More seed capital key to bridge the 'pioneer gap' for social business

Innovations and social enterprises can disappear — not because of a bad idea or lack of effort, but rather due to insufficient seed capital to grow and scale.

The international development community and philanthropic dollars have traditionally funded social entrepreneurs to test an idea or innovation. However, what’s often missing is the money necessary to take that idea, bring it to scale and access commercial capital markets for long-term sustainability. This challenge is called the “pioneer gap” or the “valley of death.”

So how do you bridge that gap?

Those working in the field are trying several things: Effective accelerators that help make businesses investment-ready, blended finance that allows public or charity funds to de-risk and unlock private capital, and work to build out a system with additional support for these companies.

Many of those working to address these challenges in creative ways gathered last week at the Social Capital Markets annual conference in San Francisco, which brought together investors, entrepreneurs, connectors and academics focused on building the field of impact investing.

Getting businesses ready for investment

One common problem in creating successful innovations is that many of the places and programs — incubators and accelerators — charged with helping get businesses grow and get ready for investment are not doing their job.

Will Poole, co-founder and managing partner of the Unitus Seed Fund, which focuses on highly scalable businesses that have built-in impact in health care, education, agriculture or livelihoods in India, compared it to a teacher failing to adequately prepare their students for the next grade. Many of these spaces or programs continue to emerge, but few are producing companies that are ready for venture capital investments and are thus failing to serve one potential role as creators of a pipeline for impact investors.

Incubators are often started by well-meaning people, but they often don’t have the business experience or skills to adequately prepare the businesses, Poole told Devex. These businesses need programs that help them build financial plans and go-to-market plans, hire quality employees and handle human resources, among other things.

The development community can work with incubators both to help provide education but also to hold them accountable. In cases where they are directly supporting incubators they also need to be sure to build tighter linkages to investors.

That pipeline of investments is critical. Poole just closed $20 million for the fund last week and needs to find additional companies in which to invest.

What Unitus has done is launch an impact acceleration program — hiring startup scouts in what will be 10 cities in India to find entrepreneurs, connect them to resources and help get them to a stage where Unitus or other funds can invest in them.

The U.S. Agency for International Development announced Friday it would be supporting Unitus and two other projects through its Partnering to Accelerate Entrepreneurship initiative. The $6.3 million investment will leverage nearly $40 million in additional capital to test some new models and support accelerators that will address those gaps.

“We wanted to have a diversified portfolio … and generate the most innovation,” Chris Jurgens, global partnerships division chief at USAID Global Development Lab, said about PACE, which helps the agency put in place another piece of the investment puzzle and try to address problems in the social entrepreneurship ecosystem and test some new strategies.

One of the other partners supported by USAID through PACE is the Shell Foundation, which is receiving funds to support testing three accelerator models in the access to energy sector.

We believe there is a first mover disadvantage and we help offset that and help validate pioneers,” Simon Desjardins, portfolio manager at the foundation, told Devex. “We have a heavy more-than-money approach.” When they invest in a social enterprise, it helps the company build a strategy and a business model, and raise funds.

Access to finance

On the entrepreneur side, one of the biggest barriers to growth is access to affordable, adequate-sized capital.

An organic fertilizer company in Nairobi today doesn’t have the network to access capital or perhaps the right financial model to succeed, said Ross Baird, executive director of Village Capital, which both runs an accelerator and has a seed fund for social entrepreneurs. What’s needed, he explained, is for funds, investors and others to come together to “put the scaffolding around companies.”

One of the key challenges for many of these companies is that they need capital but may need only $15,000, $50,000 or $100,000 and not more than half a million dollars. Unfortunately, the market incentivizes funds and venture capitalists to make larger investments — the cost of due diligence is relatively equal regardless of the size of the company.

Village Capital has started a commercial investment fund to invest in those companies. The challenge is keeping management costs low and convincing investors that these smaller investments can yield positive returns.

To help the organization test the model and prove that such a fund can work and generate returns, USAID is providing $2.6 million to offset the operating costs of the fund, keep the management fees at the standard 2 percent and expand the company’s ability to build a team that is on a par with bigger funds.

The idea is that in five years, when USAID funding runs out, Village Capital would have made the case for this type of investment vehicle and will be able to do it without the additional support. Another unique part about the firm is that it chooses which companies to invest in through a peer selection process in which entrepreneurs do much of the due diligence, which also helps keep some of the costs down.

“This is a pilot [program] to prove the viability of small funders,” Baird told Devex. “We believe the model works.”

For most of the companies Village Capital invests in, it’s their first sources of outside capital. To date, 91 percent have survived the initial investment. Supporting the “pioneer gap” allows the company to implement their projects but also provides an opportunity for “incredible leverage for a small amount of money.”

Indeed, Village Capital has been able to bring to the table traditional — and therefore conservative — commercial investors like Chilton Capital Management.

So far, though, investors are satisfied and the USAID commitment is critical to helping the fund grow, according to Ann DeRosa, the Registered Investment Advisory firm’s chief impact strategist.

“USAID’s role is utterly pivotal,” DeRosa told Devex. “It’s an extraordinary catalytic move.” These kinds of arrangements of layered capital — with donor funding, philanthropic funding and traditional investor capital — are necessary to build the field.

“The sector needs more philanthropic capital deployed as smart subsidy than investment capital,” Desjardins pointed out.

In addition to tapping into public and philanthropic capital to subsidize more traditional investment, high-net-worth individuals should be increasingly engaged in impact investing, and the key to attracting the rich is educating the gatekeepers to their capital.

Creating supportive infrastructure for entrepreneurs

Beyond access to training and finance, entrepreneurs face a host of other challenges — from a lack of mentors, to a need for professional services, professional associations and government barriers — which combined could help create an infrastructure that encourages innovation and growth.

The issue of mentorship comes up frequently. Many entrepreneurs lack access to a peer network or local mentors from whom they can learn practical skills, said Julienne Oyler, founder and executive director of the African Entrepreneur Collective.

Oyler, based in Rwanda, told Devex that part of the challenge is cultural, as entrepreneurs are hesitant to share their experience either as a matter of pride or from protecting their business or idea. Still, those mentors are critical, mainly to have examples of how businesses can grow.

A need for professional associations and affordable professional services may not be the most exciting pieces of an infrastructure, but they are nonetheless key to success.

Many companies end up spending a lot of their operating expenses on accounting or legal services, Oyler said, which can make it harder to be profitable and repay investors. Apart from collaboration and organization, professional associations also critically help entrepreneurs gain representation and push for government regulations that will be helpful and against those laws that will limit growth.

“We need industry body representation to create policy change, set standards and provide market information,” Desjardins said.

Education can also make a difference in reducing the perception of risk. A better understanding of the markets may help more money flow to support the development and scaling of innovations tackling development challenges.

Sharing lessons learned will help accelerate progress and it is a central part of the structure of the PACE partnerships, according to Jurgens. That’s why USAID is working to finalize a memorandum of understanding with the Lemelson Foundation, the Omidyar Network and potentially others to share research and learning about mobilization and acceleration.

“It’s important for the agency to think about scale from seed to proven business model and I hope this makes an intellectual contribution to that,” he said.

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