If We Want Social Enterprises to Thrive, We Need a New Funding Approach

By Don Shaffer

What will it take to build a thriving social enterprise sector that can lead the way to the next economy?

That’s a question that’s always on our minds at RSF Social Finance, and we’re convinced that one essential step is to challenge the dominant funding model. In that compartmentalized approach, venture capitalists aim to make as much money as they can in the shortest possible time, philanthropists give money to donation-dependent nonprofits, and early-stage investors — even in the impact sector — look for the hockey-stick growth graphs typical of tech pitches.  (“Growth Financing for Social Enterprises: 5 Options and How to Make Them Work for You” provides an analysis of funding options.)

We need to rethink the purpose of capital for social enterprises and adopt an approach that crosses conventional boundaries — a model RSF calls integrated capital. Integrated capital is the coordinated and collaborative use of different forms of capital (equity investments, loans, gifts, loan guarantees, and so on), often from different funders, to support a developing enterprise that’s working to solve complex social and environmental problems.

Integrated capital addresses the funding challenges social enterprises face in a number of ways. It allows for longer development times by including some types of investment that don’t need to make a large return (or any return). It gets enterprises through the “valley of death,” where they have a promising business model, technology, product, or service, but need more capital to realize its potential and don’t qualify for traditional financing. And when community foundations and local investors participate, it creates a community commitment to the enterprise’s success.

Testing shows the model works

We know this model can succeed. In 2012, we launched the RSF Local Initiatives Fund, in collaboration with lead donors, to pilot an integrated capital approach to financing regional food systems. (See “How Can We Fix Our Broken Food System? Start With the Base of the Supply Chain” for context.) In the first two years, the fund deployed $2 million to 40 early stage sustainable food and agriculture enterprises, with a focus on technical assistance grants, loan guarantees, convertible notes, and place-based Shared Gifting circles. Those investments have leveraged well over $10 million in additional financing to date.

For example, a $200,000 loan guarantee from the Park Foundation made possible RSF’s $1,150,000  mortgage loan to Regional Access, a wholesale food distributor focused on creating a sustainable regional food system in New York and expanding access to quality food for underserved urban and rural residents. The mortgage loan and a $200,000 line of credit, supported by a $50,000 Local Initiatives Fund guarantee, allowed the company to consolidate debt and expand its reach and operations. That translates to more ecologically responsible and locally grown food for more people (Regional Access currently serves 600-plus stores, restaurants, and institutions) and improved economic viability for local farms—all for a small, low-risk investment.

Fair Food, an enterprise dedicated to bringing locally grown food to market and promoting a humane, sustainable agriculture system for greater Philadelphia, is another great example of growth through integrated capital financing. In early 2014, RSF provided a $100,000 line of credit for working capital that enabled Fair Food to maintain timely payments to farmers and producers in the long-term, and bridge immediate cash flow needs in the short-term. Guarantees were crucial to making the loan work: Fair Food requested support from community members and raised $50,000 in RSF Social Investment Fund accounts to back the loan, and RSF provided an additional $20,000 guarantee from the Local Initiatives Fund. Then in September 2014, Fair Food participated in a food and agriculture–focused Shared Gifting Circle and received a $9,900 grant to train and assist farmers with Group GAP (Good Agricultural Practices) certification—a cooperative approach to farm food safety that addresses the needs of small and midsize farms.

Four new funds are on deck

Building on the success of the Local Initiatives Fund, RSF is preparing with core donors to launch four new Integrated Capital Funds: the RSF Fair Trade Fund, RSF Biodynamics Fund, RSF Soil Health Fund, and RSF Women’s Fund.

These philanthropic funds will provide loan guarantees, equity investments, grants, and other types of capital that position social enterprises—for-profits, nonprofits, and hybrids—to obtain additional equity or debt financing and give them time to develop. We expect to recycle about two-thirds of the money into new financing (we’ll consult the lead donors in each fund on the exact target ratio).

The focus for each fund is based on needs our community identified. The Biodynamic and Soil Health funds grew out of regenerative agriculture advocates’ search for the next step beyond organic. The Women’s Fund provides capital to women-led social enterprises, which tend to be underserved. The RSF Fair Trade Fund will initially provide loans to our fair trade borrowers’ suppliers when existing sources don’t meet those suppliers’ financing needs. Initial partners include Guayakí, a beverage company that sells organic, fair-trade yerba mate tea leaves and drinks; Indigenous, a clothing company that pioneered Fair Trade certification for apparel and linens, and also developed the Fair Trace Tool™ to show consumers how a garment was made; and Equal Exchange, a worker-owner cooperative that sells fair trade coffee, tea, chocolate and other foods.

Collective action is needed

Our goal, which we hope others will join us in, is to use low-interest loans, loan guarantees, equity investments, and other instruments from philanthropic funds to leverage significant amounts of market capital for social enterprises. We intend to support catalytic enterprises, and we know that not all of them will succeed—but it’s worth the risk. If philanthropic funders start using their money fearlessly where it has the greatest chance to spur sustainable social innovation, we could collectively fill the funding gap between seed money and growth capital for social entrepreneurs.

One key aspect of making this work is recalibrating our thinking around gift funding. Our purpose with these funds is to be nimble, agile, and opportunistic, so that we can get the right capital to the right entrepreneurs at the right time. To that end, we’re requiring minimal reporting. Philanthropy has developed a compliance culture that puts a lot of focus on layers of reporting and calculating return on investment. But making a true gift rightly involves releasing control. We think the whole movement to measure every little thing is a waste of people’s time; recipients should be able to just get to the work. It’s not about being sloppy or undisciplined. It’s about reestablishing a more human-centered sense of accountability.

Bold funders can move the field ahead

As our work with Regional Access and Fair Food illustrates, RSF has the advantage of being able to draw on a diverse mix of both investment and philanthropic funds under one roof to support organizations that are models for systemic change. We see ourselves as a laboratory for the integrated capital approach, and we’re taking on that challenge by reorienting our entire funding operation around the concept. We’re finding that it requires us to break down the internal walls between investing and philanthropy—a reflection of the need to break down the walls between these sectors generally.

It’s encouraging to see that others are thinking along the same lines. Integrated capital shares collaborative and creative aspects of Nonprofit Finance Fund’s complete capital approach, which brings together financial, intellectual, human, and social capital to help nonprofits succeed, and Pacific Community Ventures’ catalytic capital concept, which recognizes that grants, guarantees, and seed funding can trigger additional financing that otherwise would not have been available to an enterprise. Activist community foundations are also considering an integrated capital approach.

The fact that we’re seeing this fresh focus on the uses of capital to achieve social benefits tells us that there is a real opening now for vastly greater collaboration between impact investors (individuals, networks, and firms), foundations (community and private), and community banks. As the holders of capital, it’s up to us to create a finance infrastructure that enables social enterprises—and the communities they serve—to thrive.

Image credit: Juan Carlos Castaneda, Indigenous Designs 

Don Shaffer is president and CEO of RSF Social Finance, a pioneering funder of social enterprises based in San Francisco, and is a B Lab board member. He welcomes inquiries into using the integrated capital model.