More business for more impact

Inclusive Economy02 Jun 2014Martijn Blom

Social entrepreneurship is booming, as is impact investment. However, the very specific raison d’être of these social ventures brings a whole new set of challenges. The most imminent of these is probably a persistently misperceived friction between business and social goals, which is causing concerns about the interest of many social entrepreneurs in financial models and entrepreneurial practices.

Investing in small and medium enterprises (SMEs), especially start-ups, is not for the faint-hearted. It is a harsh game of winning and losing, as only one in ten SMEs really succeed. Investing in social ventures, especially when they are focused on developing countries, often brings about even more risks. Bureaucracy, cultural differences and sometimes straightforward corruption can seriously test investors’ patience.

For this very reason a fierce debate is evolving on whether impact investors can expect normal market rate returns. Stanford scientists Paul Brest and Kelly Born, for example, say “We do not reject the possibility of earning market-rate financial returns while achieving social impact, we are skeptical about how much of the impact investing market actually fits this description”. Nevertheless, as Brest and Born show in the same article, most impact investors believe that they will achieve normal market rate returns.

Whatever investors’ exact intentions are and whether or not social impact can be measured, however, it is perhaps more relevant that the above discussion could muddle entrepreneurial minds. Some purposely lower their financial ambitions to allow their social ambitions to flourish. This phenomenon is fuelled by the widespread misconception that social entrepreneurship requires tempering business ambitions. This attitude can be lethal for social enterprises.

Sustainable impact

A company we are involved in intentionally kept their profit margins low, refusing to obtain financial gain from people at the bottom of the pyramid, to whom they sold cheaper clean water. But low margins also mean no reserves in case of emergencies. Thus prices needed to go up, new sales channels were introduced and costs were cut. Gradually we built a social company based on real business models and minds, which tripled not only our gross margin but, even more strikingly, our social impact.

Measuring impact is very useful for all impact investors. But in the end the success of every company is defined by revenue, profit, valuation and scalability. Seeking social return on investment (SROI) should not be used as an excuse for lower financial ambitions as it might make companies inherently vulnerable to the bumpy road of entrepreneurship. Sustainability is also a financial virtue.

Business skills

The main reason for investing in a social enterprise is not the plan, not the profitability, but the entrepreneur. In entrepreneurship, the proof of the pudding is always in the eating. Certainly in early stage companies, there often are no other indicators of real value.

Entrepreneurs themselves are probably one of the biggest liabilities in social entrepreneurship. They never lack passion or eagerness, as they are driven by their ideals. They aim to achieve impact for their client, which should be the focus of every entrepreneur. Although they never lack a brilliant concept and have an abundance of creative ideas, they tend to have limited real business skills. It’s hardly rocket science, but all too often it is just not their prime interest.

Impact investor

We once considered participating in a company that created the most beautiful products. The entrepreneur had won several prizes in design. Her wish to both source and produce socially in developing countries meant that she had a wide variety of suppliers and producers and thus high and multiple transport costs. This resulted in very highly priced products and low margins, making the company unsuitable for sustainable growth. A greater focus could have meant more business and thus more impact.

Social entrepreneurs should in the first instance be entrepreneurs. Their success will be determined first and foremost by financial factors like growth, revenue, profit, margins and scalability. Impact investors idealistically have a large role to play in building the capacity of companies in their portfolio. That is where they can make a difference. For them to do so, it is even more important that they can work with experienced entrepreneurs with a flexible and entrepreneurial approach. More knowledge of and focus on business minds and entrepreneurial principles will lead to the long-term impact that many aspire to for social enterprise.

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