Venture philanthropy — The Shell Foundation's funding approach and what you need to know

Editor’s Note, May 2: This article was updated to reflect the number of portfolio managers working at the Shell Foundation. Last year, Envirofit — a social enterprise that develops low-cost clean cookstoves — hit a startup jackpot when it announced it had secured $4 million in financing to scale up its operations. Around the same time, another company with a mission to provide solar energy to the poor — d.light — announced it had raised more than $22 million in investment. Both these social enterprises might have died years earlier were it not for the continued backing of a special kind of funder willing to invest in regions and sectors where traditional donors and even impact investors are often still too risk averse to tread. The Shell Foundation — which has a $250 million endowment from the Shell Group but is run independently — has developed a successful funding model offering early-stage, patient capital to social ventures working on access to energy, affordable transport and small and medium-sized enterprises finance in Africa, India and Latin America, which would be deemed too high risk by the majority of investors and donors. Working with a team of 10 portfolio managers in London, and also through incubators like Factor[E] based out of Colorado State University, the foundation currently invests in 45 social ventures. The foundation was an early investor in d.light and has been working with Envirofit since 2007, providing start-up investment which has leveraged $20.5 million from other financiers, including a $4 million investment from the Overseas Private Investment Corporation, the United States Government’s development finance institution. Director Sam Parker, who took over in 2015, calls the approach “venture philanthropy,” and explained that supporting private enterprise-based models such as d.light and Envirofit is a cost-effective and sustainable way of driving inclusive economic development and the most effective way to help countries develop and achieve the sustainable development agenda. His previous role was head of Water & Sanitation for the Urban Poor, a private sector-NGO hybrid working to support commercially viable solutions to providing water and sanitation services for the urban poor. Unless other investors and funders come on board and adopt a similar model, the private sector will remain on the sidelines and progress will fall far short of the targets, he warned. “My main plea [to investors] would be to recognize and accept the role of early-stage risk-tolerant capital to really put a rocket boost up the private sector ... I think it is a very legitimate way to grow a business — any business needs a lot of capital.” --— Sam Parker, director of the Shell Foundation To get a sense of the scale of the funding need, Parker calculates that achieving SDG 7 in Africa alone will require an additional $1.5 billion per year in patient capital over the next 8 years, just in off-grid distributed energy systems. If the foundation and its funding partners — for example the United Kingdom and U.S. development agencies have both co-funded with it in the past — put in $35 million a year, that would still leave a huge funding gap. In fact, 42 more times that investment is needed, Parker estimates. “My big challenge now is saying to the market, we’ve proven the model, if we want companies to genuinely make a contribution to the SDGs, then we need to invest 42 times what we’re investing in private sector energy solutions. If I can convince the financiers to do that, then the rest of the market will take care of the rest and take them forward,” he said. Devex spoke to Parker to find out more about the Shell Foundation’s funding model and what makes it different from the rest. Looking for market failures, not proven businesses Most investors and funders, including the Shell Foundation before Parker took over, generate a pipeline of deals by actively looking for business opportunities or advertising and issuing calls for bids, he said. “We don’t wait for them to come to us, we search for them by sweating, that’s the secret.” --— One of the first changes the new director made was to switch the emphasis from looking for enterprises to invest in, to looking first for the market failures preventing progress in specific sectors, and then searching for entrepreneurs who might be able to find an entrepreneurial solution to that failure, Parker explained. “We don’t wait for them to come to us, we search for them by sweating, that’s the secret,” Parker explained, adding that, “you tend not to find people by advertising but through networks.” The type of person or enterprise the foundation is looking for varies, they may be someone running a successful business in another line of business, or it could be an entrepreneur with little more than a promising business plan, but generally speaking, they are “entrepreneurs with a passion for something,” Parker said. The quality of the entrepreneur or the senior management team is the main deciding factor for the foundation when considering whether to support a partner or not, much more so than the business plan, which is likely to go through multiple iterations, Parker said. High-touch, long-term relationships with investees Once the foundation identifies a potential investee, or “partner” as Parker describes them, the next step is what he described as the “courtship stage,” which can last for up to a year. “We find people who are interested in solving a problem, we brainstorm with them, and then we put them through a courtship process, whereby we will give them a certain, limited amount of funding and then if that works well we will go to a more committed, long-term relationship,” he explained. If, after the courtship stage, the foundation sees enough potential in the partner to take it further, then they will progress to the next funding stage, which Parker describes as being more like a marriage — about 70 percent of partners will not make it beyond the courtship stage. This next stage is more intense and involves close contact between the partner and the foundation, who will allocate a business advisor to manage the relationship. “It’s a very high touch relationship, it’s almost like we are part of their business, we live through their successes and their failures and we go through their journey with them in the passenger seat as opposed to observing them from a distance and waiting to read their reports,” the director explained. Patience and a high tolerance for failure Being a private foundation, Parker and his team are able to be flexible, forgiving and more risk tolerant than other would-be investors and funders and it is this “privileged” position which has enabled it to fund organizations as they develop their business model and eventually get to scale, he said. “All of the companies we’ve worked with have got to scale having been written off by other people, we’ve often been the only people who’ve stuck with them,” he said. The Foundation has companies on its books it has been working with for up to seven years, Parker said, something which would be unheard of among government funders who face political pressures and tend to “dump and run” if an investment doesn’t show immediate success. He also said impact investors would be unlikely to “last that long” as funders, nor would a traditional grant funder operating in three to four year funding cycles be likely to come back for a second round of funding, he said. However, time is crucial to developing and scaling a successful business which provides goods or services to low income groups which he described as being “very discerning” customers and not always easy to serve. “Quite often it takes a lot of time to find the mechanism that gets an actually viable business around that,” and so companies need long-term funding in able to be able to “stick at it,” he said. A mixture of grants, debt and first loss capital Another element which differentiates it from other funders is their willingness to give social businesses grant funding, which Parker sees as a crucial, but often misunderstood, part of the early stage funding “jigsaw puzzle.” “Grants are seen as a bad thing in the development space, but the fact is that in the commercial companies world companies work at a loss for years — but in this sector we apply different standards.” The foundation starts by supporting organizations with grants, and then moves to repayable grants, convertible debt products, and then onto first loss capital. They rarely provide equity funding since it can “dilute an enterprise too early,” is difficult to value at an early stage, and can also prove difficult for the Foundation “to get out of,” Parker said. Specialize “We actually know this is going to work, because we understand enough about the market. It depends on you having a better feel for the way the market works than anyone else.” --— The Shell Foundation considers its staff to be experts in the three sectors it funds — access to energy, transport and SME financing. In the uncertain world of early-stage investing, knowing the sector well is one of the reasons it can justify asking its own board of directors to agree to fund organizations over and over again, Parker said. “We actually know this is going to work, because we understand enough about the market. It depends on you having a better feel for the way the market works than anyone else … otherwise how on earth can you make the judgement to stick with these organizations?” The foundation’s advisors themselves are also specialists in entrepreneurship, which gives them an added advantage when it comes to spotting and nurturing potential, Parker said. His current staff of 10 portfolio managers are drawn from a variety of business backgrounds, the critical thing being that they are entrepreneurial and “enjoy building businesses,” he said. “We have a team of entrepreneurs working with entrepreneurs, their job is not to be a grant manager, but to be a business partner and think about it from that perspective,” Parker added. The downside — it is hard to cut enterprises off If the foundation’s model has a weakness it is that it can prove hard to stop funding an organization which has reached the “marriage stage” of close partnership and long-term funding, Parker said. Having said that, the foundation has a realistic expectation of failure, predicting that five or six of its current portfolio partners will fail, while between 50 and 70 percent of those at the earlier, courtship phase will not make it through. “I don’t think we are good enough at it yet, we probably should be tougher, but one of the disadvantages of the model is you get attached to these businesses, and you don’t want to cast them adrift,” he said. Check out more practical business and development advice online, and subscribe to Money Matters to receive the latest contract award and shortlist announcements, and procurement and fundraising news.