In July 2019, Siemens Stiftung, the foundation of the Siemens engineering firm, convened startup CEOs and experts in financing for the first of a series of talks attempting to surmount financial barriers that stymie social enterprises. The sessions extended from the foundation’s work to support early stage startups through its epowering people. Network. Cairo and a working session during the Sankalp Africa Summit 2020 in Nairobi in February 2020 bookended a series of virtual meetings.
The takeaway from the talks, broadly, is that better digital tools built to reflect different expectations could streamline the financing process and improve the likelihood that a startup succeeds. But the details amount to valuable insight into the problems that confront startups and financing agencies, as well as their potential solutions. Siemens Stiftung has now published a report on those sessions and research that followed. The report breaks down the concerns and ideas of the sessions’ participants, and it intersperses the bullet points with interviews of thought leaders in this sector, including startup CEOs and executives in financing agencies.
What follows is a condensation of bullet points from the talks. Please see the full report: How Digital Solutaions May Enhance Social Finance (pdf).
Limited provision of “patient” capital
- Limited “patient” capital: There are not enough investors in the market for impact-driven enterprises with rather linear (instead of exponential) growth journeys.
- Expectation asymmetries: Social entrepreneurs report a perceived mismatch between expectations of social investors (especially those who have a VC mindset) vs. reality of social entrepreneurship.
- Diverging timelines: Social business models are often complex and innovative and might only lead to financial returns.
- Risk aversion: Many social entrepreneurs perceive risk aversion among social investors to be too high, inhibiting them to create social impact.
Lack of common definitions
- Lack of impact definitions: There is little consensus in the impact space on what social impact is.
- Lack of transparency / blurred lines: For many existing investors, the risk-return profile of most investment opportunities is not suited, but many social enterprises still try to get their investment because they are not aware of the structural mismatch. Many investors are not able to clearly define what they are searching for and what matters to them.
Insufficiently cooperative mindset
- High costs of filling pipeline & due diligence: Investors tend to piggy-back on the due diligence of other intermediaries. Only few make the effort to go out and search for undiscovered investment opportunities. Hence, actors stay in a “bubble” with limited new influences, innovation and growth.
- Insufficient cost sharing: Little willingness of investors to share due-diligence data, thereby inhibiting cost sharing.
- Barriers to cross-sectoral funding mixes: Social enterprises that try to mix commercial and philanthropic capital have experienced an unwillingness of socially-oriented investors to collaborate with commercial investors.
- Little collaboration with local investors: Local investors and institutions are largely left out of the discussions around impact investment. But their knowledge about local markets, their networks to provide context-specific capacity building and their ability to fill pipelines is of high value.
- Power asymmetries: Social entrepreneurs often don’t dare question thepractices of social investors due to power asymmetries. Responsiveness of social investors is sometimes perceived as inappropriate, particularly if they don’t answer at all or communicate too late that they are not interested, which results in a waste of precious time that could be avoided.
- High costs of mapping available and appropriate opportunities: It lacks a place where social entrepreneurs can search for bundled information about different funding opportunities. It lacks robust data and information on the social enterprise market. This is a major obstacle to market attractiveness.
- Information asymmetries: There is a high level of information asymmetries in the market, leading to inefficiencies in matchmaking. Particularly in early stages, social entrepreneurs often require capacity building to understand the financing jargon and success factors for fundraising and they often don’t know what type of financing they actually need and what is out there. There is a high need for training social entrepreneurs on how to do accounting properly. Social investors often have a financing background with little knowledge about the complexities of creating different types of social impact.
- Lack of ability to translate / contextualize business models in larger context: For social enterprises, it is sometimes difficult to develop an impact thesis that makes sense in the larger context that matters to social investors.
- Insufficient collaboration with local capacity builders: There is a large capacity gap that needs to be filled by experts with specific local know-how. It is difficult to identify providers of capacity building services that are verified regarding their quality of services.
Fragmentation of the impact space
- Transaction costs: Preparing multiple funding applications for various funders takes an unproportionate amount of time for social enterprises. Due diligence costs are generally high, no matter the investment size, that’s why smaller ticket sizes and shorter investment periods are less attractive for many investors. Co-investments are interesting for many investors, but time-intensive, which is a challenge for enterprises that seek funding.
- Interoperability and data exchange: Social enterprises and investors are too heterogeneous to allow for significant level of standardization.
- Viability of digital solution for matchmaking: Many platforms are not generating enough traction. For platform hosts, it remains difficult to establish a viable business model.
- Relevance of personal interaction: Human interaction is a very important (if not the most important) factor in how social entrepreneurs successfully raise funds. Investors make their decisions based on both rational and irrational factors.
- Usefulness of existing platforms: Not all platforms are perceived to be user friendly and lack a level of information that would increase traction and usage. There are few solutions that try to pool investors systematically, e.g. around a certain topic.
- Used tools: For due diligence purposes, most actors rely on “mainstream” digital solutions. Many social enterprises use accounting software solutions which are easy to use, widespread, and free of charge.
Quality of data and trust
- Securing quality data: Digital data comes from many different sources, with a high variance of quality and lacks standardization. Social investors can only make use of data if they know it is accurate, updated and validated.
- Need for credibility and trust: Social entrepreneurs are hesitant in sharing their confidential data with investors if they don’t know anything about them.
- Securing of data security: Data privacy is seen as highly relevant for customer data, not so much for own financial data (such as size of funding requested). Data privacy is only an issue if social entrepreneurs don’t feel like there is sincere interest from funders. More traditional VCs tend to request a high amount of data, something that some social entrepreneurs might not feel comfortable with.
How to Develop a Digital Solution?
There is big potential for digital solutions that address specific aspects of the overall funding lifecycle such as improving the efficiency of the due diligence process. All digital solutions need to be integrated closely with the respective offline measures and require strong support from existing players in the field. More work needs to be done in order to implement digital solutions that are well integrated into the existing system and to build sound trust on the power of digital solutions.
In a statement, Siemens Stiftung writes, “Digitalization provides new opportunities for both social entrepreneurs and social investors. The positive experience on digital and virtual working tools during Covid-19 might have a lasting effect and could, in the end, change the financial world and development work as well. We will keep you posted.”
See the full report: How Digital Solutaions May Enhance Social Finance (pdf).