In 2015, the European Commission through the European Investment Fund announced a €92m investment facility for social entrepreneurs. It is one of the largest public sector commitments ever in this field. Bigger than Obama’s initialSocial Innovation Fund. Bigger than anything that has come out of the G8 Social Impact Investing Task Force. It took almost five years of lobbying to make it happen.
Curiously, even six months later, nobody seems to have noticed.
Perhaps this is because the new program does not offer one of the two familiar types of financing for social innovation, and therefore sits outside the established silos (or planets, as I argued years ago). It neither offers traditional grants nor traditional investments but rather something in between: A guarantee. This guarantee allows investors to reduce their risk when investing in social innovations that are hard to fund in Europe's still misaligned impact investing market today. It will lose money over time but in the smartest possible way - by allowing others to engage in types and sizes of deals previously impossible.
This is hugely significant. Perhaps even revolutionary. It will help establish what we have called hybrid finance. It may finally tackle the second biggest problem in our field: The lack of a pipeline of investable social entrepreneurs. And this in turn will help fix the biggest challenge in our field: The persisting mental (and very real) disconnect between the world of charity and the world of business.
But let’s start from the beginning: Hybrid finance is the discipline of combining repayable and non-repayable sources of funding in order to offer to social entrepreneurs the type of funds that actually correspond with their business models. For example, a social organisation that discovers it can not only operate on grants but can build a revenue stream in addition, may not look very attractive to impact investors until it can return upwards of 5-10% (if not more) on an investment. So once an organisation leaves the pure grant end of the financial return spectrum (-100% return), it enters a no man’s land, being neither attractive to grant givers nor to investors.
The result: since the European (and most other) markets for social entrepreneurs are so far made up exclusively of donors looking for non-profits, and impact investors looking for profitable social businesses, organisations operating at the exciting but frequently not-yet-profitable transition stage to new business ideas have had to be very creative. Typically, they set up two different vehicles, one for profit, one nonprofit, to correspond with the preferences of investors. In effect, they create hybrid organisations.
Recently, the Financing Agency for Social Entrepreneurship have mirrored this practice on the financing side, by putting together (or "syndicating“) hybrid deals involving investors (and sometimes donors) with different risk return profiles. The EU new guarantee facility adds a puzzle piece that could help create deals that have so far not been possible, funding even earlier, and riskier innovations, because investors will factor in the reduced risk of default, and be able to bring down their return expectations. And in time, donors will learn from these guarantees that bringing non-repayable capital into investments can be a really good idea. In effect, they can help fund many times more organisations than with a pure grant model.
Ultimately, everyone interested in funding great social ideas will realise that the idea of some players investing funds with no repayment, while others are aiming to get their money back, and others trying to turn a profit is not such a strange thing. After all, grant givers fund academic research that sometimes leads to profitable ventures (and other investors benefiting), and governments do the same, even providing subsidies to for profit businesses, as well as export guarantees.
We believe that hybrid finance will be taught in business schools soon, and practised to fund social innovation everywhere. It allows investors, donors, really everyone, to come together and put the idea first, not the financial instrument. Great organizations such as MyBnk, which brings financial literacy to millions of kids and prevents personal debt, could benefit. About a dozen have been funded by hybrid deals in the past year. They include organizations as diverse as the DORV centers which help citizens maintain basic local services together, or the Insolvents Anonymous.
The EU is about to create a functioning financial market for social innovations. Next it needs to build a true internal, cross-border market that will allow these ideas to travel freely between member states.
Hopefully, many member states will replicate the EU’s idea. That would be more great news for the continent’s social entrepreneurs - and for a world in which the walls between sectors need to come down far more quickly.
By Felix Oldenburg. Find Felix on Twitter here.
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