Tafterjournal n. 66 - dicembre 2013

Exploring the emerging model of social enterprise capital markets


Rubrica: Reti creative

Parole chiave: , , ,

The ways through which a social enterprise gets funding have undergone major changes in recent years. An innovative entrepreneurship vision, based on issues which are different from the traditional return on capital principle, has been brought to light asking for logical criteria not diffused in the current financial systems. In the realm of social enterprises, investment/funding operations presume principles and motivations which are very diverse from those lead a traditional investor or financier to invest his/her capital in a venture, relying on a future financial return.


In the traditional model of social enterprises, the spread of Social Venture Capital’s practices represents a breaking point. This article analyzes the theoretical and practical criteria of the Italian fund “Oltre Venture”. Such a fund combines capital, skills and entrepreneurial innovation in order to achieve more efficient and effective results, by using Venture Philanthropy principles, defined by “Oltre Venture” founder, Luciano Balbo, as the “gray area”, i.e. an indeterminate area composed of social demand and organizations that combine financial sustainability and social goals.


Social Venture Capital & Venture Philanthropy
External funding sources’ benefit is extremely important for a company both at the start-up stages and at the expansion ones; that same principle can be also applied to investments that support social programs and to organizations and companies that put those programs into practice. This is a critical aspect of a social enterprise.


In the Figure 1 (Perrini F., Vurro C., 2010), you can see different approaches used by organizations to funding social enterprises, going from a philanthropic model to a market-oriented one. The vertical axis represents lender’s or investor’s involvement degree in the investment program or in the beneficiary organization.


Figure 1. Social enterprises funding models

Source: Perrini F., Vurro C., Social Venture Capital & Venture Philanthropy, Egea 2010


According to the diagram (Perrini F., Vurro C., 2010), charitable donations made by individuals are characterized by low level of involvement. The complexity of the donations is that they are not connected with the function of risk capital for multiple reasons:
• First, none organization can fully rely on donations to be sustainable in the long term, due to the difficulties of collecting this type of funds and to the administrative limits of specific social programs, that not allow to use these funds to repay the operating costs of business management.
• Secondly, the market access of donations is inefficient and represents a potential factor of uncertainty for the organizations.
• Finally, a big problem lies in the fact that only non-profit organizations can access this kind of funding.


In the right lower quadrant, we can find the category of debt. Although it is certainly more efficient than liberal donations, thanks to its strategic flexibility, there are many difficulties that social organizations have to face in order to attract this kind of investors. In addition to the traditional problems related to the banking system, that compares a social enterprise to a traditional company, the former faces other significant difficulties linked to their peculiar nature. In particular, it becomes complicated to evaluate risks and revenues, to provide guarantees of the ability to generate revenue flows and to be able to repay the debt.


In the right upper quadrant, we can find the use of venture capital, i.e. the capital of founders or external equity investors in the form of equity instrument. Risk capital is used to collect a very large amount of money, usually in the early stages of organization’s life cycle, when the access to credit is virtually precluded, such as during start-up phases. Obtaining venture capital is complicated in practice, basically for the fact that an investor is much more interested in the return on his/her invested capital rather than in social or environmental benefits. Moreover in several countries, including Italy, there are rules and legislations which impose limits on the distribution of profits for some social organizations and non-profit entities.


The main difficulties connected with venture capital investment in social organizations are the following ones (Perrin F., 2007):
• First, the priority objectives of a social enterprise and an investor often are not the same, in the sense that a social enterprise is more oriented to reinvest the profits generated from operations rather than distribute them. This question becomes relevant when it is the legal structure chosen by the organization that limits the distribution of profits.
• In addition, this kind of investment could compromise the achievement of the social mission.
• Then, we have to consider cultural limitations and skills: social organizations avoid the use of external risk capital to finance themselves, either because they are reluctant to change their social structures for fear of jeopardizing the achievement of its objectives, and because they consider the equity a typical speculative financial instrument.


In the left upper quadrant, there are Social Venture Capital and Venture Philanthropy models, which are the subject of this article. These two financing/investment tools were developed in the ‘90s, and they arise as a combination of venture capital and philanthropy. On one side, what differentiates the Social Venture Capital from other philanthropic practices, such as donations, is the high involvement of the investor in the project during a medium-long period that goes beyond the mere provision of financial resources. On the other side, what differentiates the Social Venture Capital from venture capital is entrepreneurial innovation and the achievement of social or environmental purposes.


According to the model adopted by EVPA (European Venture Philanthropy Association) practices of Venture Philanthropy should be flexible and adaptable to any situation, while maintaining the necessary features such as:
High involvement: venture capitalists share the strategic and operational management with the organization supported, and often find a place in the organizational structure. Reaching a method of financing/investment with a high degree of involvement includes not only financial support, focusing on limited investments for a longer period of time and consistent with the beneficiaries. Focusing staff resources on a limited investment allows the achievement of a strong involvement with the business.
Customization of funding: funding varies from company to company. It may consist of a donation, a loan, other financial investments such as mezzanine capital or quasi-equity financing.
Support for many years: the financial support/non financial input from the social venture capitalists generally covers a period from 3 to 5 years.
Organizational Capacity Building: unlike the philanthropic grants aimed at specific social projects, the organization of VP link the operating costs of social organizations to the aim of developing operational efficiency and improving organizational and managerial skills.
Non-financial support: also a Social Venture bases its investment decisions on an analysis of the prior business plan, and tracks the performance of the target company with the measurement of the economic, social and environmental outcomes.
Performance Measurement: like any venture capital organization VP also bases its investment decisions on an analysis of the previous business plans, and tracks the performance of the target company with the measurement of economic, social and environmental outcomes and managerial skills.


Thus, the main peculiarity of the Social Venture Capital is the development of a relationship between venture capitalists and the beneficiary organization, able to reach both financial goals and social ends through genuine partnerships. This could create a virtuous circle, thanks to the optimization of financial structure, management skills and organizational capacity. This improves reliability, attractiveness and the confidence of investors in more of that undertaking.


Social Venture Capital interventions aim at improving the effectiveness of long-term financing, through tailored interventions, long-term interaction and the optimization of capacity building organization. These results are achieved through a dedicated focus during the entire span of the investment, with a high degree of involvement both in the evaluation of financing and in the subsequent stages, by planning and programming actions to equip the enterprise target with solid financial and organizational bases in order to produce both its social and environmental impacts (Metz Cummings A., Hehenberger L., 2010).


But, which are the typical target companies of a Social Venture Capital or Venture Philanthropy fund? We have already mentioned that these models of social investment invest in social enterprises. This term was coined in Western Europe and the United States in the mid-90s to define those companies that were operating in the third sector, also called the non-profit sector, and in the social economy. With the term “social enterprises” we indicate companies that provide goods and services to people whose needs are not met neither by private companies nor by public undertakings, through innovative solutions. According to the definition of the 2002 UK Department of Trade and Industry, social enterprises are: “[…] a business with primarily social objectives, whose surpluses are reinvested principally for that purpose in the business or in the community, rather than being driven by the need to maximize profit for shareholders and owners”.


We could distinguish four levels of enterprises in pursuit of social objectives:
Leveraged non-profit venture: covers a wide variety of companies, organizations and non-profit organizations, including even government agencies. These businesses depend on external philanthropic funding.
Non-profit venture hybrid: it includes those companies, organizations and bodies that recover some of their costs through the sale of goods or services. This often requires the creation of separate legal entities to separate units that generate revenues from operational charities.
Social business ventures: are social enterprises, which reach their goals ethically, social and/or environmental conditions through their business strategy. Social enterprises usually reinvest for the cause of the financial surpluses generated by their business or industry. Some social enterprises indicate in their statutes the obligation to reinvest the revenues.
Impact companies: they have commercial objectives, to increase revenues and grow social objectives. These companies are for profit, whose goal is both to maximize profits for its shareholders but also achieve economic independence, and pursue social and environmental goals.


Although there are differences, social enterprises share characteristics, values and goals that easily show in a traditional business environment. A social enterprise implements innovative and sustainable method to achieve the remuneration of their own inputs, but at the same time it directs its attention to economic sectors, targeting customers and geographic locations where their activities can generate positive impacts. Different ways might generate this positive impact: reconsidering the value chain, reformulating products to customers less well-off, restructuring its organization, involving direct suppliers, applying business practices that have a direct impact on society and the environment, but also sharing some ethical values such as transparency of its operations and corporate governance structures, responsibility towards the community in which they work, fair pricing.


A basic problem is to assess and measure scientifically – and in an explicit manner – the results of non-financial performance of social enterprises. A social entrepreneur and an investor are facing business models that are still based on a traditional value chain; the solution may be instead to add the concept of impact value chain, which describes the structure of the processes within a social enterprise. (Clark C., Rosenzweig W., 2004). The figure below shows a hypothetical impact value chain:


Figure 2. The impact value chain

 Source: Clark C., Rosenzweig W., Double bottom line project report: assessing social impact in double bottom line ventures, 2004


Considering inputs, we mean the resources necessary for the operation of the enterprise, i.e. money, tangible and intangible assets, human resources and so on. Activities are the business activities normally performed. Outputs are a series of results and measurable variables by management. Outcomes are changes in a given social system, with regard to the attitudes, behaviors, knowledge, abilities (skills) generated by business. The difference between social/environmental outcomes, obtained by the business entity, and what would have happened anyway, determines the level of impact. Goal alignment is the degree of alignment of the initial expectations with the results obtained: it is the phase of the evaluation of the outcomes and the process of preparation of refinements for subsequent activities.


The case of  “Oltre Venture”
The case examined in this article is an Italian project, born in 2006 in the wake of the Foundation Beyond. The founder and CEO of Oltre Venture, Luciano Balbo, clearly explains his vision in an article written by him in The Huffington Post Italy, exposing a necessary premise: the demand for all those social services, which are an integral part of the welfare, is increasing, while the public offering slows down or does not evolve in parallel.


States around the world cannot guarantee the delivery of social services because they are having to cope with the downturn of their budget. This basically means that if there are falls in public spending, the citizens have to provide, privately and individually, the purchase of services not provided by the State. Taking the example of health care spending, this can be financed both by public resources and by private resources : among the public resources allocated to the health sector, there are state revenues in the form of taxes and social and health insurance, including private resources. The public health expenditure in Italy in 2011 was €112 billion, equal to 7.1% of GDP. Families have actually contributed to the overall health expenditure privately with a share of 19.5%, representing the 8% of GDP. The current inability of the NHS to cope with the gradual aging of the Italian population, that inevitably will cause a rise in health care spending over time, requires a review of the universalistic principles that inspired the public health system.


The fund “Oltre Venture” aims at giving an answer to the social needs unanswered in the Italian panorama. The basic principles of this project, as expressed by Balbo, was to create an organization in the Italian “quasi-market”, which was a cross between profit and non- profit organizations, and that had people in the “gray zone” as its segment of “customers”, i.e. people do not satisfy the parameters to receive social assistance from the state, but who do not have disposable income to meet their needs in the market. The experience that inspired Balbo is the one that inflated the new economy sector in the United States, when at the instigation of government funding and later with the inclusion of private investors, resulted in thousands of small start- ups being funded and launched.


Thanks to the idea of supplying capital to professionals and entrepreneurs with innovative projects, Balbo has shifted the Italian context of funding and supporting the social sector. “Oltre Venture” operates in this direction, acting as a traditional venture capital from the operational side, but with different objectives and aims. A venture capital fund is a corporate structure in which institutional investors, placing capital funds that invest in a specialist team of successful business ideas. “Oltre Venture” starts from this premise, but not with the aim of generating value for its shareholders, but to generate social value. The primary concern is therefore, the creation of a social return, and the economic objective is the preservation of capital.


“Oltre Venture” is actively involved in identifying and investing in companies with the highest potential for social innovation, with the aim of creating positive externalities on society in a sustainable economy. The financial return is not the goal, but the constraint, to preserve their capital in the long run. These companies often correspond to a risk/return profile, that others will not take on, and operate in the following sectors:
• Micro-credit
• Health and Social Services
• Social Housing
• Job vacancies
• Development of socially weak communities/regions.


The simple preservation of the capital in the long run may appear an illogical investment, but Luciano Balbo supports its vision with a personal philosophy: the only concern of an investor is how to employ their capital in order to obtain an economic profit, but today the economic crisis and the various asset bubbles that have occurred over time, explain that this system is unsustainable and incompatible with the generation of social utility. At this stage, the market does not generate benefit to the community, because it is limited to purely speculative securities/real estate. “Reunifying the self interest of the individual with the collective interest through activities that distribute evenly benefits between capital, workers and users” is a very difficult road to follow, because the forefront of the traditional economic concepts collides with the selfish and individualistic traditional investor.


Anyway according to Balbo, in full harmony with the philosophy of Venture Philanthropy, such a road is the only way to “get back to generating value” in a shared and sustainable manner. This suggests that the principle of Balbo is a re-evaluation of the meaning of profit and revenue. The advantage for an investor may not even be a return statement, when a return is generated by its activity and social commitment. This idea cannot be addressed in a charitable and altruistic conception, but on the realignment of individual self interest with the public interest.


There are no solutions based on the so-called goodness. The goodness belongs to the sphere of individual choices. Here the discussion concerns the interest of all. And self-interest that should guide collective choices. Take a crucial and emblematic concept … compliance with the rules. It is believed that to comply with the rules is an act of kindness. Nothing could be further from the truth. Respect the rules, it is an act of self-interest … self-interest is a concept that requires a change in the collective consciousness.


Social services that generate more efficient educational systems, health care, social security, create better benefits for society in economic terms for every single citizen. The perspective expressed by Balbo is certainly compatible with the owners or managers of large concentrations of private wealth. That is why investors of venture philanthropy or impact investing are always institutional investors, including both system managers of large capital and individual owners of huge estates ( HNWI ), which recognize the role of social responsibility of wealth. These economic resources should, however, be channeled into something more efficient than philanthropy as he explains: “While prevailed before the concept of giving and “restitution” to the company of a part of one’s wealth, now makes its way more a function wide promotion of social solutions and an engine of innovation in the social sector. It recognizes the intrinsic limit of the size of the philanthropy that is less than 1% of the GDP of developed countries”.


According to a study by Merrill Lynch and CapGemini, 7 million individuals have 26 trillion dollars in assets or liquid form, which is equivalent to the sum of the GDP of all countries around the world. A mass of untapped capital that has an immense potential to change social systems, can add the concept of social responsibility of wealth to corporate social responsibility practices.


This is a new concept that indicate the premise that wealth is the engine of development: resources and competence are the main drivers of the development of a society and “the private wealth in the last ten years has exploded! This is not only to give back a bit, but also to develop the opportunities for it to be invested for the community”.


This is an excellent opportunity for investors, who have access to large amounts of capital, to stimulate innovation and to experiment with new financial products, because they can afford more risks than the common investors can do.


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