Funding Your Social Enterprise, Part 2: Debt and Equity

By Jacen Greene, Ames Fellow for Social Entrepreneurship at PSU

This is the second in a three-part series on funding social enterprise startups. In our previous post, we covered  grants, donations, and crowdfunding for social entrepreneurs. The information in this post is based in part on a recent PSU Social Innovation Incubator seminar hosted by David Connell and Doug Morris, partners at the law firm Ater Wynne. 

Funding needs differ based on the capital intensity of an organization’s business model, and access to funding varies depending on the organization’s legal structure. For example, a for-profit tech firm focused on serving the poor may require substantial funding to develop a product, but would not easily be able to obtain foundation grants. One of the great strengths of social enterprises is that founders often can decide where to operate on the hybrid spectrum[1] between nonprofit and for-profit, based on their capital needs and mission. A clear understanding of the various funding options available to social entrepreneurs is therefore essential even at the earliest planning stages of a venture.

Loans:
Banks typically lend only to businesses with at least two years of positive cash flow, and lending terms are based on the financial health of the firm—so you’re not going to get a loan when you really need it. The good news is that interest rates are now so low that a business loan or line of credit is an attractive tool for expansion, inventory purchasing, or to smooth out seasonal fluctuations in revenue.

Government agencies and nonprofit or not-for-profit organizations, including local credit unions and Community Development Financial Institutions, will sometimes lend to businesses that wouldn’t otherwise qualify for a bank loan. In Oregon, Mercy Corps NW provides microloans of up to $50,000 to both new and established firms, Craft3 provides microloans and assistance in securing larger amounts, and Business Oregon offers a range of loan types. The U.S. Small Business Administration offers loans targeted for specific regions, industries, and uses.

Program Related Investments (PRIs):
Foundations may lend to businesses or nonprofits in a manner that will serve the foundation’s purpose, so long as the goal is not to earn a significant profit. However, IRS guidelines around the issue are complicated enough that few foundations actually use PRIs, despite the creation of a new business entity, the L3C, designed to facilitate the process. A proposed IRS regulation would make it easier for foundations to grant PRIs, potentially creating a substantial new source of funding for social entrepreneurs. For now, revenue-generating nonprofits are far more likely than for-profit social ventures to receive PRI funding.

Private Investment:
Businesses can sell shares directly to private investors so long as the sale is not advertised. In Oregon, up to $1 million in stock can be sold to 10 friends and family members over any 12-month period, regardless of the financial situation of the investor. For larger amounts, or more individuals, businesses can generally sell only to accredited investors: individuals with more than $1 million in net worth (excluding their home) and greater than $200,000 in income for the past two years, or businesses with more than $5 million in assets (such as investment funds or angel investor associations). An early sale to non-accredited investors, however, can complicate later deals. This approach works great if you have a truly impressive pitch, or a lot of rich uncles.

Direct Public Offerings:
A Direct Public Offering enables a firm to sell shares directly to the general public, after registering with the SEC and state regulators. Unlike an Initial Public Offering, the firm typically does not go through a broker-dealer or investment bank and is not listed on a stock exchange. Unfortunately, the lengthy and complicated process typically costs as much as $100,000 in registration fees, accounting fees and legal assistance. With the passage of the JOBS Act, which reduced the barriers to an IPO, the Direct Public Offering may become even more rare.

In our next post, we’ll discuss the most groundbreaking part of the JOBS Act, a crowdfunding provision that would allow firms to sell shares to the public through an online intermediary, much in the way Kickstarter is used to source donations or generate pre-sales.

[1] Hybrid spectrum graphic by Virtue Ventures.

Disclaimer: these posts are not intended as legal or financial advice.