Writing for Business Advice, David Bartram, head of ventures at social enterprise support network UnLtd, argues that high costs, lack of consistency and sector exclusivity mean investment is not reaching social enterprise startups desperate to access funding for growth.
While initial seed funding can be relatively simple to access for a social enterprise, most entrepreneurs would agree that follow-up funding of between £50,000 and £200,000 is far harder to come by. Whilst programmes such as the Big Venture Challenge and Big Potential are helping, this “missing middle” of finance is hampering the market.
Deals of this size are impeded by high transaction and due diligence costs. Against the purely commercial market, the cost of due diligence is higher for the social investment market as deals are rarely standardised in form or sector. As each deal is bespoke it often carries its own unique challenge. On top of this, investors are required to evaluate and monitor social impact in addition to standard financial metrics.
Simply put, it costs too much. According to Cabinet Office reports, many social investment intermediaries cite transaction and due diligence costs averaging £5,000 per deal. Social investment funds are forced to make a simple decision – make ten deals averaging £100,000, resulting in £50,000 of sunk costs, or two deals at £500,000 with £10,000 of costs.
This scenario ignores further challenges to investing in early stage social ventures looking to scale – namely, increased risk, lack of transparency and uncertainty that these deals offer. The result is social ventures struggle to access investment of between £50,000 and £200,000 and are therefore unable to grow.
So who pays for the high transaction cost and the cost of the due diligence required to make deals of this size? Should we expect investors to exclusively pick up the bill? Can social ventures absorb these costs? It’s likely to be a no on both fronts.
As the market grows, we will see more specialised funds and more efficient due diligence processes, thus a reduction in transaction and due diligence costs, but for the time being this is rarely the case.
UnLtd’s Big Venture Challenge has played a valuable role in this space by getting social ventures investment ready, thus reducing the cost to the investor, but this is coming to an end later this year. Social enterprise businesses need access to larger funds enabling deals at the lower end of the market, effectively addressing the “missing middle”.
The objectives should be to better equip social ventures to take on social investment while ensuring that social investors are better able to carry out due diligence and reduce their high transaction cost.
It is unlikely that any intervention will work in isolation and practically achieving both requires changes in the market. Here are four ways to help the early stage social investment market:
Investing in social investment readiness and accelerator programmes
This will ensure social ventures are better prepared for investor conversations and negotiations. This will take away the pressure from social investors to undertake this capacity building work which is often required before they can start their due diligence process.
Supporting partnerships between investors and support providers
Greater collaboration between investors and support organisations will ensure there is a sharing of the cost of due diligence.
UnLtd’s Big Venture Challenge has been successful in doing this with many investors stressing that the most valuable risk mitigation came through the filtering and due diligence provided through the programme.
Creating sector specific social investment funds
If the market were to develop sector specific funds then then we would see a slicker and more cost effective due diligence process. Investment deals would be more consistent within funds, thus reducing lengthy due diligence and negotiations. Sector specific funds such as the Health & Wellbeing fund between Resonance and the South West Academic Health and Science Network should be seen as trailblazers for the sector.
Encouraging investors to share due diligence information from deal to deal
Investors should work more collaboratively to ensure there is a sharing of information. Greater transparency would not only reduce cost of multiple due diligence rounds between investors, but also ensure a more efficient investment process.
High transaction and due diligence costs is not the only barrier in the social investment market. However, it is a problem that can be solved and if done properly could attract other funds into the much needed “missing middle” of social investment. Investments which could help ambitious social entrepreneurs to grow their businesses and create impact.
Birmingham-based social enterprises have been boosted by a new fund-raising campaign from the city council
David Bartram is head of ventures at UnLtd
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