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.

Funding Your Social Enterprise, Part 1: Grants, Donations and Crowds

By Jacen Greene, Ames Fellow for Social Entrepreneurship at PSU

This is the first in a three-part series on funding social enterprise startups.  Information in the first two posts is based in part on recent sessions of our Social Innovation Incubator: one with Mark Grimes, founder of ned.com and NedSpace, and one with David Connell and Doug Morris, partners at the law firm Ater Wynne LLP.

The biggest challenge faced by many social entrepreneurs is how to obtain funding for their venture. Because social enterprises exist in the space between traditional, grant-funded nonprofits and profit-maximizing businesses, they may have access to the funding options of both, but without the clearly defined methods and access of either.

The “capital curve” — sources and amounts of money needed to become successful — has yet to be fully developed for social entrepreneurs, but as the field grows, strategies for obtaining funding have begun to emerge. From small investments by friends and family to major equity deals with impact investors, here’s a brief overview of different ways to fund your social venture.

Social Enterprise Capital Curve

Earned Revenue:
The most common funding source for startups is earned revenue. Whatever money the venture makes from selling its service or product is simply reinvested into growing the business. This has the added benefit of providing immediate validation of the model, as well as enabling the founders to retain full control. Some capital-intensive firms, however, require significant investment before they can even launch a product. For them, some other source of funding is needed.

Grants and Donations:
Tax-deductible grants and donations are a common source of income for nonprofits, but donations to social ventures organized as a for-profit business offer no tax benefit. This can discourage individuals and corporations from giving money, as can the expectation that a business should operate solely on earned income and credit or investments. Foundations may also believe themselves to be constrained from offering grants to a business, given the rather complicated legal restrictions around the practice.

However, if a business operates some strictly charitable programs, it can partner with a fiscal sponsor to process donations for those programs. A fiscal sponsor is a tax-exempt nonprofit that can legally receive tax-deductible contributions on behalf of another organization. These contributions are placed into a fund for the recipient, and the sponsor charges a fee, typically between 5% and 15%, for managing the process. State or local nonprofits may also take advantage of fiscal sponsorship to avoid the cost and complications of a full 501(c)(3) filing.

Grants to low-income social entrepreneurs are available through Individual Development Accounts (IDAs), a government-funded program that matches the personal savings of the entrepreneur with a grant several times larger. In Oregon, both Mercy Corps Northwest and MIPO provide IDAs in amounts ranging from $4000 up to $10,000.

Crowdfunding:
Crowdfunding is essentially a way for any organization to receive donations (although not tax-deductible ones) or earn revenue from pre-selling a forthcoming product or service. This is not to be confused with equity crowdfunding, a component of the recently passed JOBS Act. Equity crowdfunding, or the sale of company stock  directly to the public through a website or broker intermediary, will not be legal until the SEC finishes writing new regulations in early 2013. Our third post in the series will cover equity crowdfunding in detail.

A number of websites now offer non-equity crowdfunding services targeted at specific project types. StartSomeGood.com provides crowdfunding solutions specifically for social ventures (read our interview with the co-founder here), but as with any crowdfunding campaign, it’s important to know how to create a successful outcome. Here are a few tips:

• Put together a great team: a well-known project team has a much higher chance of success.
• Offer a great product: the public is more likely to donate to a campaign if they receive something new or unique in return.
• Create professional media: campaigns with well-made videos perform better. Make certain you have an engaging (and copy-edited) campaign description.
• Do your research: some sites, like IndieGoGo, allow you to keep what you raise even if you don’t meet the target. Most, like Kickstarter, require your fundraising goal to be met—or you receive nothing.
• Set a reasonable target: $10,000 is a typical goal, and 30 days is a good campaign length. A shorter campaign may not give you enough time to reach your target, and a longer one risks a loss of momentum and flagging interest. More than 50% of campaigns fail to reach their goals, so make certain you have a Plan B.
• Leverage your network: email suggested tweets and Facebook posts to your friends and fans for them to use in promoting your campaign.
• Generate buzz: reach out to bloggers, local reporters, and Twitter celebrities in your subject area or local community.

Next week’s post covers debt and equity capital — funding sources that you have to pay back, in one way or another. Perhaps unsurprisingly, they tend to come in much larger amounts than grants, donations, and crowdfunding contributions. Get ready to grow your business as we move higher on the capital curve.

Read part two now >>

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