Friday, March 05, 2010

Who Will Invest in Social Business?

I find myself very drawn to the concept of social business, as introduced by Nobel Prize winner Muhammad Yunus. In his book Creating a World Without Poverty, Yunus defines a social business as a non-loss, non-dividend company. In this post, I will discuss Yunus' definition of social business and the implications for investors.

So, what exactly is a non-loss company? First of all, it is not a non-profit. The term "non-profit" implies that organizational revenues must not exceed organizational expenses. The term "non-loss," on the other hand, implies that organizational expenses must not exceed organizational revenues. This wording change may seem insignificant to some, but it has huge implications. For example, although some non-profits generate revenue by providing goods or services, most non-profits owe their viability at least in part to charitable donations. Non-loss businesses, however, are intended to be financially self-sufficient, remaining viable because the goods and services provided by their organizations are valued and paid for by their customers, not because of charitable donations. Profit is not a dirty word for non-loss companies, as long as profits are reinvested in the social business.

Although profit is appropriate and necessary for non-loss companies, social businesses are not intended to be profit maximizing businesses. Instead of maximizing financial returns for investors, social businesses maximize social returns. Which brings me to Yunus' second part of his definition: social businesses are non-dividend companies.

Why must social businesses be non-dividend companies? Honestly, I'm not sure that they must be. In fact, Yunus' first social business, Grameen Danone, provided a small dividend to its investors. Presumably, through his experience, Yunus has determined that when trying to balance financial returns with social returns, financial returns are often sought at the expense of social returns. Therefore, in order to reduce the likelihood of mission drift, he prefers to remove financial rewards from the mix altogether. Investors earn back their initial investment, but nothing more. Their returns come in the form of lifting people out of poverty or some alternate social metric viewed as important by investors. The more I consider it, perhaps separating social returns from financial returns is the best approach to avoid organizational and investor frustration.

But then it begs the question, who will invest in social businesses?

On the one hand, it sounds absurd to invest one's retirement funds in a business that may or may not return the initial investment and certainly will not return more than the initial investment. Some socially-responsible investments, such as those offered through Calvert Foundation or MicroPlace, at least offer a one to three percent return on funds invested. When compared with a money market, some investors could reasonably feel that they are getting close to a market return while sacrificing only slightly to make a difference in the world. Not so with social businesses as defined by Yunus.

But on the other hand, investing in a social business may not appeal to human generosity to the same degree as giving to charity. It feels inherently good to give away money to help young children, victims of natural disasters, or people who've otherwise been dealt a bad hand in life. Investing in social businesses may feel downright uncharitable to some.

However, social businesses will draw two types of new investors: 1) socially minded individuals who have never invested in startups, and 2) those whose donations to charity are limited not so much by their lack of financial resources but by their belief that non-profits are inefficient and ineffective. Funds for the first type of new investor will, at first, be diverted from other charitable investments, while funds for the latter type of investment will come largely at the expense of excess consumption. Investors will say, "rather than giving $100 to Nonprofit XYZ or spending it at LuxuryGoods XYZ, either of which has questionable value, I will instead invest in SocialBusiness ABC, which looks very promising and may even return my money to me for future reinvestment." As social businesses begin to prove their effectiveness, the overall pool of philanthrocapital (that is, the combination of philanthropic donations and social investment capital) will grow.

I have recently made donations to two organizations that seek financial self-sufficiency in the near term: Living Goods and One Acre Fund. Today, neither organization is a social business, because neither is a non-loss company. I hope that both Living Goods and One Acre Fund will successfully transition to social businesses within the next several years and that other organizations will follow the same path, building social business into a sustainable, scalable alternative for capital flows, be they human, financial, or otherwise.

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