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5 hard truths about social investment and how to handle them

April 20, 2014

Social investors don’t like surprises, they have comfort zones, an eye on the future and clear social business favourites. There’s a cold hard truth out there explains Chris Hardy of Inspire2Enterprise, and it’s worth getting to grips with it.

1. Noble goals get you nowhere.

HARD TRUTH: A social investor will not invest where they cannot see a future for the business, despite the good that you do. Many social enterprises have emerged from being dependent on grant funding and have not been exposed to the landscape of external investment and what that entails. It can be quite a daunting task for young social enterprises to move into this unknown territory.

HANDLE IT: One way to transition is to use intermediaries who can evaluate where your organisation is in this cycle and advise you how to become investment ready. Be prepared to learn. Understand the players in the social investment market and what they are looking for. Many will not invest in an organisation if they are not investment ready. Engage with investors as early in the cycle as possible to understand what their requirements are, establish an on-going dialogue about the enterprise’s own needs and plan for it to take longer than you expect.

Questions will emerge which will take time to answer – more often than not there will be a need to revisit the business plan, the strategy, the financial plan, the governance, the organisation structure, and the revenue plan at a minimum. Are you self-funding or will you need external finance? How fast do you want to grow and how fast should you grow? These questions will only be answered if you have a solid financial plan in place. Get organised – understand your own enterprise, how your costs are structured, how you will generate funds from your own sources.

2. Social investors don’t like surprises.

HARD TRUTH: The relationship between social investors and social enterprises is still developing. Surprises can be hit and miss in any relationship, but giving an investor something they weren’t expecting – a cost that it turns out you’re unable to cover or an unforeseen cash flow problem – will not be appreciated.

HANDLE IT: The important thing is making sure you have an accurate financial plan and understand your cash flow needs. Lack of cash is one of the main reasons why businesses fail, so it is really important to ensure that there is enough cash on the balance sheet both to grow the enterprise and indeed to survive a downturn in business. When doing your cash flow ensure you have the repayment schedules entered correctly with the right interest rates. Is the enterprise able to generate the additional revenue needed to pay for the loan? Many businesses overstate their planned revenues and therefore get into trouble. Be cautious in your planning.

3. If you’re awkward talking about the profit-making side of things, you’ll make an investor uncomfortable.

HARD TRUTH: In the private sector, you fail if you do not have revenue coming in to your business. For many new social enterprises who have been dependent on grants and have not had to rely on revenue streams for the first time they have to think commercially.

HANDLE IT: If you do not have the skills in house you have to source the right advice externally from those skilled in this area. Transitioning from a grant based organisation to one, which has to be self funding takes time and demands a different mindset. It requires an understanding of the different ways the public sector pays for its services, an understanding of how to work with the private sector and corporate sponsorship. It can also require a disciplined approach to cost cutting and a rethinking of the organisation’s strategy

When operating before the involvement of external investors, the social enterprise would probably have only needed to answer to the owners/shareholders/and maybe some other stakeholders. However as soon as you get external investment then there is a need for communication of the business performance on a regular basis and in a professional way. Expectations will be set through a business plan and the need to report performance in line with those expectations becomes a priority. Investors like to feel that the social enterprise is in good control of its destiny and are planning ahead in line with their original forecasts. Yes business conditions change but the importance of managing risk comes into play.

4. Social investors have favourites.

HARD TRUTH: Often organisations that win investment will be low risk and large scale as opposed to high risk and small scale. More sophisticated and developed outfits tend to steal the limelight from smaller less polished organisations. You can’t fake it if your organisation is not suited to investment. But if it could work for you, there are some clear things you can do to boost your appeal.

HANDLE IT: Successful organisations use as many resources as possible. To have non-executive directors or trustees who have gained an array of experience in their careers, can help the executive board and operational teams enormously. Not only internally but also good governance can enhance the reputation and image of the enterprise from an external perspective. Investors feel more secure knowing that experienced professionals are involved in the organisation even if it is on a pure advisory capacity. Of course you also need key operational managers.

Whilst noble goals alone won’t cut it, deliberate attention to social impact measurement is a wise move. There can even be clauses written into the terms of agreement for a social investment. One business that I know of, a successful start up, which has grown steadily since its inception realised it needed additional working capital and decided to seek social investment. One of the subsequent social investors included a clause specifying targets for the numbers of ex offenders to go through back to work training courses, which were being run by the enterprise. It also included an additional requirement that the enterprise hired a social impact manager within a certain period of time after the investment was made. Investors can therefore have influence in the way organisations develop their social business.

Measuring social impact is in itself not an easy process to implement when there has been no prior need to measure it formally. There are different methodologies to consider. And it’s worth taking into account that often social investors have built their own measurement tools, which they expect enterprises to use as part of the funding requirements.

5. It’s a long and arduous route.

HARD TRUTH: Getting finance takes longer than you think. It takes time to get finance even once it is broadly agreed by the investors. The paperwork trail can feel endless to the point that you question why you decided to go this route.

HANDLE IT: If you have decided to go this route, you better make sure you understand how long it could take you to get to your desired destination. Here’s a story about a social enterprise CEO that will help you handle this particular hard truth. 18 months ago the CEO realised that additional funding would be required in order to grow his enterprise and deliver the social impact that he was trying to achieve. In this particular case, the investment arrived six months later than the CEO had first anticipated. The enterprise needed to secure additional interim short term funding from its directors in order to ensure the growth of the enterprise was not impacted due to lack of funding. So what’s the moral of the story? Be aware that preparing to present your social enterprise in its most attractive light to prospective investors takes time and resources. This is the process often referred to as becoming investment ready. Always allow longer than you think.

Source: http://www.pioneerspost.com/comment/20140421/5-hard-truths-about-social-investment-and-how-handle-them

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