Social enterprises are a relatively new and growing sector in the business world.[1] According to a Global Sustainable Investment Review, from 2012-2014 there was a 61% increase in managed assets that used sustainable investing strategies.[2] The growth in the US was the highest among the countries surveyed.[3] JP Morgan considers the market for socially responsible investing to be between $400 billion and $1 trillion.[4] With this rise of impact investing and also conscious consumerism, financial returns and positive societal impact are no longer mutually exclusive. In the startup world, founders of social enterprises do not need to worry about a wholesale lack of investment potential for their businesses, solely due to their social missions.

An Introduction to Social Enterprises

There is no one definition for a social enterprise; these organizations blur the line between the traditionally discrete business and non-profit sectors. The Social Enterprise Alliance defines the space as organizations that address unmet needs or that solve social and environmental problems through a market-driven approach.[5] Within their businesses, social entrepreneurs’ goals go beyond simple profit maximization. These founders focus on financial, social, and sometimes also environmental objectives.[6]

This multifaceted mission raises the question of whether financial growth and profit necessarily have to be sacrificed for the advancement of social objectives. This pressure is especially acute in the startup landscape. With many companies having to bootstrap their growth and operate in the hope of securing venture funding to provide large injections of cash, social enterprises may feel that they face larger barriers than traditional for-profits. The reality is that this is not true. Venture capitalists (VCs) are becoming increasingly open to investing in social enterprises.[7] Additionally, there exist funds that are focused on impact investing and supporting companies that have this social purpose.[8] Two prominent examples are Bamboo Capital Finance and The Builders Fund.[9] On the legal side, a majority of states have enacted legislation that allows for companies to form entities, which contain both socially beneficial and financial goals.[10] The advent of these entity forms makes it easier for social enterprises to attract capital and be successful.[11] Currently, over 5,000 companies have been incorporated as benefit corporations, the most common hybrid form.[12]

Venture Capital Investment Basics

Most VC firms, with the exception of the aforementioned impact funds, invest solely to create returns for their investors. As a starting point, VCs expect to generate an annual return of 40% over a period of three to five years.[13] Just the potential for this return is not enough though. On the business side, VCs will also want to see an addressable market of at least $1 billion combined with an opportunity for a business to grow in that market.[14] On the personnel side, they want to see a functioning and committed management team with high EQ.[15]

Many commentators think that investors are reticent to fund social enterprises incorporated as benefit corporations because these founders need to worry about more than just bottom-line profits.[16] After all, achieving a sufficient return is hard enough if founders are solely focused on profit maximization. Skeptics think that profit and social purpose are incompatible and that one will ultimately have to be prioritized.

Social Enterprises and Investment

However, the truth is that social enterprises can successfully attract capital. Some of the most successful and largest VCs have invested in social enterprises, including: Andreesen Horowitz, Benchmark, Sequoia Ventures, and Union Square Ventures.[17] Almost every Silicon Valley VC has invested in at least one benefit corporation.[18] Impact investing is no longer limited to socially-oriented investors. It is becoming clear that there are viable business reasons for backing social enterprises, irrespective of any social benefit.

Social enterprises have advantages for attracting top employee talent and in consumer marketing. Millennials will form 75% of the workforce by 2025. Deloitte research has found that 78% of millennials view a company’s purpose as part of the reason they chose to work there.[19] Socially-oriented companies also connect better with customer values. Millennials are willing to pay a premium for social consciousness and sustainability. Nielsen found that over 66% of consumers are willing to pay more for sustainable brands.[20]

Sustainability improves performance. Impact investment funds have been found to achieve the same, and even a higher, IRR for investors than conventional funds.[21] An Oxford survey of over 200 academic studies determined that 88% of the reviewed sources found companies with robust sustainability practices had better operational performance and that 80% showed that sustainability practices had a positive influence on investment performance.[22]

Further, public market investors, who also form the investor-base of VCs, are focused on environmental and social governance factors when they consider their investments.[23]

Attracting Investment as a Social Enterprise

Beyond needing the specified return and addressing an appropriate market, there are additional considerations that can make social enterprises attractive to investors. A social enterprise’s product or service should directly create the social impact.[24] In this, there should be as much alignment as possible between revenue and the impact that is created. The social good should be inherent to the company’s business model and work.[25] Usually, companies’ impacts aren’t ranked because of the diversity of social advancement causes. Rather, it is the centrality of this mission that can set a startup apart. That said, impact investors may prefer certain causes. Just like for a regular for-profit company, the vetting of VCs is extremely important in this regard.

VCs’ focus on return can complicate investment. They are constantly thinking about exits because that is how they earn their return. This can present a problem for social enterprises. Many of these companies operate in sectors where there is a paucity of M&A activity.[26] This can increase the difficulty of a VC exit. Founders should understand the range of potential aligned buyers of their businesses. In this, they should know companies that share their vison for impact. This will usually be companies in the same addressable market. Societal and investment trends are making this easier for social enterprises though. With public companies and public investors now placing a greater emphasis on sustainability and environmental and social governance, the range of possible future buyers has naturally expanded.

The management of a social enterprise is even more crucial to attracting investment than in a for-profit. In addition to skill and EQ, investors want to see a founders’ passion and commitment to creating a social impact.[27] A strongly aligned, managing founder will be more likely to make decisions that uphold and further impact objectives during company growth. This allows for impact continuity, as well as financial growth.

Conclusion

Social enterprises should not hesitate to incorporate as a benefit corporation and pursue their impact goals. It is entirely possible to operate with a dual-focused mission. Available investment capital is only increasing as consumers and investor bases are recognizing the financial benefits that can result from companies having a social purpose. Startup founders no longer need to prioritize growth or impact; it is possible to do both.

[1] See https://www.huffingtonpost.com/danielle-sabrina/rising-trend-social-respo_b_14578380.html

[2] http://www.gsi-alliance.org/wp-content/uploads/2015/02/GSIA_Review_download.pdf, page 7

[3] Id.

[4] https://cbey.yale.edu/our-stories/the-value-of-b-corps-what-investors-need-to-know

[5] https://socialenterprise.us/about/social-enterprise/

[6] Dana Thompson, L3Cs: An Innovative Choice for Urban Entrepreneurs and Urban Revitalization, 2 Am. U. Bus. L. Rev. 115, 116 (2012)

[7] http://benefitcorp.net/benefit-corporations-raising-capital

[8] See://bthechange.com/the-2017-best-for-the-world-funds-beb7a7e3589d and https://www.impactassets.org/ia50_new/ for some examples.

[9] http://www.bamboocp.com/; https://www.thebuildersfund.com/

[10] https://www.socentlawtracker.org/#/map

[11] For more discussion see https://www.forbes.com/sites/forbestechcouncil/2017/12/22/the-forprofit-social-enterprise-is-the-impact-model-of-the-future/#5b6497b25571

[12] https://cbey.yale.edu/sites/default/files/Just%20Good%20Business_An%20Investor%27s%20Guide%20to%20B%20Corps_March%202018.pdf, page 38

[13] Constance E. Bagley & Craig E. Dauchy, The Entrepreneur’s Guide to Law and Strategy 439 (5th ed. 2017)

[14] https://www.forbes.com/sites/geristengel/2013/11/20/want-venture-capital-here-are-10-must-haves/#3e1172ef9489

[15] Id.

[16] https://www.bloomberg.com/news/features/2017-05-18/the-barbarians-are-at-etsy-s-hand-hewn-responsibly-sourced-gates

[17] http://benefitcorp.net/benefit-corporations-raising-capital

[18] https://cbey.yale.edu/sites/default/files/Just%20Good%20Business_An%20Investor%27s%20Guide%20to%20B%20Corps_March%202018.pdf, page 38

[19] https://www2.deloitte.com/content/dam/Deloitte/global/Documents/About-Deloitte/gx-dttl-2014-millennial-survey-report.pdf, page 8

[20] https://cbey.yale.edu/sites/default/files/Just%20Good%20Business_An%20Investor%27s%20Guide%20to%20B%20Corps_March%202018.pdf, page 31

[21] https://www.cambridgeassociates.com/research/introducing-the-impact-investing-benchmark/

[22] https://arabesque.com/research/From_the_stockholder_to_the_stakeholder_web.pdf, page 8

[23] See, e.g. https://www.calpers.ca.gov/docs/board-agendas/201702/pension/item7-01.pdf

[24] https://news.crunchbase.com/news/growth-impact-rise-vcs-looking-fund-profitable-cause/

[25] https://thegiin.org/assets/GIIN_Responsible%20Exits_2018.pdf, page 7

[26] Id. at 7-8.

[27] Id. at 8.