Navigating Funding for Social Impact Startups

Marian Wright Edelman said, “In trying to make a big difference, don’t ignore the small daily differences we can make.” Small but targeted differences have the potential to make a great impact. According to Good Finance, social impact is the effect on people and communities that happens as a result of an action or inaction, an activity, project, programme or policy*. Social impact startups operate uniquely, aiming to drive positive change in society and the environment, prioritising more than just financial returns for investors. This article delves into the distinctive context and funding considerations for social impact startups.

In the realm of social impact startups, key questions often revolve around achieving financial viability while maintaining sustainability. These ventures are unique because they seek to make a difference in society and the environment at large through their products and services. Startups must strike a delicate balance between fulfilling their purpose and attracting compatible investors. The fundraising process requires a meticulous analysis of potential investors who align with the venture's broader societal or environmental goals, rather than solely seeking financial returns.

Quantifying impact is another crucial facet for social impact startups. This involves measuring the number of beneficiaries, positive changes instigated, and the venture's overall sustainability. Typically, this necessitates scaling operations. In addition to a compelling idea, the founders' skills and unwavering focus play pivotal roles in persuading investors to support these startups.

Given the diverse landscape, how should social impact startups position themselves to secure funding? The approach may hinge on the priorities of funding organizations dedicated to various impact initiatives, encompassing grants, equity, (convertible) debt, or a combination thereof.

Exploring grants constitutes a common starting point, especially for emerging startups. For social impact startups, a grant serves as a financial award to facilitate specific goals outlined in the grant's terms. Alignment with the ethos of the grantor organization is paramount, necessitating thorough preparation to demonstrate eligibility and compatibility with the cause.

Crowdfunding emerges as a dynamic fundraising method, pooling resources from a broad base of contributors, each making relatively modest contributions. This can be achieved by having either individuals, institutions or a mix of both, coming together to fund a social impact startup(s). Recently, crowdfunding through the internet has gained significant traction.

Crowdfunding has the ability to raise significant capital from a diverse pool of sources, while cementing the social element of the venture through increasing the society’s buy in. Depending on the initiative and its success, this could either catapult or deter stakeholders from participating in a similar venture in future.

Explore obtaining convertible debt Typically, startups do not have the benefit of having a credit history, making obtaining a traditional loan difficult. Considering convertible debt is an option for startups lacking an established credit history. This instrument enables swift capital acquisition, with the understanding that the debt may eventually convert to an equity stake. While less costly than equity funding, it carries the potential risk of founders relinquishing control.

Many social impact investors are grappling with the question of how they can make a positive change to society. Engaging impact investors is another avenue, as many are actively seeking opportunities to effect positive change in society. According to the Global Impact Investing Network, impact investments are investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return*. Financial investments are different from grants because investors would usually require a financial return over a period of time, unlike a grant which may be non-redeemable. These investments are therefore assessed with a lens of financial returns over and above the social impact, but not necessarily at higher priority. Increasingly, investors are demanding a demonstration of financial returns for impact ventures to demonstrate sustainability.

The projects that are most affected by corruption at the conception and planning stages tend to fall in the opposite ends of the ‘Return on Investment’ (ROI) spectrum. Infrastructure projects that promise the highest returns such as those connected to the extraction of natural resources (e.g. oil pipelines or coal plants) or support manufacturing are on one end. Such projects are susceptible to corruption as it is easy to justify their high cost on the basis that they will have an even higher return. In such cases, persons involved in both the purchase and supply side are less keen on the costs and more likely to allow, or incorporate, unnecessary or exaggerated costs with or without kickbacks. Project sponsors are also more likely to ignore matters such as negative environmental impact assessments. On the other end of the ROI spectrum are projects which have no real or measurable economic value and are implemented because they are pet projects or ‘political flagship’ projects. In such cases, the people involved expect that the projects will go on regardless of their viability as they have a powerful sponsor.

Projects that are plagued by corruption at inception are more likely to suffer from further cost escalations during the construction phase. This is because the persons involved with the projects are either already compromised or not motivated to keep costs in check. They are also more likely to be poorly designed.

Corruption at the conceptualisation and planning phase takes many forms. Some will only involve the buy side, like designing and approving white elephant projects, or overstating budgets to factor in future kickbacks, or exorbitant valuations of land. Others will involve both the buyer and the preferred suppliers, such as providing information or requirements selectively and including features that can only be met by the favoured supplier are introduced to justify single sourcing. Some schemes will only involve the supply side for instance where contractors present unsolicited proposals that are hard to understand or compromise the results of feasibility studies in cases where contractors undertake the studies.

To avoid association with tainted projects, it is therefore imperative that one pays keen attention to how these projects are conceived and the processes leading to the tendering process. One should be particularly careful if the project does not seem to make economic sense or where its benefits are billed as overly good. Failure to do this may leave organisations having to grapple with poor ratings and adverse ESG reports.

Crowdfunding emerges as a dynamic fundraising method, pooling resources from a broad base of contributors, each making relatively modest contributions. This can be achieved by having either individuals, institutions or a mix of both, coming together to fund a social impact startup(s). Recently, crowdfunding through the internet has gained significant traction.

Crowdfunding has the ability to raise significant capital from a diverse pool of sources, while cementing the social element of the venture through increasing the society’s buy in. Depending on the initiative and its success, this could either catapult or deter stakeholders from participating in a similar venture in future.

Explore obtaining convertible debt Typically, startups do not have the benefit of having a credit history, making obtaining a traditional loan difficult. Considering convertible debt is an option for startups lacking an established credit history. This instrument enables swift capital acquisition, with the understanding that the debt may eventually convert to an equity stake. While less costly than equity funding, it carries the potential risk of founders relinquishing control.

While the essence of social impact revolves around making a difference, social impact startups face the challenge of transitioning from great ideas to the stage where they materialize the positive change they aim to bring about while also ensuring sustainability. Additionally, when it comes to funding, there are particular financial terms to the lending or equity funding into the venture. The achievement of these terms could take away from the priorities and the focus of the social impact startup, making it less “impactful”.

Social impact startups must priorities ensuring that their value proposition is foolproof. Additionally, their founders and management should be equipped with the necessary skills to effectively present their case for funding, allowing them to scale to their envisioned heights and deliver their intended impact. Strategy serves as the key instrument that enables success, and this principle applies equally to social impact startups. Sources used:

* Good Finance, “Measuring social impact”.

* Global Impact Investing Network, “What you need to know about impact investing”.