Are Social Enterprises Ready for Market-Based Capital?

Over the last few weeks, one of the issues that I have been focused on my twitter stream on is that of social entrepreneurs, more specifically how the term “social entrepreneur” largely implies an organization that (1) solves a social mission and (2) rarely grows bigger than anything “cute”.  That, while there are certainly a few organizations like GroupOn and Whole Foods that have broken out of that mold, the vast majority of social entrepreneurs and enterprises remain small.

And while attending a speech by Lester Salamon from Johns Hopkins University at the Lien Centre of Public Policy in Singapore on the global trends in philanthropy and social investments, I was once again asking myself about where “social enterprises” would ultimately end up.

Focused on global trends in the social sector, Professor Salamon’s presentation provided great insights in the financial conditions that exist for social enterprises (profit and non), and while the current options available bring in trillions of dollars per year, it was his assessment that we were headed towards a new level.  A level that will be achieved through a market based system of funding enterprises much like the NASDAQ.

It was an idea that I have previously been exposed to, and have found examples of, but it was during Professor Salamon’s presentation that I began to debate it a bit deeper about the potential of external (market based) funding and the impacts that it would/ could have on the social sector.

Note:  I must admit that many of my comments may be premature as there isn’t an active market at this point, and many of the questions/ comments I will highlight are ones that others have as well.   That, in large part, the idea of a market to support social enterprises is still largely theory, and while there are initiatives like IIX in Singapore who are close, there are no easy examples of success/ failure that I can point to.  Which is to say that my comments will be largely based on theory, and anecdotal evidence, which will have their own holes.  So, take my comments with a grain of salt, and feel free to debate me on my points all you like. 

At the most fundamental level, while I am in complete agreement that social organizations need access to capital, the idea that “social enterprises” would look to a separate “social enterprise” market is one that I am not sure is fully appropriate.  On the one hand, the very fact that we have to establish a separate market for “good” companies/ organization, or that these organizations somehow cannot compete with “other” companies/ organizations for places on NASDAQ is something I am not altogether in agreement with.  Particularly if we are discussing the “for profit” socially based organizations that have become the primary focus of those in the sector.  The issue for these firms in gaining access to capital, regardless of their profit margins, should have little difference with your average NASDAQ firm.  Sure, the market may give these firms a lower per share value as they are returning lower rates of return to the shareholders (let’s assume for a minute that this is actually true), but this is a pricing function. Not access function.  Were this firm one that were in need of 40 million USD to expand, and the market bought into the plans as laid out by advisors and underwriters, there should in theory be no barrier for this firms to list.

So, what then would be the role of a “social enterprise” market?  Would it be one that focused on non-profit organizations who were unable to distribute dividends to shareholders?  Would it focus on those social enterprises have limited scale, or limited funding requirements?  Or would this be a middle step for social enterprises whose real goal would be to scale up and list on the “big board”?

I think this, at a fundamental level, needs to become clearer because it will be critical in developing (and managing) the expectations of organizations and investors.  That, while few would argue that access to capital is important, it is also important to understand the expectations on both ends just as there needs to be in a grant, donor, or service arrangement.

Second to that, One of the issues I see as most pressing, if social exchanges were to proceed, is that of valuation and how would a ‘social enterprise’ be valued. In traditional markets, there are a number of factors related to the business, and there are several fundamental models for valuing a firm that are tied to its financial performance, growth projections, risk analysis, and industrial conditions.  Models that rely heavily on comparables (other similar organizations) and historical market data,  but not only is this data largely void for this sector, it is operationally largely irrelevant as well.  That while many traditional firms are continually measuring themselves against their competitors on a basis of available data, penetration rates, and stickiness, the average social enterprise is using completely different metrics at times.  Metrics linked to improvements in education, healthcare, and access to clean water, metrics that the market would have to learn to incorporate into their models.

Another issue, related to valuation and risk, is that social enterprises already have a wide variance in financial resources (government funding, service fees, donations, grant, and competitions ), and yet there has been little discussion about the impact each of these sources would have on valuations.  Would an enterprise with 95 percent service based funding be more attractive, be given a higher valuation, because of an appearance of sustainable cash flow?  or would a regular measure of government support be better?  How would winning a widely recognized competition impact the valuation, versus winning a privately run competition?

Finally, assuming that a valuation is constructed and the organization is able to successfully list on the “social” market, the next big question becomes what rights would the investor have, and how would these organizations learn to work with their new investors?  Would strategic investors have the ability to make strategic decisions and placing managers within the organization?

As said on Samasource’s FAQ Website:

If we were a for-profit or profit-maximizing business, we might be urged by investors or shareholders to alter our methods in order to generate higher returns. We believe that our first commitment is to our beneficiaries. As a non-profit organization, our legal structure ensures that we maintain that commitment while growing an organization capable of sustaining itself through earned income.

What restrictions would be placed on investors whose expectations for a financial return competed with the social mission of the firm? Would social organizations be judged on its per share net profit? Or a wider impact kpi that is (1) set by enterprise (2) benchmarked against the industry (3) other???  and would these metrics be adjusted by scope, scale, and geographic conditions that represent the real conditions the enterprise exists in?

Finally, what is the end game for those organizations who have listed on the “social” market.  Would there be an ongoing expectation that the enterprises are to then use the money in a way that would lead towards a full listing, making the “Social” market a mezzanine lender of sorts? Or would this “social” market be “THE” market for social enterprises?

At a fundamental level, all of these issues for me are quite important in understanding the benefits/ limitations/ potential of the “social’ markets being discussed.  There are some clear opportunities for expanding the sources of funding, and that is certainly a good thing, but I am still a bit stuck in the details and unsure where the long term position of a market like this would be in effectively supporting the scale of socially focused firms (profit and non).

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