation.

Too often donors starve organisations and entrepreneurs by refusing to cover overhead. This makes it impossible for social organizations to scale.

Interviews conducted in 2000 by the Social Investment Task Force in the United Kingdom, revealed what most non-profit leaders already know: Almost all social sector organisations are small and perennially underfunded, with barely three months’ worth of working capital at their disposal. And that hasn’t changed in the last 12 years.

Compare that to the world of venture capital. If a business entrepreneur came to us with a plan for growing a new business without spending a penny on overhead, we would show him the door. Why should it be any different for a social entrepreneur?

We believe we are on the threshold of a major change not unlike the early days of the modern venture capital industry. In the mid-1960s and early 1970s, a new type of investment vehicle was created: the professionally managed venture capital partnership.

This organisational innovation drew investment capital from institutional players like pension funds and endowments and allowed for appropriate time horizons. Soon venture capital became a core part of many economies, and entrepreneurship has never been the same since.

Just as the formation of the VC industry ushered in a new approach toward funding innovation in the private sector, impact investment has opened up opportunities to harness entrepreneurship and capital markets to drive social improvement. In time, this will bring much needed change to the social sector.

We are already beginning to see innovation. People are developing new securities that link social performance to financial returns. There are new experiments – models that use the tools of finance to try things in different ways – creating income streams from novel concepts, like funding cancer research.

During the past century, governments and charitable organisations have mounted massive efforts to address social problems such as poverty, lack of education and disease. Governments around the world are straining to fund their commitments to solve these problems and are limited by old ways of doing things.

Meanwhile, social entrepreneurs are stultified by traditional forms of financing. Donations and grants don’t allow them to innovate and grow. They have virtually no access to capital markets and little flexibility to experiment at various stages of growth. The biggest obstacle to scale for the social sector is this lack of effective funding models.

But the problem is not money, per se. Take a look at the social sector in the United States. There are a total of $700 billion in foundation assets, and, as of 2010, more than 10 million people working for nonprofits. These are huge numbers. Yet there are massive inefficiencies in capital allocation.

Too often donors starve organisations and entrepreneurs by refusing to cover overhead. This makes it impossible for social organizations to scale. Interviews conducted in 2000 by the Social Investment Task Force in the United Kingdom, revealed what most nonprofit leaders already know: