A missing middle in funding exists for social enterprises as well as for-profit ones. What are the underlying causes? If we knew perhaps we could solve the problem in both venture investing and venture philanthropy.

In Chris Allen's Life with Alacrity he discusses the difficulties with being an angel investor and the problems in the transition between the angel funding stage and the venture capital stage.

First a few words about problems in the venture-investing marketplace after which I will draw analogies to similar problems in the funding of social enterprises. In the venture-investing world, there is a missing middle between the angels and the VCs. This missing middle comes in two varieties:

1. There is a development stage gap: Many angel-financed ventures are not far enough along by the time the angel funding runs out to avoid being raped by VCs. What is needed is a mezzanine round financing institution that is eager to invest in ventures that have come a long way but are not far enough along to create a feeding frenzy among professional VCs. When an exciting venture is far enough along competition between VCs for the deal drives the valuation up to a level that provides a good return to the original angel investors.

2. There is a dollar amount gap: Many angel rounds raise funds in the hundreds of thousands of dollars. Modern VCs generally get interested in deals five million and up. There is a dearth of funding sources for firms that need a million or two.

The Missing Middle in Philanthropy

In the philanthropy world there is a similar missing middle for social enterprises, namely those that, while philanthropic intent have a strategy that allows them, once they mature, to earn much or all of their revenue from selling a service or product.  Social enterprises that address major issues are becoming increasingly important to our society. We cannot afford to address all of society’s  major problems  with services entirely funded by charity. Social enterprises in the narrow sense are non-profits earn much of the money they need to do good by selling product and services. As a result, they have a potentially unlimited source of funding. However, like many for-profit ventures, they face funding problems during the middle stage of their growth. Is it for the same reasons or different ones?

A Social Enterprise Growth Story

In 2002, my wife, Libba, our friend, Sherman Severin, and I co-founded a new business school, The Bainbridge Graduate Institute  to bring social and environmental issues into the core of business decision-making. Although we intended to grow the school to a size where it could deliver the basic MBA in Sustainable Business using only tuition revenues, our purpose was philanthropic and we adopted a non-profit form.

A Note on the Philanthropic Purpose

We launched the school because business is both the cause of many environmental and social problems and a key part of any solution.  Our deep belief: Business can make money building a better world.  However, business schools in general do not teach their students how to do so. Business school students are generally educated to see environmental and social issues mainly as costs and risks, not as opportunities. According to the Aspen Institute, MBA students (on average) graduate from traditional business schools more committed to making money regardless of costs to society and less committed to building a better world. This is a serious problem given the power of business in shaping or economies, our governments, our media, our health, our universities and our environment. Libba and I decided to devote the remainder of our lives to changing business education so the leaders of our world will be educated to manage with the health of ecosystems and the needs of society in mind.

Initial Angel Philanthropy Funding

When we first started, the idea of changing business by changing business education was compelling to many philanthropic angel “investors” who donated money to get the school started. Using donations from angel totaling less than it takes to endow a single faculty chair in a major university, we created an entire new school with about 100 students, a complete socially and environmentally responsible MBA curriculum, a 92% cumulative growth rate and a national reputation among sustainable business educators that brings us a flood of professors and deans from other business schools who come to learn more about what we are doing. The angels go a very good social return on their investment. By example and by sharing curriculum, we are changing the programs of major universities.

The Problematic Middle Stage

The Bainbridge Graduate Institute is now in the “interesting” middle stage; we have proven the ready market for our Sustainable MBA, proven that our team is up the challenge of building a great school cost effectively. However, we are still one and a half years from breakeven on tuition receipts. How do philanthropists respond to our successful proof of concept? We are now mature enough that most foundations and even major individual philanthropists no longer see us as a promising start-up. Now that we clearly exist, they want to propose new initiatives that they can fund. This means diverting our attention from bringing our core environmentally and socially responsible MBA business to breakeven. Is that a wise use of attention and resources? BGI still needs investment in the core to achieve financial stability.

The Problem of Restricted Funds

In the non-profit world the focus on funding the new gives rise to “the problem of restricted funds.” Funders want to give funds for new uses and demand careful accounting to make sure those funds are not used to support the core of the enterprise. The social enterprise becomes too old and too well established to be seen as a start-up project, but it is not yet big enough to earn the funds it needs. Too often, the core of the enterprise is starved and the new projects rest on a weak or even failing base.

The Missing Philanthropic Institution

What is missing is a philanthropic institution devoted to helping social enterprises complete the growth of earned income initiatives to the point where they become self-funding. Granting unrestricted funds to mezzanine stage social ventures will often provide a far greater social benefit than forcing the young organization to do something new before that is strategically smart.

The Search for Root Causes of the Missing Middle

This missing middle stage funding for social enterprises has an eerie similarity to the missing middle in funding for for-profit enterprises. While the mechanism that causes the missing middle appears to be different, the result is so similar that I wonder if there is not an underlying similar cause.

1. Perhaps both have a network exhaustion problem, close in angel investors/donors become fatigued when success takes a bit longer than originally projected.

2. Perhaps the problems of the enterprise become clearer once the venture is well underway and even real success cannot match the enthusiasm of the early stage dream.

3. Perhaps the fun goes out of it for investors as the organization becomes less malleable and more committed to what is working.

4. Perhaps it has nothing to do with investors, rather the entrepreneurs become tired and don’t sell funders as well as they did when fresh and innocent. I am hoping someone has a deep and compelling explanation. I await better ideas with an open heart.

One Last Venture Funding Problem: Exit Vehicles

Returning to the discussion of funding vehicles for for-profit ventures: There is no good exit vehicle for values-driven for-profit ventures. As a person dedicated to the flourishing of businesses driven by values in addition to the value of making a buck, the lack of appropriate exit vehicles made socially responsible angel investing more difficult. Without an exit vehicle, one cannot attain the ROIs on the winners generally considered necessary to compensate for the percentage of ventures that are likely to fail.

The virtues that make value driven ventures great are often incomprehensible to the “professional managers” of acquiring firms. Too often the result is both damage to those values and destruction of much of the value of the business they acquired. When Lever Brothers bought Ben and Jerry’s or when Coke bought Odwalla, much of the cultural value of those organizations was lost. In my own experience selling Consensus Development, we negotiated promises concerning various aspects of our culture ranging from GLBT partner benefits to dogs in the office. Perhaps our culture was idiosyncratic and, to some, even funny, but it worked. Even when talented engineers were offered over twice what we could pay by other companies, we hired and retained them. Our values created bottom line value for the firm. Sadly, as the culture changed after acquisition, the talent they had acquired left. 

If part of the socially and environmentally responsible angel investor’s  purpose is to fund ventures with high standards around social and/or environmental issues , and if those virtues are not likely to survive either going public or being acquired by a typical multinational, what is the responsible angel to hope for?

The lack of a suitable exit vehicle for socially responsible ventures creates great difficulty in obtaining initial financing as often causes investors to look forward to either violating the trust of the founders or to much lower returns. This happens not because the socially responsible ventures fail to grow large and profitable businesses, in fact their commitment to higher principles often gives them a competitive advantage. It happens because investors can anticipate no responsible way to liquidate their positions once the ventures succeed. Who knows of a solution to this problem? One bright light on horizon is Upstream 21 which is designed, among other things, to provide an exit vehicle for responsible investors looking for good financial and social returns.

Comments

[Marcos]

After reading your post I could only think that maybe you are running BGI too much like a for-profit and not enough like the nonprofit that it is.

First of all, I'm surprised to hear you say that BGI is less than 2 years out from a break even point. That seems very soon. Are you really going to run BGI entirely on tuition revenue? It's my understanding that no school survives on tuition alone.

Perhaps BGI's pursuit of financial independance is preventing it from implementing a traditional philanthropic fundraising campaign. Most schools, of any size or phase, must run unending, consecutive campaigns to survive. It is unlikely that once you move beyond start up phase that your original funders will say, "you're no longer a start up, we won't fund you anymore". More likely those funders will be happy to continue donating based on BGI's great success. They may even refer new donors. You might try adjusting how you tell your story now that you're in a new phase.

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We need professional help for finding funding our important project.Can You help us please?
Thank You

NGO “Svetlost”
Proleterska 6 , 22400 Ruma
Serbia , Europe
www.svetlost.org
office@svetlost.org

Letter of intention for cooperation

Dear Sirs,
“Svetlost”,/means Lightness / nonprofit humanitarian organization from Serbia, Europe, working to promote well being of children and youth in need have serious project in making different in our Country.
Our urgent project is to incorporate, to make FIRST YOUTH SOCIAL ENTERPRISE in Serbia , employ young people with disabled too and all income give in humanitarian aid , to make budget for health care , education and other urgent needs of extremely poor children and youth. Our Country still does not possess sufficient resources for such undertaking, so we decide to request You to support us in so important project. We suggest You to discuss about our request.
If You appraise that our offer is correct and that can make difference (specially in Serbia, it would be innovation) let us know , to prepare all details for You. Frame cost of this project is about 350 000 Eur, , understanding buying equipment , location with building ,raw material and turnover capital as all enterprise have .We will be glad to work with You , Your great experience can teach us how to improve our mission.
Thank You very much for taking time, thank You for Your interest and Your support.

Chairman of NGO “Svetlost”, Mrs. Dragica Kejic

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